As you may have noticed at the pump recently, gasoline prices have fallen by 35% over the last few months, from just below $4.00 per gallon down to around $2.60, a five-year low. During this same time period, the price of petroleum, the raw material from which gasoline is made, has dropped from $110 to $70 per barrel. A quick calculation shows, unsurprisingly, that the percent reduction in the price of gasoline is nearly identical to the percentage drop in the price of petroleum. In order to understand why gasoline prices have dropped, we need to examine why petroleum prices have dropped.
Petroleum (or oil) is a global commodity, and its price is extremely sensitive to the balance of supply and demand. Back in 2011, global supply and demand for petroleum were roughly in balance, at approximately 91 million barrels a day (MMbbl/d) each. While these conditions existed, the price for a barrel of oil hovered in a narrow range near to $110 per barrel.
The breakdown of the approximate world oil supply from 2011 is shown below:
|Rest of OPEC||20||22%|
The United States uses about 19 MMbbl/d of petroleum, so back in 2011 we were producing 8 MMbbl/d (42%) of this demand and importing the other 11 (58%).
Since 2011, petroleum production in the U.S. has increased from 8 to 11 MMbbl/d, an increase of more than 30%. Since our use remains at about 19 MMbbl/d of oil, our import and export percentages have flip-flopped, with domestic supply at 58% and imports at 42%.
The increased petroleum production in the U.S. has allowed us to supplant Saudi Arabia as the world’s largest supplier of oil, and our operations have increased the global petroleum supply by about 3%, from 91 to 94 MMbbl/d. A three percent increase may not sound like much, but as I mentioned above, commodity prices are strongly influenced by the supply and demand balance. Therefore, even this seemingly small increase in supply has driven the price of a barrel of oil down from $110 to $70 per barrel.
The reason that the U.S. has been able to dramatically increase its oil production can be summarized in one word: fracking. In case you have been living in a hole (pun intended) for the past few years, fracking is the process of shattering underground rock with a high-pressure mix of water, sand, and toxic chemicals to liberate oil and gas trapped within. Since these rock formations are usually made of shale, the resulting oil is often called “shale oil.” For the past several years, thousands and thousands of fracking wells have been drilled all over the country, particularly in North Dakota, Pennsylvania, Oklahoma, and Texas. Here in North Carolina, the General Assembly is rapidly pushing through legislation to allow fracking to begin here as well.
Financially speaking, an increase of 3 million barrels a day of oil production is a really, really big deal, in that it results in an increase in revenue to the U.S. oil industry of 100 trillion dollars a year! However, to really understand the economic and political implications of the increase in U.S. petroleum production, we need to discuss why I underlined the word revenue above.
While revenue is nice, what companies really need is profit, which is revenue minus expenses. Unfortunately for U.S. oil companies, fracking for shale oil is a very expensive enterprise. It costs about $70-75 to produce a barrel of oil from a fracking operation, compared to less than $40 for a traditional oil well. As you can imagine, when the price of oil was $110 per barrel, U.S. frackers were quite pleased to be making a profit of $40 per barrel. So pleased, it turns out, that they got overzealous, drilled too many wells, and the resulting over-supply drove the price way down.
Now that the price of oil has dropped to $70 per barrel, profits from fracking operations have dropped to zero. Given that drilling companies borrow huge sums of money to drill these wells, and that the banks who loaned the money want to be paid back, this situation is rather problematic to say the least.
To alleviate their difficulties, U.S. oil companies want Saudi Arabia and the rest of OPEC to cut back their own production to reduce supply and drive the price of oil back up. Since the Saudis have traditional rather than fracking wells, they still make a healthy profit at $70 per barrel. For the moment, they have rebuffed requests from the U.S., as have all of the world’s other noteworthy oil producing nations. I suspect that they are extracting a bit of revenge on U.S. companies as payback for their role in creating the oversupply situation in the first place.
It is unclear how long the Saudis, the big dog at OPEC, will maintain their current stance. If I were a betting man (and I most certainly am), I would bet that somewhere in a smoky room in Riyadh, negotiations are ongoing to determine what concessions the Saudis require before agreeing to cut back their production.
If you live in North Carolina and are hopeful that fracking will not commence there, I’d suggest that you root for the Saudis to remain obstinate. At $70 a barrel for oil, no one will start a new fracking operation, particularly in a zone with modest production potential like the Tar Heel State. So the next time you fill up your tank at $2.60 per gallon, consider pausing for a moment to think about what that really means.
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AAA Carolinas reports that the gas prices in North Carolina are the lowest they have been in more than a month and drivers are paying less this July than the July of last year; this trend is predicted to continue as the summer progresses.
Public Relations Manager at AAA Carolinas, Tiffany Wright, says that the drop in gas prices this past month is certainly impressive, and that this current trend in prices is not going to stop yet.
“Gas prices are trending downward, and that’s something I think is going to continue,” says Wright. “When you look at the fact we’ve seen North Carolina’s average gas price drop 12 cents in a month, I think that’s saying a lot.”
She attributes to the recent decline in prices to a greater reliance on gathering oil within the U.S.
