Are you ready for some $1.50-per-gallon gasoline? Sounds pretty good, huh? It's likely heading our way.
Yep, filling up a 20-gallon tank is going to cost you around $30. But there's a hook: $5-per-gallon gasoline is also a virtual certainty. That would move your SUV to $100 for a fill-up.
Here's why: Earlier this month the Saudis and Russians announced they were splitting up their little honeymoon where they cooperated to cut oil production in order to prop up prices at around $50 to $60 a barrel. That sent shock waves through the already depressed-by-coronavirus oil market, and the price of a barrel dropped from nearly $50 down to $30 (it's in the $20s as I write this.)
The president has announced the feds will start buying oil to put in the Strategic Oil Reserve, but that's like putting the Smackover Fire Department in charge of putting out the California wildfires. The outlook is beyond grim.
According to a press release by the Saudis, as of April 1, they are going to ramp up their 9 million barrels of oil a day to somewhere around 13 million during the year. The Russians, not to be outdone, announced they were also opening the taps for an unannounced major hike in oil production. And the Persian Gulf states, allies of the Saudis, said they are aligned with the Saudis to boost production.
As part of the same announcement the Saudis said they were cutting the price of current deliveries $4 to $6 per barrel. If you do the math, that puts somewhere around 8 million barrels a day of new oil on an already depressed global market during 2020. That's why oil dropped nearly $20 per barrel, and that's not even close to the bottom of the price slide.
Why are the Saudis and Russians trying to drive the price down? If you read their comments, it's because they want to kill the high-cost producers who are taking advantage of their price stabilization.
The target is American shale oil drillers, who have put several million barrels of new oil on the market, making the United States the leading oil producer in the world. However, that oil comes with a high price tag, and I won't go into why, but believe me, the drilling of a 10,000-foot well-- half of which is horizontal--shooting holes in 30 to 50 places in the pipe, then blasting these holes with a water mixture that forces a couple of million pounds of sand into the ground--is expensive. To justify spending $10 million-$15 million per well, the price of oil must be $40 to $50 at a minimum.
The American oil industry has developed a brilliant method of getting oil out of rocks that before were considered non-productive. The Saudis and Russians feel like they have been propping up the price of oil while the United States increases production and takes up more of its share of the world market. They are committed to put a stop to that.
If just the threat of increasing production dropped the price of oil by $20 per barrel, what will happen if the Saudis and Russian actually put an extra 8 million barrels of oil on the world market? Both countries have shown they are willing to reduce their prices in order to keep their market share, so the price of oil will tumble.
When you drop below $30 per barrel, that makes most of the shale wells uneconomical. A further drop to $15 per barrel, which is possible, essentially makes all high-cost wells uneconomical. That is the goal of the Saudis and Russia: to keep prices low until the American oil industry is in shambles.
In the crossfire are small oil and gas operators who don't produce one drop of shale oil; they are operating what are known as stripper wells, which produce sometimes as low as three to five barrels a day. Because of high labor costs and the need to dispose of sometimes several hundred barrels of saltwater, these wells are only economical if the price of oil is high. These producers are in every state in the country that produces oil. Thousands of small operators will go out of business, and some of them will be in Arkansas.
This is the outlook, assuming the Saudis and Russians don't kiss and make up. The small to medium sized oil companies that are heavily invested in drilling for shale oil and are dependent upon extensive bank financing will go bankrupt. The banks that are heavy into financing these companies will take huge losses. The companies with strong balance sheets will pull back from drilling, and several thousand drilling rigs will be stacked. Several hundred thousand oil workers will lose their jobs.
United States oil production will begin a decline this year that will ultimately be as much as three to five million barrels a day. However, the real question is how long will the Saudis and Russia hold down the prices by over-producing? Since they tried this once back in the 1980s-- they cut production but it went back up quickly--that this time they will try to finish the job, and the oil industry in the United States will suffer not just a few months, but maybe as long as two years.
If we look to the future, we know exactly what will happen, but not the timing. When the Saudis and Russians see the drop in oil production from the United States is sufficient to resume their proration, and our infrastructure is sufficiently damaged, they will agree to curb production and the price of oil will steadily climb.
How much? The Russians need $40 to $50 per barrel for their country's budget, and the Saudis need at least $80 per barrel, so prices will climb back to above that level. However, in the past, a Saudi oil minister stated he thought $100 per barrel was a fair price. Will the Russians and Saudis stop at $100 per barrel? What do you think?
The bottom line is simple: Cheap gasoline seems like a good deal, but the long-term costs to get that $1.50 gasoline will greatly overshadow the short-term benefits.
I'm sitting here with coronavirus sweeping the country, oil prices whistling down, and the stock market dropping like a rock, wondering: Where am I going, and why am I in this handbasket?"
Email Richard Mason at richard@gibraltarenergy.com.
Editorial on 03/22/2020