Tuesday, May 22, 2012

America's Market-Driven Energy Revolution

While Washington squabbled over energy policy, the markets moved us toward cheap, plentiful energy.

Joel Kurtzman has an excellent editorial in today's WSJ about how market prices and technology, more than government policy, are driving the U.S. boom in oil and natural gas production.

"Those who doubt that market forces still have the power to transform the world aren't paying attention to America's revitalized energy sector. Four years ago, oil prices climbed to about $145 a barrel world-wide (see chart). The impact on the U.S. economy was devastating.

But eventually prices did what they're supposed to do in a market economy—they prompted the development of new sources of oil as well as oil substitutes. Some companies began drilling new oil wells using new technology including 3D seismic imaging and directional drilling. In 2002, when oil prices were in a trough, there were roughly 800 oil-drilling rigs operating in the U.S. Today, there are roughly 2,000. The last time we had that many rigs drilling for oil was 1985. In addition, energy companies went after and found more offshore oil, and far more "unconventional" oil from shale, tar sands and long-abandoned wells than most people thought possible.

Not surprisingly, companies also sought opportunities developing cheaper alternatives to oil. Chief among these fuels is natural gas, which is a cleaner fossil fuel than oil and coal. In 2008, estimates were that the U.S. had just 12 years of natural gas reserves left. Plans were being put in place to import liquefied natural gas from the Middle East, perhaps even Russia, to meet future demand.

But high energy prices prompted companies to develop new technologies. Hydraulic fracturing—drilling deep vertical wells then drilling horizontally to release natural gas from shale rock—was perfected. Because of that, natural gas reserves increased dramatically while prices fell. In 2008, natural gas sold for about $12-$14 per thousand cubic feet. Now it sells for about $2 per thousand cubic feet (see chart). Instead of supplies lasting only 12 years, there is now sufficient natural gas for at least 100 years.

Right now, natural gas is so abundant and cheap that some worry the U.S. and Canada, which has large reserves north of those in the U.S. Midwest, may soon run out of storage capacity. Some companies have even announced plans to curtail drilling due to falling prices and oversupply.

But here the price-mechanism is again at work. Trucking companies and fleet operators, wanting to take advantage of low natural-gas prices, are looking into converting trucks from diesel to natural gas, cutting their fuel bills by half. (See related Bloomberg article "Shale Glut Means $1-a-Gallon Savings at the Pump.")

High energy prices have transformed the American energy landscape. New oil and gas finds, combined with traditional sources of energy, including cheap-but-dirty coal, have transformed the U.S. from an energy has-been to a heavyweight.  Total U.S. energy reserves now exceed those of all other countries, including those in the Middle East. The U.S. is so energy rich there's little to prevent us from achieving energy independence."

Bottom Line: "Prices more than policy are driving these remarkable changes. While Washington squabbled over which energy direction to take, and which energy bill to kill, the markets moved us in exactly the direction the country should go—toward cheap, plentiful energy."

12 Comments:

At 5/22/2012 9:33 AM, Blogger Jon Murphy said...

Ah the power of prices!

 
At 5/22/2012 10:00 AM, Blogger Jet Beagle said...

I agree that fundamentals will primarily account for oil price changes, and that oil supply is extremely sensitive to prices.

I've heard another explanation for the massive oil price drop in mid-2008. I'd appreciate opinions about this explanation (which is not mine):

In early 2008, the mortgage crisis was first assumed to be a U.S. problem. The dollar weakened vs other currencies, and oil prices skyrocketed as a result.

By mid-2008, it became apparent the mortgage crisis was a global problem. Foreigners sought safety in the dollar, and it quickly appreciated (25% vs the euro after May-2008). The suddenly strong dollar led to a sharp reversal of oil prices.

Would the shifting relative strength of the dollar account for the unusual oil price bubble and subsequent plunge?

 
At 5/22/2012 10:07 AM, Blogger Jon Murphy said...

