Tag Archives: oil

Follow the Money

Since we covered the drop in crude a month ago, prices have continued to fall. An updated chart is below. A commodity crash looks like any other crash. If you are holding oil stocks or futures, you want to get out today because it may go lower tomorrow.

This is worse, actually, because everybody knows the other guy’s cost of production. Here in America, shale oil is comparatively expensive – and subsidized with cheap (relative to risk) financing. The producers best equipped to endure price pressure are the Saudis, and they know it.

Crude

Yesterday, we read that the oil crash is not a problem for Russia because the ruble is also crashing. Jeremiah enjoys the unique insights at Zero Hedge, but this is the dumbest idea ever. They printed a chart showing that the price of oil is stable – in rubles. All this proves is that Russia has two crises, and they’re related. So what if oil consumers in Russia have a stable cost? Their purchasing power is still getting crushed.

This is an example of “reasoning from your conclusions.” The author must have some thesis about the Russian economy, and he’s looking for a way to support it. Maybe he’s long Russian stocks. The key to understanding the world is always to have an unbiased model of reality. As Saint Francis said, “Seek first to understand.” Only then is it safe to make investments – or public policy. Jeremiah is not even interested in the stock market. We only follow it because of Mark Felt’s advice.

Some pundits say the Saudis have spiked the price of oil because America asked them to help crush the Russian economy. That’s a little conspiratorial, but it does explain the (one) cause and effect. Our original post was more market oriented, and held that the target is actually marginal American shale producers. Only the Saudis know what went into their analysis, but we’d like to believe it was based on maximizing their long term revenue.

The catalyst could have been any early warning of lower prices to come. Destroying Russia? How about a slowing global economy? One would certainly want to be proactive about that – or Venezuela. The wheels have been coming off the Bolivarian Revolution since Chavez died. It was only a matter of time before a glut of North and South American supply ran into waning global demand. The present crash was unpredictable only because a key participant chose to force the issue.

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Save Our Crude

Saudi Arabia has recently cut the price of crude oil exports to America, while holding the line in Asia. Oil experts are analyzing the latest price schedule relative to the price of domestic oil from fracking. Depending on your perspective, this is either simple capitalism, an attack on our oil industry, or proof that fracking is evil.

OilIt would make sense for the Saudis to undercut American producers, in a bid to put some of them out of business, while supporting their revenues with shipments elsewhere. Whether this is an “attack” or simply meeting the market price depends on the cost of production for each well. Below $85 a barrel, many producers will be shaken out.

Abdalla El-Badri, secretary-general of Opec, said he expected a reduction in higher cost oil production such as US shale if Brent remained around $85 a barrel.

Readers may be forgiven for assuming that there is a single, world price for oil. Opponents of fracking argue that American oil will flow to the world market, diluting the advantage of domestic production. In fact, American oil producers are not allowed to export. It’s a form of protectionism.

Jeremiah is generally against protectionism, but on a case-by-case basis (see On Protectionism). You have to look at who is being protected. In the case of prescription drugs, for example, trade restrictions benefit pharmaceutical companies at the expense of consumers and taxpayers.

In this case, American oil producers are harmed because they cannot sell in higher priced markets. The benefits accrue to American consumers, in the form of lower factor prices – and cheaper gas at the pump. That seems like a good deal, but it makes us vulnerable to dumping by the big, global producers.

Jeremiah would place this one in the “shortsighted” category and call for liberalization, except for one thing – the curse of oil. Ours is not meant to be an extractive economy.   Those countries have some nasty tendencies, which ours has lately come to emulate. The last thing America needs is an economy that resembles Venezuela.

See also: The Case for Allowing U.S. Crude Oil Exports

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The Curse of Oil

CNN reports that America will soon be a bigger oil producer than Saudi Arabia.  Jeremiah has mixed feelings about this.  We have been wanting energy independence for a while, but – do you want to live in Saudi Arabia?

Rulers have no incentive to develop non-oil sources of wealth, and the ruled (but untaxed) consequently have little incentive to hold their rulers accountable.

It’s one thing to have a dynamic economy in services and manufacturing, and then have to worry where your energy is coming from.  It’s quite another to have a moribund economy where extraction is the only bright spot.

There is a known correlation between dictatorships and extractive industries.  It’s oil, in the case of Russia, Venezuela, and the Middle East.  Along with oil, gold and diamonds prop up brutal dictatorships in Africa.  The Economist covered this correlation here, and Jeremiah included it in his Rules for Dictators.

It is much harder for a dictator to seize control of an advanced economy.  Communism infected Russia when its economy was just starting to industrialize.  Chavez controlled Venezuela because he controlled its oil wealth.  We hope for a boom in domestic energy, to fuel our own industries, but we hope not to become an exporter.

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Frack with Crude

WaterBarrelContinuing our series of “iconoclastic environmentalism,” we consider hydraulic fracturing.  Jeremiah is a huge fan of cheap natural gas.  This is a clean and abundant source of energy – especially for electrical generation, where it displaces coal.  He does not believe the hype about setting off earthquakes or contaminating groundwater.  Groundwater is miles above the typical gas deposit.

The environmental damage from fracking is in the huge quantities of fresh water consumed by the fracturing process.  If only there were an alternative.  It would have to be an incompressible liquid, like hydraulic fluid, and it would have to be readily available at the site.  Hmmm.  What liquid could that be?

Since oil and gas are often extracted together, by the same driller, it would seem natural to use oil as the fracturing fluid – unless you’re a petroleum engineer.  They are hardwired to pull oil out of the ground, not pump it back down.  Plus, oil is $100 a barrel and water is basically free.  This highlights a famous paradox of resource pricing – water must be cheap because life depends on it, but keeping water cheap opens it up to abuse.

Water must be cheap because life depends on it, but keeping water cheap opens it up to abuse.

You may think that oil is $100 a barrel and water is eight cents – but neither of these is the relevant price.  The relevant price for the oil is the cost to pump it down, install the proppant, and pump it back out.  It’s not going to escape.  Normally, you would pump out the contaminated water anyway, so the cost is invariant.

Obviously, this glosses over some engineering challenges, but it illustrates the key point.  Drillers use water as an industrial fluid costing eight cents a barrel.  They are making an arbitrage profit on the artificially low price of water.

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Five-Dollar Gas

Time’s cover story this week is a survey of the Gulf oil spill.  The article is strong on engineering and generally weak on economics.  Amid the misconceptions, however, are commendable candor – and one big idea.  Author Bryan Walsh dispenses with airy-fairy arguments for “renewable” energy and states frankly that America needs a lot of oil – about 20 million barrels per day, according to the DOE.

His big idea is to start taxing oil consumption.  The misconception is that this tax would fall “on the back of a wealthy industry.”  Americans burn an unbelievable 378 million gallons of gasoline per day.  An oil tax would mean higher prices at the pump, and no politician has the nerve to do that.  Better to blame the auto industry, tax carbon – whatever that means – and send our children to Arab wars.

We need to address the underlying issue, and that’s our dependence on oil.

Higher gasoline prices are exactly what America needs.  This is the only way we will begin the adjustment to smaller cars, public transit, and shorter commutes.  If we start now, there will be time to adjust.  Europe is already far better prepared than we are.  Perhaps President Obama, never one to waste a good crisis, will seize this opportunity.  He can use the tax money for his fusion program.

See also:  The Politics of Disaster

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