Monday, February 27, 2012

Responding to High Oil Prices and Low Gas Prices, U.S. Drilling Companies Switch from Gas to Oil

With crude oil prices above $100 and rising, and a glut of natural gas pushing prices down to record lows, U.S. oil and gas companies have been shifting from drilling for gas to drilling for oil, as the chart above illustrates.  According to weekly data from oilfield service company Baker Hughes, the percentage of rigs drilling for natural gas dropped below 36% in the last week, the lowest level since 1987, as the share of rigs drilling for oil increased to 64%.  As the chart shows, the trend started accelerating in about October of last year.

It's an example of how the "invisible hand," profit motive, market forces and market prices work their magic, and bring about natural and automatic self-correcting adjustments to demand and supply.  As the Law of Supply would predict, higher prices for crude oil increase incentives for producers to supply more (the "smell of profits"), and lower prices for natural gas reduce incentives for production, and producers supply less.  And the best part is that it all happens automatically through the miracle of the market, without any oversight or central planning, just by "spontaneous order" and "producer greed."       


At 2/27/2012 11:23 PM, Blogger Benjamin Cole said...

Actually, the even better news is that a lot of those gas wells deliver liquids too. Many gas companies are still drilling, but usually when they can get liquids too (oil and condensate).

The longer we see $100 oil, the better the chances of a glut, sometime in the next five years.

The oil-thug states (Venezuela, Nigeria, Mexico, Russia, Saudi Arabia, Iran, Iraq etc etc etc) keep most product off market through bobbers or collusion, but the price signal still works.

At 2/28/2012 5:16 AM, Blogger Larry G said...

$100 oil also changes driving and car buying behaviors.

as a result, gas tax revenues have flattened in recent years leaving less and less money for new construction and for many of the new roads being built - now funded from electronic tolling.

Since a car is a multi-year durable item - how "elastic" is the supply/demand dynamic with $100+ oil?

if someone trades in their gas guzzler for a more efficient car, how likely are they to dump it and go back to a guzzler if gas gets (even a lot) cheaper?

doesn't it really take months/years for the auto/vehicle fleet to "follow" oil "gluts"?

oil shortages and gluts also affect the value of vehicles.

after 3-5 years, a twice-as-expensive gas guzzler can be worth less than a 5 year old econo-box.

but who can answer this.

if natgas is in a "glut" - why are nat gas cars not at least in the new car offerings. Wouldn't they make more sense than Volt-type cars?

At 2/28/2012 8:05 AM, Blogger Methinks said...

Very different from the way the Soviets drilled for oil.

As motivation, the government paid per meter drilled. The deeper you drill, the slower the going. God forbid you should accidentally hit a gas cap or oil because then you'd have to stop drilling altogether in order to produce.

What we ended up with was a bunch of shallow holes poked in the ground, ruined formations (from which recovery was later impossible or very difficult) and not much production.

The invisible hand and private property vs. central planning and socialism.

At 2/28/2012 10:01 AM, Blogger morganovich said...

of course, buying new cars leaves less money for other things.

today's durables number was pretty ugly (other than autos).

some of this was likely pull into dec as that was the last time you could do full purchase depreciation, but down 4% is a big number, the biggest drop in 3 years and a bigger drop than the dec gain which had the depreciation tailwind.

"Analysts were concerned by the 3.2 per cent decline in orders excluding transportation and 4.5 per cent fall in orders, excluding defense."

it's a volatile dataset and it probably does not pay to read too much into one month, but that was not a good looking number and this will bear watching.

At 2/28/2012 10:34 AM, Blogger Jon Murphy said...

it's a volatile dataset and it probably does not pay to read too much into one month, but that was not a good looking number and this will bear watching.

I agree, Morganovich. One month does not a trend make, and the annual data trend is still growing. That being said, we should watch to see if any changes are coming.

At 2/28/2012 11:51 AM, Blogger Buddy R Pacifico said...

Oil, gas and liquids can come from the same well. How is it determined what to call the well?

Baker Hughes states:

"The determination is made by the operating company when the rig permit is issued by the state's permitting authority. The operating company will drill appraisal well(s) to determine the hydrocarbon target. Based on the results, the operator makes a judgment call on how to classify the well. For example, if a well is producing – on a Btu basis – 50% gas; 20% NGLs and 30% oil, it could either be listed as a gas well (gas is the largest component), or an oil well (which is driving the economics). This judgment is solely up to the operator."

It looks like more wells are being drilled for the oil component, thus the operator is naming it an oil well.

At 2/28/2012 1:19 PM, Blogger Ron H. said...

Methinks: "The invisible hand and private property vs. central planning and socialism."

Otherwise known as the invisible fist?

I have read that there were similar perverse incentives for window glass producers: If the incentive was to produce glass by weight, then a lot of thick glass was produced. If the incentive was for area of glass produced, then lots of thin glass was the result.

If these stories are even close to being true, it's a wonder the Soviet Union survived as long as it did.

At 2/28/2012 1:38 PM, Blogger Methinks said...

Ron H, watcha mean "invisible" fist?

Yes, for glass, for shoes, for clothing, for housing, you name it.

Early on, the Soviets figured out that incentives matter. To motivate production, they established bonuses for meeting quotas. The problem was measurement.

If the quota upon which the bonus was total weight of product produced, the factory produced few pairs, each weighing as much as a cement block. If the quota was based on number of shoes, the factory spat out huge numbers of super thin shoes that fell apart as you tried to lace them.

