2014 -- 46 -- Gas Prices 01

I will never forget waiting in line as a college student to buy gasoline on my designated day. I had textbooks spread out on the passenger seat so I could study during the one- to two-hour wait to fill up my car. As disturbing as the process was of getting gas each week, it was just as unsettling to realize that a small group of Arab nations was able to disrupt the U.S. economy by implementing an oil embargo. So much for living in the greatest country in the world.

The Arab Oil crisis of 1974 marked the start of a small group of Mideastern nations exercising significant control over oil supplies and oil prices for forty years. However, due to increased U.S. and Canadian production in the last few years, the influence of the Arab producers has declined significantly. These events have culminated in the remarkable increase in oil supplies during 2014, and the resulting sharp decline in oil and gas prices.

What has caused the price decline? Is it the result of energy conservation? Will it continue? What does it mean for the future of oil prices and the U.S. and world economy?

Let’s take a quick look at these questions and what we can expect with regard to energy supplies and oil prices for the next several years.

The decline in oil prices is a result of basic economics. Increased oil production by the U.S. and Canada, as well as by Saudi Arabia, have significantly increased oil supplies. More oil supply, coupled with flat or declining demand, has caused oil prices to decline.

After years of declining oil production, U.S. production has increased sharply since 2008. The production increase is a result of two key factors:

  • New technologies and methods have allowed oil to be produced from shale fields in the northwestern U.S. and in Canada. These are oil deposits that were considered unrecoverable until recently.
  • In addition, other new technologies have allowed more oil to be pumped from wells that were considered dry. Fracturing, horizontal drilling, and other technologies are allowing oil to be recovered from old wells and from areas where it could not be recovered previously.

Essentially, these new technologies have greatly increased recoverable U.S. oil reserves. It should be noted that the increased U.S. production has occurred without help from the government. In fact, Congress and the President have failed to pass even the simplest legislation, such as the Keystone pipeline bill. Bottom line is that U.S. oil production is up 50% since 2008, as a result of the investment in technology by the innovative U.S. oil industry. U.S. production has grown despite having no help from the President or Congress, even though Obama was trying to take credit for lower oil prices in his comments last week.

It should be noted that conservation has played a role in reducing demand for oil and other energy products. The green movement has helped increase the use of alternative energy sources such as solar and wind. It has also caused reduced oil usage as a result of more efficient cars and other equipment. But conservation alone does not have a large enough impact to reduce oil demand and oil prices as significantly as what has occurred this year.

The largest factor in the decline in world demand for oil is lower European demand, due to the weak European economy. There is also a reduced demand from China and other manufacturing countries due to lower manufacturing production. These factors have caused lower oil demand overall. Flat or lower demand coupled with significantly higher supplies has caused the sharp drop in oil and gasoline prices.

This year the U.S. will be the largest oil producer in the world. Our oil reserves will increase sharply due to finding new oil in new areas and also being able to recover more oil from areas thought to be completely out of oil. The new role of the U.S. as the largest producer of oil has undercut the power of Saudi Arabia and other OPEC producers. It has caused these countries to panic as they have lost power and influence in the world. In addition, the OPEC nations, as well as Russia, depend on oil revenues to support their economies and service their debts. Lower oil prices means less revenue and weak economies for these countries.

The final factor in the decline of oil prices is that Saudi Arabia and other OPEC producers are over-producing oil with two goals in mind. First, they need money so more production allows them to get the same income at lower prices. Secondly, since they have the lowest production costs per barrel of oil, they hope to make the new production in the U.S. and Canada uneconomical if they can drive oil prices low enough.

The changing picture regarding U.S. oil reserves radically changes the world landscape. Experts now suggest that the U.S. has more oil than it will need for centuries. These experts believe that the U.S. will be the dominant oil producer for many years. As a result, the power of OPEC and the importance of the Mideast to the U.S., Europe, and China has changed significantly. This means that peace in the Mideast is less important since unrest in the Mideast is less of a threat to the U.S. and western economies.

The current decline in oil prices will not continue unabated. Oil prices will recover when the world economies are stronger and demand picks up. Periodic events will again cause oil prices to increase and spike occasionally. On the other hand, continued conservation will help keep a lid on oil prices. But the biggest factor, significantly higher U.S. oil production, is a trend that is just starting. And it is a trend that will positively influence energy prices and the U.S. economy for many years.