By now virtually everyone is aware that the price of gas is currently very low with respect to the recent past. As usual, an event like this often spurs on various conspiracy theories involving OPEC, the US, Russia and others that are deliberately deflating prices so as to hurt other countries and possibly destabilize their economies. Unfortunately for the Tom Clancy fans out there, there is no evidence that supports any of these conspiracy theories, while there is quite good evidence (detailed below) that these low prices are in fact due to the following factors.
First: A temporary imbalance of supply over demand at the level of 1 to 1.5 million barrels per day (MBD). Figure 1 shows the relation between supply (green) and demand (yellow) since Jan 2009. Thus the market is imbalanced by about 1.5% but this has been enough to almost halve the retail price of gasoline since its summer time peak.
Figure 1: Global crude oil demand and supply balance through 2015
Second: The lack of any rapid or easy way to strategically store this excess supply in real time. Instead, any extra crude must be liquated quickly and the best way to do that is to greatly lower the price of consumption.
Figure 2, originally from the New York Times, shows the rapidly falling price of Crude Oil over the last few months relative to the standard of $100 per barrel. This graph indicates that we are likely bottoming out at $50 per barrel.
Figure 2: Price of Crude Oil May 2014 to Feb 7 2015
The last time Crude Oil prices were this low was about Jan 2009, a response to the economic crash that begin in fall of 2008.
From gasbuddy.com we also see (Figure 3) the corresponding rapid decrease from end of July 2014 to the present time of the average national retail price of a gallon of gas with some indication that prices also have bottomed out.
Figure 3: The Average Retail Price of Gasoline
The Temporary Supply Increase:
Supply: In recent months, several unconventional crude oil extraction techniques and locations have recently been able to significantly increase production. These locations include the Canadian Tar Sands, and shale oil operations primarily in the Bakken formation in North Dakota as well as several new fields in South Texas in the Eagle Ford Shale region. At the moment, these three locations have increased the available world supply by about 0.6 MBD. Note that shale wells have relatively rapid rates of decline due to more rapid depressurization than standard crude oil vertical wells (legacy wells). Core Laboratories is the industry expert on oil reservoir physics and has recently shown that decline rates in the Eagle Ford Shale region for new wells is approximately 70% in the first year, and another 30% in year 2. This means that, after two years, production will be down to 21% of original peak production meaning that new wells have to be rapidly drilled in order to maintain production (this rapid well head decline also plagues the shale gas industry as well). This is one reason why this current “excess” in supply may be short lived.
Figure 4: Change in Oil Production for the Eagle Ford Shale Play
New Refining Capacity: By mid-2015, three new refineries will be fully on line in the Middle East (two are already mostly on line) and together are expected to increased global supply of refined products (gasoline, diesel, etc.) by an addition 1.2 MBD. Planning for these new facilities started about 10 years ago and they represent the largest new refinery operations that have come on line in more than a decade. The addition of these new facilities has potentially raised global production, under ideal conditions, to about 94 MBD, with some of this increase occurring in Iraq as that country rebuilds some of its war-damaged infrastructure.
Demand: According to the latest EIA Monthly oil market report (to be released 2/10/2015), demand was slightly down in a few world markets (refer to Figure 1 above). This demand reduction is dominated by the European Market which saw a 3Q14 record high demand of 14.6 (MBD) down to 13.6 in 1Q15. This decrease of 1 MD over this 6 month period coupled with the increase in supply of 0.6 MBD almost fully explains the oversupply of crude oil during this time.
Storage: Last September a Chinese firm known as Unipec commissioned the world’s largest super-tanker to simply act as a crude oil storage container at sea. Its capacity is 3.2 MB. Further analysis suggested that about 50 MB of oil may be in some form of storage on a worldwide basis. However, 50 MB of storage is only equal to about half the daily production capacity of the word. This means that a current daily oversupply of 1.5 MBD cannot be easily stored rapidly (this daily excess along would already equal half the Unipec super tanker’s volume). Hence, literally and figuratively this oversupply is quite liquid, thus putting pressure on lowered prices to encourage consumption over the logistical difficult of storage.
The current imbalance of supply and demand in the world oil market is primarily a consequence of new sources of unconventional oil coming to market as well as increased world refining capacity. Although the imbalance is quite small, this nonetheless drastically affects global crude oil and retail gasoline prices due to the lack of worldwide storage infrastructures to smooth over this imbalance. As low prices will inevitably produce a demand response, it’s then quite likely that current prices will rebound back to recent, historic levels by mid-summer (if not earlier). Indeed, spurred by low retail gasoline prices, consumption of gasoline in January 2015 averaged 1.27 MBD compared to 1.18 MBD in January 2014, an increase of 7.5%. If sustained at this rate, summer time US consumption will be about 1 MBD above winter time consumption, which, couple with expected increase in European demand, will completely make up the current oversupply and very likely lead us to the more common imbalance, namely that global demand exceeds the world wide physical capacity of distributing oil on a daily basis.