Oil Prices Again: A Brief Commentary...On March 4 I wrote an essay A Primer on Global Oil Production and on March 8 I wrote an essay A Follow Up to A Primer on Global Oil Production. Both of these are on my blog. This is a follow up to those essays.
The Dallas Federal Reserve Bank just surveyed (March 25) the publicly traded oil companies. It asked why they were restraining oil production despite high oil prices. The answers were as follows: investor pressure to maintain capital discipline (59%), environmental reasons (11%), the lack of finance (8%), government regulations (6%), and various other reasons (15%). Investor pressure to maintain capital discipline means that the industry is trying to avoid the boom bust cycles that have historically characterized the oil market and subsequently characterized the returns to its investors. In the post-pandemic world, oil companies now want to pay down debt, return cash to their shareholders, and to limit spending. Just as I pointed out in my earlier essays, this is further evidence that higher prices may be with us longer than expected largely due to the decisions of oil companies to not increase investment into the expansion of oil production despite the high prices.
Experts believe that the oil rich Permian Basin (shale oil basin) in West Texas and part of New Mexico is the best place to see an increase in production in the US despite the fact that it is currently producing at its pre-pandemic levels. Yet, Pioneer Natural Resources’ CEO Scott Sheffield said last month that US shale companies are not going to change their growth plans to switch to an aggressive drilling program despite the higher prices. According to Vicki Hollub, President and CEO of Occidental Petroleum, those that are beginning to increase shale oil production face 3 problems: the age of the wells, labor shortages, and the problem of securing raw materials (supply chain issues). Companies will face difficulty in making up for the declining production in the older wells, hiring new employees because shale oil production in more labor intensive than traditional crude production, and they are still dealing with supply chain issues such as the need for frac sand and equipment and shipping issues. This will make it almost impossible to “quickly” ramp up shale oil production.
Another possible source of global oil production is OPEC +. OPEC + (OPEC plus Russia) in a recent meeting declined to dramatically increase its production goals despite the price of oil. It set a modest goal of an increase of 432k barrels per day. It was noted that in March OPEC + set a goal of an increase of 253k barrels per day, but only increased it by 90k barrels per day. Many analysts are not putting much faith in OPEC + production goals.
On Thursday President Biden announced the decision to release 1 million barrels of oil a day for the next 6 months from the US strategic reserve. It is the largest release of oil from the strategic reserve in its history. The US consumes about 20 million barrels per day. The impact of the release remains to be seen. The amount released will essentially make up for the Russian oil that is imported by the US but falls short of the loss of the 3 million barrels per day of Russian oil in the global market. The loss of Russian oil in the global market due to sanctions continues to be the primary cause of the recent sharp increase in oil prices.
To put it another way, the short term inelastic supply and demand curves of the global oil market coupled with oil company strategic decisions to avoid the traditional boom bust cycle will leave us with high oil prices longer than expected. Overtime or in the long run consumers will respond by traveling less, carpooling, buying cars that use less gasoline, using public transportation, and turning to the growing market for electric vehicles. As I noted in my previous comments, the decision by the major auto makers to move to all electric vehicles by 2035-40 is also affecting the current strategic decision making by oil companies.
Just as an fyi. The top 5 largest oil producing countries are the US, Saudi Arabia, Russia, Canada, and China.
Sources: Dallas Federal Reserve Bank, US Energy Information Administration, Wall Street Journal, oilprice.com, and CNBC.
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