“They’re trending down right now because right now we are producing a ton of oil domestically,” she says. “So, as we rely less on overseas oil and, at the same time on our end, consume less, that results in declining prices at the pump.”
Because of this dependency on oil we have accessed on our own soil, Wright says that gas prices are not being heavily affected by the conflicts going on in the Middle East.
“It’s a little opposite of what you think would be happening right now, everything that’s going on overseas,” says Wright. “Despite that, oil prices are expensive, and they remain expensive, but they’re relatively stable right now because oil production and export levels, they haven’t really noticeably changed that much. So, we really aren’t having to rely that much overseas.”
While the unrest in Russia progresses as well, Wright says she believes that as long as we stick to our oil supply, we will not encounter much difficulty.
“It’s hard to tell,” she says. “As long as we keep producing as much as we’re producing domestically, I don’t think that will be a problem.”
Wright says she expects travel to continue to as usual, and gas prices will continue to fall below less than what they were around this time last year.
“July and August typically are the busiest driving months of the year, but right now gas prices, they’re really in a good position,” says Wright. “For the remainder of what we call the ‘summer driving season,’ gas prices might actually cost less than in recent years this August, just as long as the refinery production continues and remains strong.”
To see the AAA Carolinas gas price chart that compares prices from this year to last year, click here.http://chapelboro.com/news/state-news/nc-gas-prices-continues-trend-downwards
While gas prices have remained steady for the past month, the recent militant assault on the largest oil refinery in Iraq will most likely spell greater increases in American gas prices.
Spokesperson for AAA Carolinas, Tom Crosby, says that this conflict in the Middle East will take its economic toll on how much we are paying for gas, just not immediately.
“There is no doubt that the problems in Iraq are going to affect gas prices domestically eventually,” says Crosby. “It probably won’t go up overnight, but that pipeline will suddenly start drying up if they cut off the oil supplies, and as a result all oil prices will rise because of the decreased supply.”
When compared to gas prices at this time last year, Crosby says prices will go up, but we cannot know for certain exactly how much just yet.
“Right now, we’re paying a higher price than we did last summer by about 10 to 12 cents a gallon,” says Crosby, “so we can be looking at paying 15 to 20 cents a gallon more than we did last year, but we have to wait and see just how those actions affect the supply of oil.”
Crosby also says that, despite the greater likelihood of rising gas prices, it is not going to stop Americans from travelling this summer.
“We’re having an economic boom. I think people are still going to drive and travel. I don’t think 10 to 20 cents a gallon more is going to cause people to cancel their trip,” says Crosby. “It may curtail some of their discretionary driving, or maybe the distance their going to travel, but I don’t think it is going to have a major impact, unless the prices were to approach somewhere in the $4 a gallon range, and that is not on the horizon at this time.”http://chapelboro.com/news/state-news/gas-prices-spike
RALEIGH – North Carolina lawmakers are honing rules that would govern underground natural gas drilling and encourage offshore oil drilling.
The Senate gave final approval Tuesday to legislation intended to spur the state’s energy. It now goes to Gov. Pat McCrory.
The measure removes an earlier idea to begin issuing permits in March 2015 for underground gas drilling using a method called hydraulic fracturing, or fracking. The existing law directs state agencies to craft rules for oil and gas exploration by October 2014 and requires the legislature to act before issuing any permits.
The legislation also directs McCrory to negotiate an offshore energy alliance with the governors of South Carolina and Virginia.
Republican Rep. Mike Stone of Sanford says lawmakers want to tell the energy industry that North Carolina welcomes drilling.http://chapelboro.com/news/state-government/nc-lawmakers-hone-rules-for-gas-oil-drilling
Image courtesy of Clotee Pridgen Allochuku
CHARLOTTE – You may never see gas prices go below $3, according to a new report by the American Automobile Association.
Director of communications for AAA Carolinas, Angela Daley, says that, with a few exceptions like South Carolina, this looks like the future of gas prices in America.
“I think it’s reasonable for some parts of the country to drop below $3 a gallon, but for the most part, what we’re seeing is that range between $3 and $4 a gallon, with $3.50 being about normal,” Daley says.
Oil prices are only expected to go up, as Daley says prices typically rise in the second half of the summer.
“It’s due to demand, but it’s also due to the fact that unrest in Egypt is causing concerns over the distribution of oil through the Suez Canal,” Daley says.
Daley says that conflict in other countries affects our oil prices because the oil market is global and interconnected.
“I think the more that we can produce domestically, we’ll be able to keep the volatility from being as dramatic as we have seen over the past few years,” Daley says. “But it’s really all about supply and demand and remembering that we’re working in a global market, so as much as we’re producing here, much of that oil is still being exported elsewhere.”
Daley says rising gas prices are also a result of both oil production and oil demand from growing economies.
“For the most part, we’re seeing that countries, like China, India, Brazil, are all increasing their demand,” Daley says. “So as we increase our supply here and globally, the demand is also going up.”
Daley says oil prices in North Carolina especially are expected to rise throughout the summer, as the Carolinas get 90 percent of their oil from the Gulf and hurricane season is just getting started.http://chapelboro.com/news/business/aaa-report-no-more-gas-below-3