Supply
The supply of oil and natural gas embedded in the Earth is still very large, yet it is finite. Even more importantly, much, if not most, of the oil that is easily accessed has already been tapped, leaving a hungry infrastructure dependent on a resource that is steadily increasing in price. Worse, the price increase is not only due to increasing demand and global market factors, but because it’s increasingly costly to extract and refine.
Oil extracted using established, or “conventional” methods, remains the least expensive to produce and therefore generates the best profits to oil companies and, generally, the best prices to consumers. The problem is that, in North America, there are not many “conventional” deposits left. Even oil-rich nations like Saudi Arabia are turning to fracking to divert natural gas to domestic electricity production and free up additional oil for export.
The cost of extraction is directly related to the type of deposit in which the resource is found. Oil deposits beneath the ocean floor, for example, are obviously much more expensive (and risky) to access than a simple vertical well and pumpjack located on a flat plain in central Texas. In other cases, cost is dependent upon the physical characteristics of the deposit itself. Shale, or tight oil has only recently begun to be accessible with advances in technology not only in hydraulic fracturing but in horizontal drilling as well. These advances have played a major role in the global market for oil and gas in recent decades. In the US, for example, more and more shale formations are being tapped and fueling a resurgence of oil production in the US, where the industry was previously fairly close to being tapped out. This increased supply of oil has kept global market prices lower as it hits the market.
Production Costs
Disregarding market forces, it’s a simple fact that, currently, shale drilling and extraction require much more labor, equipment, and materials than conventional setups. This leads, inevitably, to higher production costs, and these production costs in turn, affect the viability of shale oil on the world market. In 2022, producers in Texas’ Eagle Ford Region needed minimum WTI benchmark prices of $23 per barrel to break even with established wells. To drill a new well, the WTI needed to reach $48 per barrel. Shale oil producers in newer plays, like the Bakken in North Dakota, have breakeven costs as high as $90 per barrel. Compare that to Saudi Arabia, who can still produce conventional oil at under $10 per barrel.
Conventional, vertical oil wells are fairly simple: the parts and equipment are standard, the technology and skill level of the crew are straightforward. In shale oil, however, you need to directly access much more of the underground deposit for the well to produce. To do that, the drill hole must travel down thousands of feet to reach a deposit, then take a 90 degree turn and extend through the formation horizontally, usually for thousands more feet. This type of well takes more time to drill, more materials, and is technically more complex than a simple vertical well, all of which costs more.
The physical challenges of shale and other types of tight oil always require some sort of well stimulation for them to produce at high enough volumes to be economically feasible. Fracking, or hydraulic fracturing, is the most common, used in conjunction with horizontal drilling. Expenses associated with any kind of well stimulation also increase the price threshold for new wells to break even, which can affect the industry’s ability to respond with agility to changing global market conditions.
Production Decisions
When oil prices on the world market slump and refiners can import crude oil at a lower price than what’s available domestically, shale oil producers may idle their rigs and simply wait for a more favorable market, although even when the rigs are idle, land expenses and some other contracted services continue. When oil prices shoot up, as during the current disruptions arising from the conflict between Russia and Ukraine, shale producers from the Permian, Marcellus, and Bakken plays, among others, ramp up production. However, as with almost any complex industry, it’s impossible to turn production on and off with the flick of a switch. Logistics from hiring labor to leasing equipment take time and generate their own costs. In the end, large, well-diversified companies are better suited to manage this kind of feast/famine cycle while smaller independent companies struggle.
Reliance on foreign oil
For over 50 years, presidents and leaders of the United States have sought to achieve “energy independence,” a state where the country could achieve self-sufficiency and declare itself immune from vagaries of the global energy market, distant crises, and foreign influence.
Since 2018 the U.S. has actually become the world’s largest producer of oil and natural gas, out producing even Saudi Arabia and Russia. The massive increase in US oil and gas production is primarily due to new technology that has permitted extraction from shale formations formerly considered too difficult to be worthwhile. U.S. consumers have certainly enjoyed the effect that this sudden abundance has had on domestic fuel prices in the US, a full decade earlier. In the span of one year, the Producer Price Index (PPI) for natural gas dropped by nearly 75% and even now, prices remain below projected levels. This is certainly a nice effect for U.S. consumers, but it’s important to recognize that natural gas is typically traded primarily on the domestic market, mostly because it is expensive to convert to a liquid state for shipping over long distances. Therefore, natural gas prices in the northeast, who benefitted from high local production levels in the Marcellus Shale, tended to be much lower than those in other parts of the country.
Now that the U.S. is established as a net exporter of fossil fuels, we’re officially energy independent…sort of. In real life, our ability to meet our own energy demands does not make us immune to fluctuations in the world market and pressures of geopolitics. In fact, following increasingly belligerent behavior on the part of Russia to the Ukraine, which eventually led to war, the average global price for crude oil nearly doubled from approximately $68 per barrel to over $112 per barrel in the 7 months from Aug 2021 to Mar 2022.
Currently, in mid 2022, record breaking consumer gasoline prices have followed along, with the national gas price average skimming just below $5 per gallon. Beyond that, though, the rapid inflation of oil and gas prices extends through the world’s economy. Transportation and shipping are only the most obvious sector affected by the high cost of petroleum products. Yet, both fertilizer and plastics are derived from petroleum, as well as a seemingly infinite list of consumer products, from denture adhesive to heart valves, refrigerators, and hand lotion. This year’s sudden rise in inflation across the globe has been attributed variously to rising shipping costs, an expanding energy crisis, and supply chain problems.
So why hasn’t all this new oil production resulted in more price stability for everyday consumers? Well, since the ban on oil exports in 2015 was lifted, oil produced in the U.S. has been priced based on the global marketplace, which means that crude oil extracted here will be sold to the highest bidder, whether that’s an American company or Chinese. It’s a simple business decision. Once those market forces come into play, our economy is subject to the same surges and drops as the rest of the world experiences, no matter how much we produce.
