A new international war has started in the Middle East as Syria continues to burn. Russia is slowly being strangled by international sanctions that are now cutting off their ability to produce and sell oil. With all of this happening in the world, something remarkable is happening to the price of oil – it’s dropping.
How could this happen? The short answer is that the US continues to move towards energy independence, producing its own oil while consumption is stagnant. It’s a good thing, all in all, but it means that the environmental degradation that was once found only in distant lands, and conveniently ignored by nearly everyone in the US, is now upon us. What can we do?
There’s a decent chance that the free market will actually sort it all out – once it’s been properly regulated to account for the environmental damage, that is.
We have to start with the price of oil, usually expressed as West Texas Intermediate (WTI). This is a description of a grade of oil well explained by its name – intermediate in viscosity and sulfur content, about the middle of the road. It comes out of the ground in the middle of the US and a few other places ready for fairly easy refining.
It bounced around for a while after the downturn in 2008 as US wells came online, now settling down in a healthy range of $90-110 per barrel (42 gallons). At $93 per barrel now it’s at the low end of a range and will likely bounce back up into the range we expect, blissfully independent of world events.
If an Iraqi or Ukrainian war doesn’t drive the price, what does?
A lot has been said about the Bakken reserve in North Dakota, but that only accounts for around 10% of the oil produced in the US. A lot more is being found in old wells dotting Oklahoma and Texas, but the cost of pulling this out of the ground is prohibitive. It takes something like 1,000 barrels of water for every barrel of oil produced, and that water is pumped back into the ground as a toxic sludge of petroleum waste.
This process can’t be cheap, and somewhere around $90 per barrel they’ll stop doing this. The price of oil will go back up when the supply goes down, and some of those wells will come back online. That’s part of the cycle of oil prices.
Meanwhile, all that water being forced deep underground is causing earthquakes, previously unknown in Oklahoma. This must be regulated at some point because the destruction being caused is extremely nasty. When this whole process becomes more expensive because the wastewater can’t just be pumped back underground, expect the price of oil to go up.
Not a lot, that is, but back around $100 per barrel. That seems to equate to about $3.40 a gallon here in Minnesota.
Meanwhile, consumption of gasoline is utterly flat – and a solid 15% below the peak that was set in 2006. Average fuel economy of new cars is up to 32 miles per gallon – from 25 back in 2007. That means that new cars are consuming 30% less fuel than they did just seven years ago. It’s the main reason that consumption is flat in a growing and expanding economy. Demand for oil is not constantly rising, putting the first downward pressure on oil prices for decades.
If you’re thinking to yourself, “We could have $2 per gallon gasoline if we just drilled more oil wells!” the short answer is “No.” The long answer is that this is all about the market for oil, all around the world, and when it makes sense to extract oil from places like nearly dry wells in Oklahoma or on a deep sea bed.
The costs of refining, delivering, and of course paying for roads with taxes add about $1 per gallon onto the cost of crude oil when it reaches the pump. $2 per gallon gasoline means a WTI price of about $42 per barrel, which isn’t happening. At that price, the US production would pretty much shut down – and world events would have us gasping for oil again.
Instead, US production is up, consumption is stable, economy is up, and aside from an inability to price the environmental damage into the cost of our production the price is stable in a fairly narrow window. The market is working.
And the US can analyze the wars that are being fought around the world without being driven into craziness by an economic mandate for cheap oil. It’s a good thing.