Would the shifting relative strength of the dollar account for the unusual oil price bubble and subsequent plunge?

Interesting thought, Jet. I bet that the dollar trading would account for some of the drop, but not all of it. I mean, oil fell by $100/bbl in a very short period of time. During the same time period, the dollar's value didn't change that significantly (according to the Trade-Weighted Exchange Rate Index).

 
At 5/22/2012 10:22 AM, Blogger Larry G said...

Why is this "market-driven energy revolution" seemingly largely as US-only phenomena?

It would seem to be the perfect antidote for debt-ridden Europe, eh?

do they not have similar resources to exploit?

Canada? Mexico? South America?

 
At 5/22/2012 10:37 AM, Blogger Jon Murphy said...

do they not have similar resources to exploit?

Oil-wise, Europe doesn't. Natural Gas, however...Several European countries are looking into tapping into their own shale: Ukraine, Great Britain, and Poland.

I mean, the US has enormous reserves of natural gas and oil we can tap into. Europe, not so much. That's why they need to buy so much from Russia.

 
At 5/22/2012 10:48 AM, Blogger Jet Beagle said...

Jon Murphy: "During the same time period, the dollar's value didn't change that significantly (according to the Trade-Weighted Exchange Rate Index)."

Not sure what that index is. Data from the European Central Bank shows these exchange rates for 2008:

22Jan2008 - 1.449
15Jul2008 - 1.599
28Oct2008 - 1.253

That's not as big a drop as the oil price drop from $145 to $30 (jul2008 to Dec2008). But an almost 25% drop in the dollar to euro exchange rate - in just 3 months - is still pretty large.

 
At 5/22/2012 11:00 AM, Blogger Jon Murphy said...

Not sure what that index is.

The Trade-Weighted Exchange Rate Index is an index that tracks the US Dollar against a number of different currencies, weighted by the amount of trade the US does with these countries.

But an almost 25% drop in the dollar to euro exchange rate - in just 3 months - is still pretty large.

No argument there.

 
At 5/22/2012 12:23 PM, Blogger juandos said...

"Foreigners sought safety in the dollar, and it quickly appreciated (25% vs the euro after May-2008). The suddenly strong dollar led to a sharp reversal of oil prices"...

Well jet b I heard Larry Kudlow make a very similer argument sometime after Labor Day of '08...

Interesting thought...

 
At 5/22/2012 12:37 PM, Blogger Its GSATT said...

There's a little peace of mind in respect to our government not being able to obscure a market as much as they would like.

What I would do if there were $30 barrels of oil again.... 6 hour drives around Michigan to see family and friends are well overdue. It hurts when I realize going to see family will cost me half my paycheck. And that's before I take a day or so off work. Ouch

 
At 5/22/2012 5:23 PM, Blogger bix1951 said...

this is cause for optimism.Modern markets move so rapidly that government can't keep up. Government may be the dinosaur that is made extinct by technology.

 
At 5/22/2012 7:58 PM, Blogger VangelV said...

Bottom Line: "Prices more than policy are driving these remarkable changes. While Washington squabbled over which energy direction to take, and which energy bill to kill, the markets moved us in exactly the direction the country should go—toward cheap, plentiful energy."

Prices went up. Companies jumped to take advantage by investing in a very low return technology that is not suitable for most shale formations. Once the leases were signed the companies had to keep going and lose money or risk becoming insolvent if they chose to write down the value of their 'assets'. This was great for local job markets and state revenues but horrible for investors and creditors.

What is more interesting are the SEC rules that allow companies to state reserves without really doing much to prove that they exist and for the BOE conversion to use the BTU rather than the price ratio. These rules make money losing shale operations attractive to large conventional producers with reserve depletion problems. In the end this means a bigger loss once the bubble pops.

 
At 5/26/2012 11:47 PM, Blogger My Life is My Art said...

how nuclear-based energy?

 

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