Everyone loves low priced gas. With the amount we drive
today, the cost of gas can add up very quickly. This is why when gas prices
started plummeting the past few months, many celebrated. Even though, in the
short run, this is a nice break from the prices we are used to; these low
prices is not something to be excited about.
Before talking about why such low gas prices are not
favorable in the long run, we must first understand how this happened. Put
simply, the supply of oil in the global market right now is extremely high,
thus causing the price per barrel of oil to plummet. Since Jan 2014, the price
per barrel has fallen to about $50 a barrel, or 48.45%.[1]
How did this happen? There are a few reasons behind this. OPEC, or Organization
of Petroleum Exporting Countries, controls a good amount of the world’s oil
production. OPEC is a cartel of oil producing countries, mostly based in the
Middle East and Africa. When OPEC meets, the member countries decide how much
oil they will produce for that year. This essentially helps them control
prices, since they are controlling the supply. Things are different this year,
however.
OPEC recently failed to agree on how much oil each country
should produce. Whether this is intentional or not is unclear, but what has
happened is that the global market is getting flooded with barrels of oil,
causing the price to plummet. Also, another action taken by President Obama has
caused even more supply in the oil market. The President essentially lifted
restrictions on fracking, which is “…the
procedure of creating fractures in rocks and rock formations by injecting fluid
into cracks to force them further open. The larger fissures allow more oil and
gas to flow out of the formation and into the wellbore, from where it can be
extracted.”[2]
With these restrictions lifted, oil production in the United States
skyrocketed. One would assume that with traditional market forces, supply should
naturally slow down, and prices would eventually return to normal. CME Group,
however, stated in a report about Energy Prices that this view has a few risks.
- “First, when powerful
asset allocation shifts are involved, there is always a strong likelihood
that markets can overshoot some hypothetical supply-demand valuation that
fails to take into account the behavior of investors.
- Second, oil production tends not to respond to short-term price
movements. A considerable proportion of oil production costs are in the
capital investment phase, and these costs are often incorrectly (from an
economics perspective) partly included in the perceived marginal cost of
producing the next barrel of oil. In fact, production dynamics are much
more complex, actual marginal costs are much lower than they might appear,
and short-term production cuts are very unlikely.
- Third, and in the other direction, while the current situation
in the Middle East (and Russia) has produced a relatively benign or
grudging consensus that Middle East oil production will stay high despite
the tensions in the region, one should not ignore the low probability, but
high impact potential, of surprise oil supply shocks.”[3]
With these three views in mind, it is unlikely that the
oil supply is going to just suddenly slow down. It is still in companies’ best
interest to continue drilling, rather than stop drilling. The consumption of
oil is also important to note. In the following graphs from the same report
from CME, we see that oil consumption is going down, and oil production is
rising. These all make for a large decrease in the price of oil.
Former Wells Fargo Chairman and CEO Richard Kovacevich
claims that “The refusal by OPEC to cut production in the face of prices
plunging to 5½-year lows shows the cartel is looking to put a lid on the U.S.
fracking boom.”[5]
The true intentions behind every party’s actions are unclear. The fact of the
matter is most people seem to be enjoying low oil prices. However, in the long
run, this low of oil prices is unsustainable.
With oil falling so fast, many oil producing companies, and
even countries, are in the red. Russia, for example, is in the midst of an
extremely dangerous economic crisis. Since oil is such a large export for
Russia, the low prices have drastically reduced its income. This, along with US
sanctions, has caused a disaster in Russia. The Russian economic crisis,
however, is deeper than just oil prices, so I will touch more on that next
week.
In the United States, low oil prices have caused a variety
of actions to be set into motion. Even though lifting the regulations on
fracking has caused a surge in oil production, many US oil companies are losing
great amounts of money. “The meltdown in
oil prices has wiped out more than $200 billion in market valuation among the
10 largest oil and natural gas companies in the S&P 500.”[6]
Now I understand that many will disregard this, as large oil corporations
losing money isn’t exactly sad news to them. However, this affects the workers
on the drills and the wells. These companies have already started “…hitting the brakes on spending and laying
off workers.”[7]
To put exact numbers on this trend, “More
than 1,000 employees at Civeo (CVEO), a provider of housing for oil workers,
have lost their jobs in recent months.”[8]
This is just one company, others are quickly following suit and laying off
workers to cut costs.
The oil companies aren’t the only ones getting hurt by these
prices, however. Consider car companies, and their initiatives to make more
fuel efficient cars. While gas prices were high, hybrids and other fuel efficient
cars were in high demand. Every year we saw cars getting more miles per gallon
than the year before. However, with low gas prices, the demand for these cars
has fallen. It has fallen so much, that some car factories that produce such
vehicles are temporarily closed. In Detroit, the President was scheduled to
visit an auto plant in Detroit to celebrate the resurgence of the auto sector,
however “The White House confirmed Monday
that President Barack Obama will visit Ford Motor Co.’s Michigan Assembly plant
on Wednesday — a factory that is closed this week because of lagging demand for
its small gasoline-powered and hybrid cars” [9]
On the other side of the spectrum, however, SUVs and fuel- inefficient cars are
in high demand. “Cheap gas prices
helped make that happen, as sales of trucks, SUVs and luxury vehicles rose
rapidly. Jeep's sales, for instance, were up 40 percent on increased consumer
demand for crossover SUVs.”[10]
This reversal in automobile demand is backward progress for automobile
efficiency. Even though oil is needed, it is in our best interest to continue
to innovate and continue advancing in new types of energy.
As seen from the evidence provided, Obama’s move to open up fracking was not the only thing that drove gas prices down. The enormous amount of supply coming from all over the world and the dropping level of demand have caused this oil price drop. As you can see, there is more than meets the eye when it comes to low gas prices.
Check out some of the sources I used for more information
on this topic. All contain even more information on the topic that, for the
sake of length, I couldn’t include in this post. Feel free to leave a comment
if you agree or disagree with what I said, I will be sure to read and reply to
all of them.
[1] http://money.cnn.com/data/commodities/?iid=EL
[2] www.investopedia.com/terms/f/fracking.asp
[3] http://www.cmegroup.com/education/featured-reports/a-look-at-what-is-happening-below-the-surface-in-energy.html
[4] http://www.cmegroup.com/education/featured-reports/a-look-at-what-is-happening-below-the-surface-in-energy.html
[5] http://www.cnbc.com/id/102313386#.
[6] http://money.cnn.com/2015/01/07/investing/big-oil-price-energy-stocks/index.html?iid=Lead
[7] http://money.cnn.com/2015/01/07/investing/big-oil-price-energy-stocks/index.html?iid=Lead
[8] http://money.cnn.com/2014/12/30/news/economy/oil-job-cuts-civeo-stock/index.html?iid=SF_INV_River
[9] http://www.detroitnews.com/story/business/autos/ford/2015/01/05/president-obama-ford/21292663/
[10] http://www.npr.org/2015/01/05/375201451/car-sales-surged-in-december-capping-a-good-year-for-the-industry
No comments:
Post a Comment