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Oil and gasoline prices: many still missing the big picture

Gasoline prices in the United States have risen sharply recently, leading some newspapers to round up the usual suspects.

(Ed. note: further interactive charts relating to this point appear in the original article here.) Data Source: GasBuddy.com

But the reality is the price of crude oil has been remarkably stable over the last three years.

Price of Brent crude oil, in dollars per barrel, weekly Jan 7, 2000 to April 18, 2014.  Data source: EIA.

Price of Brent crude oil, in dollars per barrel, weekly Jan 7, 2000 to April 18, 2014. Data source: EIA.

The international price of crude oil ultimately determines the price Americans pay for gasoline at the pump. Seasonal factors can bring the price temporarily below the long-run relation, and this accounted for the temporarily low gasoline prices that we saw last fall and winter. Movements in gasoline prices back up this spring are basically a return to normal.

Average retail price of U.S. gasoline (black) and price predicted on the basis of price of Brent crude oil (blue).  Black: average U.S. price of retail gasoline, all formulations, in dollars per gallon, weekly Jan 10, 2000 to April 21, 2014 (data source: EIA).Blue: 0.84 plus 0.025 times price of Brent, in dollars per barrel, weekly Jan 7, 2000 to April 18, 2014 (data source: EIA).

Average retail price of U.S. gasoline (black) and price predicted on the basis of price of Brent crude oil (blue). Black: average U.S. price of retail gasoline, all formulations, in dollars per gallon, weekly Jan 10, 2000 to April 21, 2014 (data source: EIA).Blue: 0.84 plus 0.025 times price of Brent, in dollars per barrel, weekly Jan 7, 2000 to April 18, 2014 (data source: EIA).

And crude oil prices have remained stable despite impressive gains in U.S. production of shale oil, referring to oil produced from tight geological formations using horizontal fracturing methods. These new drilling techniques have added 2.5 million barrels of daily U.S. oil production since 2010. Why hasn’t that new oil brought lower prices?

Here are some updated data on the answer I gave to that question last September. What the EIA reports as total oil supply grew by 5.7 mb/d between 2005 and 2013.

Annual world production of liquid fuels (in millions of barrels per day), 2000-2013.  Blue: production of crude oil including lease condensate; brick: natural gas plant liquids; green: refinery processing gain; orange: other liquids (chiefly biofuels).  Data source: EIA.

Annual world production of liquid fuels (in millions of barrels per day), 2000-2013. Blue: production of crude oil including lease condensate; brick: natural gas plant liquids; green: refinery processing gain; orange: other liquids (chiefly biofuels). Data source: EIA.

But about half of this increase came in the form of natural gas liquids like ethane and propane, whose uses don’t include making gasoline, along with biofuels, at best a marginal addition to net energy supply. The total increase in actual field production of crude oil globally since 2005 has only been 2.3 mb/d.

Change in annual world production of liquid fuels (in millions of barrels per day) between 2005 and 2013.  Blue: production of crude oil including lease condensate; brick: natural gas plant liquids; green: refinery processing gain; orange: other liquids (chiefly biofuels).  Data source: EIA.

Change in annual world production of liquid fuels (in millions of barrels per day) between 2005 and 2013. Blue: production of crude oil including lease condensate; brick: natural gas plant liquids; green: refinery processing gain; orange: other liquids (chiefly biofuels). Data source: EIA.

U.S. production of oil from tight formations is up 3.5 mb/d since 2005, and yet total global field production of crude from all sources is only up 2.3 mb/d. In other words, more than all of the increase worldwide over the last 8 years is attributable to U.S. tight oil production. Without U.S. tight oil, world oil production would be lower today than it was 8 years ago.

2.3 mb/d represents 3% of 2005 world field production. For comparison, world GDP grew by 28% since 2005. If oil prices had remained stable, with that much more income we would have expected much more than a 3% increase in quantity of oil demanded globally. The price of oil had to rise sufficiently– namely, to above $100/barrel– to restrain global oil demand to grow at a very slow rate over the last 8 years.

The EIA has recently updated its assessment of how much more U.S. tight oil production might increase. They acknowledge considerable uncertainty about factors such as how much ultimately can be recovered from each well and whether productivity will be maintained as drillers move to new areas or place wells closer together. Their reference scenario anticipates the U.S. will add another 2 mb/d over the next 3 years after which production will plateau and then gradually decline, though the EIA also sees possibilities of paths significantly more optimistic and pessimistic than this.

Source: EIA.

Source: EIA.

If the U.S. continues to be the only source of global growth in oil production, and if the world economy continues to expand at the pace it has over the last decade, oil prices are headed further higher. But how much promise does fracking hold outside the U.S.? The EIA believes Russia may have even more potential than the U.S., and Russia produced 120,000 b/d using horizontal fracturing methods in 2013. China may have about half the potential as the U.S. in shale oil and even more with shale gas, and is working hard to make that promise a reality. Argentina also has potential, but good luck with any capital you invest in that country. And turmoil in Libya is preventing shipment of even the easy-to-obtain conventional crude, let alone trying to go after the potential shale deposits.

Source: EIA.

Source: EIA.

Quantities aside, producing oil from tight formations remains an expensive proposition. Most of the companies in this business have negative cash flows, sinking more money into the operations than they are getting out. And it’s not the case that the companies are acquiring an asset that will continue to pay off for years to come– decline rates from individual wells remain quite impressive.

Production flows from typical North Dakota well.  Horizontal axis: years after production peak. Source: North Dakota Department of Mineral Resources.

Production flows from typical North Dakota well. Horizontal axis: years after production peak. Source: North Dakota Department of Mineral Resources

Peak Oil Barrel had an interesting graphic illustrating what those decline rates would mean for the path of North Dakota production if new wells stop being drilled.

Source: Peak Oil Barrel.

Source: Peak Oil Barrel.

For the next several years, the world should be able to continue to increase field production of crude oil, as long as the price stays at current levels. The real message from the new technology is this: oil prices have been remarkably steady over the last several years because of– not in spite of– the important added contribution of tight oil

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