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Monday, February 29, 2016

National Energy Security Issue: Effects of Cheap Oil

Photo Liberated from Patterson UTI Drilling
Once again the oil and gas industry has done too good a job is finding and developing new sources - so much so that its success is eating the drilling industry - the Oil & Gas Journal reports US rig count nearing lowest level in generations:

The US rig count dropped 12 units to 502 during the week ended Feb. 26, according to Baker Hughes Inc. data. While the decline is the smallest thus far this year, it represents the eighth straight weekly double-digit drop to begin 2016.
The total is the lowest since Apr. 30, 1999, a week after the 1998-99 downturn hit its bottom of 488. With additional losses in the coming weeks, the current count could dive to a level not seen in generations.
The NYTimes has reported on the "simple economics" behind the drop in oil prices:
. . . [I]t boils down to the simple economics of supply and demand.
Well, yeah.

The NPR folks have noted that these low prices, coupled with a decline in exploration and drilling, might just have an impact on the overall U.S. economy as businesses associated with that part of the oil and gas industry find less demand in Why Cheap Gas Might Not Be Good For The U.S. Economy:
Arora analyzed government data, and found that what's changed is that the oil and gas industry as a share of GDP has about doubled in the past decade. Now it has grown so large that it's changed the basic equation of whether cheap gas is a good thing overall.

"The benefits to consumers could be around $140 billion from gasoline savings," Arora says. "But the losses on the other side due to lower production, less investment, less build-out of infrastructure could be around that amount. So we're kind of at a wash."

This might help to explain why the economy still isn't exactly charging forward even with the stimulus of cheap energy. But Arora himself notes that the question needs more study.

Meanwhile, analysis by the research firm Moody's Analytics finds that cheap oil and gas are still a net positive. And plenty of experts remain in that camp.
Last year the NYTimes offered up Lower Oil Prices Provide Benefits to U.S. Workers:
Wall Street may be growing anxious about the negative impact of falling oil prices on energy producers, but the steep declines of recent weeks are delivering substantial benefits to American working-class families and retirees who have largely missed out on the fruits of the five-and-a-half-year economic recovery.

Just last week, the federal Energy Information Administration estimated that the typical American household would save $750 because of lower gasoline prices this year, $200 more than government experts predicted a month ago. People who depend on home heating oil and propane to warm their homes, as millions do in the Northeast and Midwest, should enjoy an additional savings of about $750 this winter.

“It may not have a huge effect on the top 10 percent of households, but if you’re earning $30,000 or $40,000 a year and drive to work, this is a big deal,” said Guy Berger, United States economist at RBS. “Conceptually, this is the opposite of the stock market boom, which was concentrated at the top.”
Of course, more dollars in the pockets of the 90% of the households not in the top 10% really ought to mean much more money available in the economy because of the law of big numbers. More from the NYT:
But the latest drop in energy prices — regular gas in New England now averages $2.35 a gallon, compared with $2.94 in early December, and it is even cheaper in the Midwest at $1.95 — is disproportionately helping lower-income groups, since fuel costs eat up a larger share of their more limited earnings.
“Oil prices, gas prices, food prices — luckily it’s going down, which is great,” Ms. Smith said, explaining that when prices were higher she had to scale back on groceries to save money for heating oil. “I hope it keeps going.”
You might want to, at this point, recall President Obama's plan to increase taxes on oil as discussed in Oil Dumbness from President Obama an increase in taxes is paid for by customers of the oil companies just like Ms. Smith.

This ought to be self-evident, but here's another source talking about the effect of higher gas prices.

It's not just the U.S. that rides this roller coaster of oil prices. Oil exporting states like Saudi Arabia are also taking hits, as discussed in this Forbes article, 4 Reasons Saudi Arabia Can't Control Oil Supply:
In the past, OPEC—led by Saudi Arabia—would reduce production in order to maintain the oil price. Today, however, the process isn’t that easy, and there are four reasons for that…

Reason #1: The US
Oil above $60 or $70 would mean that US production would continue to increase, and the US is already the world’s #1 producer. OPEC would have no choice but to keep cutting further in order to maintain that price.