In the absence of natural feedback loops present in market systems, any incentive they tried resulted either in unusable product or, if they were really crafty with incentives, merely severely suboptimal product.

This stuff was pretty well documented in English after the whole thing crumbled and the West was finally able to have a good look.

I'm not surprised it lasted so long. There's virtually no level of poverty or decrepitude human beings can't survive in. And we did have a black market estimated by Western economists to be at least as big as the official economy. Pleasant? No. Survivable? Yes.

At 2/28/2012 1:49 PM, Blogger morganovich said...


i remember that black market.

my HS did a trip to the cccp every year and lots of wisdom on what to bring for trade evolved over time.

i traded a carton of malboros for a full length wool kgb coat covered in medals and a pair of levis for a sable hat that i still have.

it was wild what the effective exchange rates were. we were all warmed about getting into trouble over it, but the "blind eye" seemed pretty pervasive to me and the occasional shakedown could be handled with a pack of gum.

it amazes me how quickly many americans have forgotten just how bad it was over there and how little those too young to remember communism even know of it.

At 2/28/2012 2:28 PM, Blogger morganovich said...

"I'm not surprised it lasted so long. There's virtually no level of poverty or decrepitude human beings can't survive in."

look at north korea. a population that is half starved and needs to be utterly concerned with basic subsistence has not time nor energy for revolt.

that can go on for a long, long time.

look at how tibet ran under the lamas.

that was one of the most repressive regimes in history. life expectancy was 36 in the 1950's. that's practically paleolithic.

their brutal social control was so effective that hitler studied it (that's what that movie 7 years in tibet is really about, the guy hitler send to learn repression from the best)

At 2/28/2012 4:47 PM, Blogger Ron H. said...

Methinks: "m not surprised it lasted so long. There's virtually no level of poverty or decrepitude human beings can't survive in. And we did have a black market estimated by Western economists to be at least as big as the official economy. Pleasant? No. Survivable? Yes."

I get one feeling from hearing stories like this. Gratitude.

I'm grateful that I can hear of these things from people like you, who have experienced it, without having to experience such insanity firsthand.

Thanks, Methinks. Have you ever considered writing a book? I would love to read it. With your unique view as someone not born in the US, your humor, and economic savvy, I bet it would be a best seller.

At 2/28/2012 5:35 PM, Blogger Methinks said...

Thanks, Ron H.

I'm pretty sure nobody gives a rat's pattooty about my story. Stuff which is interesting and funny to people who at least sort of know you isn't all that interesting or funny to the wider public. The world is full of unique people. If I were Angelina Jolie....NOW we might be talking best seller.

Other than almost dying (for good) in the Soviet health care system, I did not perceive my life in the USSR as bad. But then, at the time, I had nothing to compare it to and I never lived there as an adult. I only did business there and that was bad enough.

At 2/28/2012 5:40 PM, Blogger Paul said...


I second Ron's sentiments.

At 2/28/2012 6:24 PM, Blogger Mike said...


"I'm pretty sure nobody gives a rat's pattooty about my story."

One of the only things I've read from you that I thought was wrong.

At 2/28/2012 9:44 PM, Blogger VangelV said...

Actually Mark, they are responding to the funding gaps and all the losses. Shale gas proved to be a bust, just as many of us predicted. Since the producers prefer not to go bankrupt just yet they are better able to borrow more money if they pretend that they can make money from shale liquids.

At 2/29/2012 2:21 AM, Blogger Ron H. said...


Oh sheesh! If you were Angelina Jolie, you wouldn't be a very interesting person.

Anyone who can write the pink flamingo saga as you did has a future as a writer.

That's it - no more arguments. My publicist is on their way to you as we speak. I just hung up the phone (well, not literally) and I'm sharpening a box of pencils to send you. :)

If the Stainer In Chief and this creep can write books, surely you can.

By the way, whenever the availability of consumer goods in stores based on market forces is contrasted with the availability supplied by central planning, I'm reminded of this great clip.

At 2/29/2012 11:18 AM, Blogger juandos said...

Well I do hope at some time in the near future more oil will mean lower gasoline prices (the problem with closing refineries taken into account also) because gasoline prices are killing us...

70% of the benefits of the payroll tax extension has already been removed thanks to 60-80c rise in gas prices nationwide...

At 2/29/2012 12:28 PM, Blogger Methinks said...

Thank you, Gentlemen, that's very sweet of you.

At 2/29/2012 9:08 PM, Blogger Hydra said...

Meanwhile Ryder is buying long haul trucks that run on natural gas, because it is $1.50 a gallon cheaper than diesel. (Huh? Howzat?) Anyway, that is what the story said.

Either the drilling companies are moving in the wrong direction, or Ryder is.

At 3/01/2012 7:36 AM, Blogger Methinks said...

Let's see....

Ryder demands hydrocarbon-based fuel and is responding to price signals by demanding more of the lower priced fuel.

Petroleum producers (not drilling companies, btw) are suppliers of hydrocarbon and are responding to market signals by increasing production of the hydrocarbon that's rising in price.

Demand curves slope down, supply curves slope up.

All seems to be quite predictably in line, Hydra.

At 3/01/2012 12:48 PM, Blogger Ron H. said...

Methinks: "Demand curves slope down, supply curves slope up.

All seems to be quite predictably in line, Hydra.

I retract my previous statement that supply and demand are well understood by almost everyone on the planet.


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