January 23, 2015

CHEAP GAS PROBABLY WON’T LAST:

No one knows exactly what factors are causing prices to fall so far, so fast, but there is a strong suspicion that Saudi Arabia, which you can think of as the central banker of OPEC, is letting prices fall in the hopes of killing off the competition from U.S. and Canadian shale oil. The question, then, is: Who will blink first?

At first blush, you might think that Middle Eastern oil producers have the upper hand. Their oil requires relatively little investment to get out of the ground; it’s not quite as simple as sticking a straw in the desert and sucking out the black stuff, but it sure looks like that compared to the complexity of a fracking operation. And fracking wells dry up fairly quickly, requiring even more investment just to stay in place.

But the shale oil producers also have some advantages. First of all, the Saudis need high prices to support their government spending — the IMF estimates that they require a price of about $90 a barrel just to pay the bills. That means they can’t keep up a price war forever. Second of all, upstart industries tend to improve pretty quickly in their first years or decades of operation, and fracking is no exception; my Bloomberg News colleagues report that the break-even point for many operations is $70 or less, which is lower than OPEC nations can sustain.

Even if they manage to push U.S. and Canadian fracking operations offline temporarily, the technology and expertise still exist. It took less than 10 years from the time when prices started soaring to the point where the U.S. was producing more oil than most OPEC members. If oil prices soared again, it would take even less time to get up and running again.

Stay tuned.

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