Reason #2: Cheating among OPEC Members
OPEC members (other than Saudi Arabia) almost always cheat on their production quotas when they can. Considering that other OPEC nations are desperate for income, the incentive to cheat is all powerful.

Reason #3 The US-Iran Nuclear Deal
The deal and subsequent lifting of sanctions means that an additional one million barrels per day will soon hit the market. As international oil companies vie for the privilege of drilling more oil in Iran, it will put further upward pressure on supply.

Reason #4: US Production in the Market
Although drilling rig usage in the US is down by nearly 75%, production has just now begun to fall off. It will take some time before enough US production comes off the market to put upward pressure on prices.
The U.S. Energy Information Adminsitration produces all sorts of reports on oil production like this one:

The "International Energy Agency" (which is actually a creature of its 29 member countries)has issued its 2016 Medium Term Market Report:
Global oil supply growth is plunging as an extended period of low prices takes its toll, the International Energy Agency (IEA) said in its annual Medium-Term Oil Market Report (MTOMR) released today. While U.S. light, tight oil (LTO) output is falling steeply for now, the market will begin rebalancing in 2017 – and by 2021 the United States and Iran are seen leading production gains among non-OPEC and OPEC countries, respectively.
There is this warning:
“It is easy for consumers to be lulled into complacency by ample stocks and low prices today, but they should heed the writing on the wall: the historic investment cuts we are seeing raise the odds of unpleasant oil-security surprises in the not-too-distant-future,” said IEA Executive Director Fatih Birol, launching the report at IHS CERAWeek.(emphasis added)
What "oil-security surprises?"

From the downloadable Overview of the IEA report:
Another downside to low oil prices is the impact on investment. The IEA has regularly warned of the potential consequences of the 24% fall in investment seen in 2015 and the expected 17% fall in 2016. In today’s oil market there is hardly any spare production capacity other than in Saudi Arabia and Iran and significant investment is required just to maintain existing production before we move on to provide the new capacity needed to meet rising oil demand. The risk of a sharp oil price rise towards the later part of our forecast arising from insufficient investment is as potentially de-stabilising as the sharp oil price fall has proved to be.
In addition to the effects of insufficient investment there are the lost "experience" costs that will result from personnel cutbacks in the oil and gas industry as rig counts and exploration budgets drop. Experienced oil field workers will, as they have in the past, move to other jobs (assuming they exist) that might pay less.

Ah, you might say, "So what?"

The "so what" is the lag time it would take to get those workers back into the fields should there be a national need for an increase in U.S. crude oil and natural gas production.

That lag time has national security issues.

Suppose, for example, Russia decides to cut off natural gas supplies to Europe beginning in late 2016 using that gas as an economic weapon to force the nations dependent on Russian gas to accept Russian claims in the Ukraine or the Baltic States. One way for the West to resist this pressure is to have some assurance that the U.S. and its allies will be able to set into motion a stream of LNG ships carrying gas to replace that of the Russians, ameliorating the gas situation for those affected states. In addition to LNG shipping, a force of air and naval escorts protecting that LNG stream at sea might be required to prevent interference with the flow of gas in competition with that of the Russians.

Or, suppose the Chinese interfere with the flow of gas and oil through the South China Sea sea lanes to Taiwan,South Korea and Japan. Can the U.S. and Canada help mitigate the harm while alternative sea lanes that avoid the South China Sea are developed? Who will protect those shipments and how?

Or, what if Iran or someone else takes the big step of managing to destroy the Saudi oil production - say through using nuclear weapons - can the U.S. and non-Middle East producers step up and provide  at least minimal supplies to the world now depending on Middle East oil?

Cheap oil is good, but not all good.

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