Observations About the Price of Oil

I graduated from college in 1981 with a BA in geological sciences. The economy was about as bad as it was at the height of the “Great Recession” we are slowly climbing out of (anyone remember 20% interest rates in 1981?) – but unlike other graduates that year, I had no trouble getting a job – because the oil companies were lined up at the door to the geology department looking for bright young graduates. Price of oil: $96/barrel in 2010 dollars. Reminded me of the song from 1986: “The future’s so bright, I gotta wear shades.”

Ironically, just about when that song came out in 1986 – I was laid off from Shell Oil - along with about 30% of the oil industry employees in Houston when the price of oil precipitously dropped to about $21/barrel in 2010 dollars ($10/barrel in 1986 dollars). 

Ah, the good old days. The gallows humor around Houston, Texas among us suddenly unemployed petroleum geologists and engineers went like this:

Q - What’s the difference between a pigeon and a petroleum engineer?

A – A pigeon can still put a deposit on a BMW.

Or:

Geologist walks into McDonalds looking for a job flipping burgers.  Manager tells him “Sorry, all our geologists have Master’s Degrees.”

So what happened? Well, worldwide demand for oil was dropping because economies were starting to use it more efficiently, in response to high prices. OPEC was seeing its income go down, so OPEC opened up the spigots (and remember that it was OPEC closing the spigots that lead to the oil price shocks of 1973 and 1979). No better way to get people to not think about energy efficiency than to make energy cheap. So long fuel efficiency – hello SUVs. 

So, Shell Oil decided it was cheaper to buy oil reserves than look for them and I had to find another career. Nothing like going from valued human resource asset to excess overhead in 8 months flat.

In 2008, the price of oil spiked to $145/barrel in July and was down to $68/barrel by the end of the year. What happened? Well, it was speculation. Commodities traders looked at the world, saw increasing demand from emerging economies like India and China and bid up the price. Then the finance bubble burst, and the price of oil responded likewise. Was the price spike President Bush’s fault? No.

As of today, the price of oil has gone up to about $125, despite the fact that the US is importing less oil, using less oil and producing more oil than we have in a couple of decades.

So what's going on now? A few things – the world economy is recovering from the “Great Recession,” demand from emerging economies is going up again. Uncertainty about Iran is adding a premium to the price – so there is market speculation. Is this President Obama’s fault? No.

The President is also leading the charge to put sanctions on Iran to get them to stop trying to build an A-bomb. Iran is now having trouble selling their oil, which lessens the day-to-day worldwide supply.

Personally, I think this is a good approach – given the alternative – going to war with Iran or as John McCain liked to say, “Bomb, bomb, bomb, bomb, bomb Iran!” (or letting Israel do it). If you liked our invasion of Iraq – you’d love an invasion of Iran. What do you think would happen to the price at the pump if bombs and missiles were flying around the Middle East and the Persian Gulf was closed to shipping?

Another difference between 1986 and now is that the OPEC spigots are already wide open - there is not a lot of excess capacity in the world's daily production of oil right now.

Is the Obama administration preventing oil companies from drilling? Obviously not as we have more rigs drilling in the continental US than the rest of the world combined. Oil companies have thousands of leases onshore and offshore that they could exploit any time they wanted to – but have not. The Keystone Pipeline that the administration postponed would do nothing to the price of gasoline. Most of the refined products made from that oil would probably be exported and it would be years before that pipeline would be built anyway, even if it was approved tomorrow.

Yes, oil companies are making a killing right now. Their cost of getting oil out of existing onshore wells is less than $5/barrel and less than $40 for offshore wells. The rest is pure gravy.

Keep in mind that the cost per barrel of producing new reserves from new exploration areas is a lot higher: tight oil shale in South Dakota ($50), the Arctic ($100), deep offshore (over $50) and Canadian tar sands (up to $75). Oil companies can still make a lot of money – but the capital investment to extract that oil is a lot higher and given the erratic nature of the commodities market (see above) – they could just as easily get shafted by a price drop.

Granted, no one would shed a tear for Exxon Mobil or Shell if that happened, but I have to tell you – no one shed a tear for us laid off oil patch folks in the mid-80s either. Business is business.

As far as the price of gasoline goes – we are at the mercy of forces way beyond our control – worldwide demand, expense of exploiting new sources and geopolitical uncertainties among them. Any politician who tells you that they can do anything about the price of gasoline at the pump is blowing smoke up the lower opening of your digestive tract.