In a normal market, you’d expect an oversupply of something and the resulting drop in prices would lead to a dramatic decrease in production and storage capacity. You’d also expect retail prices of that thing to also drop. That isn’t happening with oil right now.
Yes, gas prices are lower for most consumers across the United States and certain forms of oil production have slowed, but the predictable market inputs and outputs we all learn about in Economics classes aren’t really at play here.
Here are two fun facts: The price of light, sweet crude oil dropped to a recent low of $39 per barrel, compared to a high of $103 last August. Here’s another fun fact: The cost of a gallon of gas rose 32 cents last week in the Midwest, the biggest such rise since Hurricane Katrina in 2005.
There’s a lot going on here and it speaks to the state of the world economy, the rationality and irrationality of certain players, and the unpredictable cause-and-effect nature of our complex global system of inputs and outputs in the world of energy.
Here are the basic features, as I see them:
In the world of oil production there’s the cheap stuff and there’s the expensive stuff and if you’re a consumer way down at the consumer end of the market you don’t really care which kind is being put in your car, you just want the best price.
Historically, OPEC represents the producers of the easy-to-find-and-easy-to-pump cheap oil. Historically, when prices aren’t where they want them they can just slow production and cause the price to go up. It’s usually not a bad system, but the price of oil (for various reasons, many unrelated) went up to a price per barrel (PPB) that caused a lot of people to look for oil in a lot of places.
While it doesn’t make sense to spend $30 per barrel to make $30 per barrel, it makes a ton of sense to spend $30 per barrel to make $100 per barrel. OPEC smarty realized this and seems happy to let high production levels continue in an attempt to keep their market share and hurt frackers and other producers. This is murder if you’re Iran or Venezuela or Russia, but OPEC is basically Saudi Arabia and Saudi Arabia can weather the storm and expects demand will be strong for the foreseeable future.
Conclusion: There’s a lot of cheaply-produced oil out there.
Investment in fracking and oil exploration was spurred on by the realities of high prices, but some have argued it was also accelerated by the Quantitative Easing (or QE) policies from the Federal Reserve Bank that have kept interest rates low and sent investors (particularly older investors) in search for high yields.
A lot of this money ended up in the search for hydrocarbons and that investment is still paying for operations and expanded storage capacity (you can see the growth in storage capacity right here). While it may seem irrational, these investments continue to play out and the oil produced can be stored for long periods of time and sold when necessary and even at a profit.
From ornery-but-interesting economist Phillip K. Verleger, Jr:
The role of QE-induced investment in the oil sector in sustaining the crude price decline through the end of March 2015—and quite possibly into 2016 or 2017—has gone unnoticed. Yet this flow of money—probably more than $1 trillion—will likely lay the foundation for energy industry prospects over the next decade. If the lessons from other such cycles apply, the outlook for energy is not good. Prices will probably be low compared to recent years for a very long time. By 2016 or 2017, $50 per barrel may seem like a high price.
So, yeah, that’s not going away anytime soon.
Conclusion: There’s a lot of expensive-to-produce oil coming, too.
Demand in the United States has been up over 2014 through the first half of the year as cheap oil prices, new cars, and an expanding economy have driven people to drive more as vehicle miles traveled (VMT) is up for the first time in a decade. Even though VMT is down relative to population growth, and fuel economy is generally up fleet-wide, there are still more gallons of gasoline flowing into cars.
This, you think, would drive prices up, but there’s still a glut of supply at the production end and the amount of fuel being consumed relative to GDP growth should still be a cause of concern to producers.
Conclusion: There’s still a market for oil so people will keep producing it.
We’ve established that oil is cheap and that both producers on the low and high end of the market will keep producing oil. There’s also a demand so there’s no incentive for people to stop producing it.
Unfortunately, someone still has to transform those barrels of crude oil into something you can put in your Subaru BRZ. Those are refiners, and they’re having a bad time of it. Outages and fires in the Midwest, West Coast, and East Coast are driving supplies of refined motor vehicle gasoline down so unless you have a propane-powered car you can expect a big delay in those cheap crude prices reaching the pump.
While it may seem like some big conspiracy, it makes sense if you look at point #3 above. There’s more demand for gasoline, producers are trying to meet that demand and are producing at full-tilt, which leads to more problems. Anyone who plays Fallout Shelter knows how this works.
All we need is a hurricane in the Gulf of Mexico to mess with prices even more.
Conclusion: While your overall gas bill should be lower than it was in the past, you’re probably driving more and that’s helping to keep gas prices up.
There’s a lot more going on here and I’ve not even mentioned the collapse of the Chinese commodity market, demand in places like India, or recent stock market adjustments in the United States.
I’m not going to pretend like this analysis explains half of what’s going on or can be used to predict the future. My gut tells me crude oil prices will stay low and consumption in the United States will grow, but there are too many factors to definitively predict any outcome.
Conclusion: The future will be uncertain and we’ll probably be surprised by X or Y happening.
CORRECTION: An earlier version of this had “qualitative” easing instead of “quantitative” easing.
Business Time is Jalopnik head honcho Matt Hardigree’s regular column about the business of building and selling cars. He can be reached at at firstname.lastname@example.org.