On Friday, the day after Christmas, in the dark hours of morning I appeared on an early broadcast — very early — of Fox Business News. The Fox reporters wanted to know my views on the price of oil, and where I think things are headed. If you missed my gig 5:50 AM (hey, it’s show biz), I just wanted to share and expand with you what I was telling all the other early risers.

The Dramatic Price Swings of Oil

Today oil is trading in the range of $37 per barrel, or about $110 less than its price back in July. That’s a dramatic, 75% change downwards. Back when oil was selling at $147, I said that the world does not run very well at such lofty energy prices. A lot of things just stop working at $147 for a barrel of oil, particularly things with a large energy component. The airlines come to mind. So something had to give. The world economy could crash (no jokes about airlines here…), or the price of oil could come down.

As it turned out, we had both events. The world economy hit the wall, and the price of oil came down in almost a straight line over five months. I believe that the high oil prices of late spring and early summer – with gasoline prices well over $4 per gallon (and over $5 in some parts of the country) – had a lot to do with triggering the financial crash that we saw in the fall.

For example, much of the extra money that people spent on pricey gasoline and heating oil was money that did not go to pay mortgages. A few months of missed mortgage payments in the spring led to foreclosures in the summer. The bad mortgages and foreclosures led to write-downs and “mark-to-market” readjustments. And the rest is recent history. Sure, nothing in this world is just as simple as A caused B, which led to C and then D. But if in 2006 and early 2007 oil had moved up to, say, $90 per barrel and then stayed there, would this be the same world? You probably see the point. Things might be a lot different.

The Sweet Life of Cheap Oil

Don’t get me wrong. It sure has been nice lately to pay just $1.65 per gallon of gasoline. The other day, for example, I filled the gas tank on my car. The pump shut off at $20 or so. My first thought was that there’s a problem. There’s no way I can fill my gas tank for under $20. In my mind, it still costs me $40 or $50 to fill ‘er up. But sure enough, the tank was full for a mere $20.

What about that “extra” $20 or $30 that I was ready to spend for gas? It now goes to savings, or the grocery store, or taking the kids to a movie, or whatever. Ah, the virtues of cheap gas. Sweet, right? Well, let’s enjoy it while it lasts. And it may last well into the winter.

Cheap Gas – Big Benefits

Let’s think through some of the macro-benefits of cheaper gasoline in the U.S. The U.S. Energy Department statistics state that the nation burns about 9.4 million barrels of gasoline per day. That’s about 395 million gallons (at 42 gallons in a barrel). Let’s say a gallon of gasoline is $2.75 cheaper than it was back in July, when I was paying $4.40 per gallon. Take 395 million gallons per day, times $2.75 savings per gallon. That’s almost $1.1 billion PER DAY that U.S. consumers are saving at the gasoline pumps. That’s over $32 billion per month of savings, or about $200 billion over six months.

$200 billion? As the saying goes, “Show me the money.” In a sense, the world oil industry has given the American people a huge tax cut. Or call it a “bailout bill” for consumers, except that Congress did not borrow the money to fund it. And that $200 billion is not just money coming out of the hides of Big Oil and those bêtes noirs like Exxon-Mobil or Chevron. No, this is a $200 billion cheap-oil tax cut paid for by the Sheiks of Araby, and Mr. Putin of Russia, and Generalissimo Chavez of Venezuela, and Mr. I’m-a-Dinner-Jacket of Iran. Could not happen to a nicer bunch, eh?

So American consumers are receiving a benefit that could be worth, say, $200 billion over six months. But there’s no addition to the national debt, and it’s being paid for by people we don’t like very much. Win-win, right? That’s the best kind of tax cut.

Expensive Oil is Bad – Cheap Oil is Not All Good

But no good deal is entirely a good deal. Just as the world does not work too well at $147 oil, the energy industry does not work well with oil at $37. If $147 oil was a problem, then $37 oil is actually NOT the solution. Cheap oil might even be worse for the world over the long term.

What do I mean? Well, at $37 per barrel of oil the incentive for energy efficiency and conservation is not high. Heck, people are back to buying SUVs, if they can get a car loan.

And low oil prices are a major stumbling block to building out the next generation of energy systems like advanced windmills, solar, geothermal, tidal power and advanced biofuels. Really, the world needs these items sooner or later. My view is to do it sooner and avoid the World War if we do it later.

Also, the traditional energy industries (the fossil fuel guys, not the environmental wacko, tree-hugging renewable-energy industries) need prices about $75 or so to keep up levels of investment in new projects that require several years to build out. That’s just to try and maintain current levels of fossil fuel output, which are declining in any event.

That is, world oil production has already peaked at about 86 million barrels per day. A growing volume of that is natural gas liquids (NGLs), which is strong evidence that we are blowing down a lot of gas caps. We were probably never going to change that overall fact of energy-life back with oil at $147. We sure aren’t going to change it now that oil is selling at $37. It’s the Peak Oil argument.

Depletion

Depletion, of course, is still with us all day and every day. Indeed, we could see swift declines in oil output from some major oil provinces of the world. Mexican oil output is already declining fast. Russia may shock us in 2009 with significant decreases from some older fields. Saudi Arabia is problematic, despite all the happy talk from Riyadh. The problem is that most of the world’s oil comes from giant fields that were discovered more than 25 years ago.

“Lots of Oil?”

When people say things like “There’s still a lot of oil out there,” they are not necessarily wrong. But they mean that there is a lot of oil out there that is NOT in giant oil fields. (Or if they’re so smart, how come they haven’t found any giant oil fields lately.) It’s oil that you will not drill up with just a relatively small number of high-output wells, like in the big oil fields of Saudi or Russia.

The “lots-of-oil” crowd is talking about hydrocarbon molecules (not necessarily light, sweet crude either) in deposits that are more dispersed, further out, in deep water, under more rock or salt layers, with higher temperatures and pressures. Or they are talking about heavy oil, or bitumen in tar sands, or kerogen in oil shales, or even some transformation of coal.

When people use the expression “lots of oil,” they mean the expensive stuff. It’s oil that requires many expensive wells or immense processing facilities, drilled or built with technology that we have just barely invented. And it’s the oil that you will never see if prices stay at $37 per barrel for long.

That’s all for now. I’ll check in with you later. Meanwhile, I hope that you are having a good Christmas and New Year’s holiday. Thanks for reading.

Until we meet again…

Byron W. King