Fine: Oil prices and the presidential election

Farmington Daily Times
Daniel Fine

Large oil operators in New Mexico are reluctant to hedge  oil (selling output forward at higher than current prices)  because it is expensive  and carries a potential risk that if the price rises above the hedge the investment loses money.   Is the industry hedged in 2017?   Surprisingly. the answer is only partially or not at all.

This reflects industry perceptions regarding the price of oil, which was at a low of less than $30 per barrel earlier this year. Saudi Arabia is prepared to cap the world price of oil in a traditional way — production volume intervention. If the price of oil and the count of drilling rigs go up, more Saudi and OPEC oil will be produced to prevent higher price recovery.

What accounts for the West Texas Intermediate price of a barrel of oil?   Since the 1970s it is traders with the ability buy 1,000 barrels of oil at cost of 5 to 10 percent of the total value of the oil.  Moreover,  at near negative interest rates speculators or hedge funds can borrow with almost no cost to buy oil contracts. Small and intermediate oil companies are restricted by banks because of negative cash flows which reflect the current prices and margins.

This is a situation that blocks a higher price recovery which would put the San Juan Basin back to work and the Four Corners regional economy in recovery. This will not happen on a stable midterm basis with Saudi Arabia and OPEC unwilling to allow higher prices which would jump-start Southwest production and conversely threaten their world oil market share.

I am not encouraged, as are some in trade associations, about oil in the current $40 per barrel range.  Saudi Arabia sets the price range  as a consequence of its forecast of world oil demand.   This is the key to the next OPEC meeting in November.  Is the world demand growth enough to sustain $50 per barrel oil?   Has the inventory of oil in storage been reduced or sold off?   Most important,  what will be the Southwest oil shale or unconventional supply?

We are on course for a reduction of 800,000 to one million barrels per day by January 2017,  mainly from shale oil production. The loss in oil field jobs including services to date is between 35,000 and 99,000 in Texas and 14,000 to 15,000 in New Mexico.  The workforce and its educational training center at San Juan College have been cut back to levels of subsistence.

In last month's issue of Energy Magazine,  I  presented an analysis that any fall in American domestic oil production will be made up by imports of foreign oil.   I was joined in this outlook in mid-July by the International Energy Agency.  Saudi Arabia  has offered competitive  discounts on its oil to American Oil refineries on the East Coast . This discounting is competitive against American crude oil producers in New Mexico and the Southwest.

This downturn has an uneven impact on oil producers. As some have said, in the Permian Basin – Delaware Basin for the “big guys” — it is business as usual.These are the major integrated (owning refineries) companies with cash reserves and manageable debt.  How different from the family-owned , small producers in Farmington!

We are approaching the end of the last term of President Obama with limited or no further anti-fossil fuel rule-making possible.  A federal court has ruled against administration
efforts to over-regulate hydraulic fracturing (stimulation) and further subvert state regulation.  In this "bust," there is no relief forthcoming from Washington, D.C., in contrast to historic help that has been provided to the petroleum industry since early in the 20th  century.

Will voters in the oil producing states mark ballots according to the conditions of their lives in communities affected by the bust?   Although climate change issues have dominated the Democratic Party in the primary period now past,  the general election will no doubt offer a choice between the parties that will impact the future of oil prices, supply and demand,  and the confrontation with Saudi Arabia and OPEC.

So far,  there has been no Republican energy policy counter to the anti-fossil fuel policies of Clinton-Sanders on climate change. No doubt it will emerge,  but how much will it depart from traditional energy policy-compromise?

This is the subject of the next public forum in San Juan County in which I will participate as well as write about on these pages.

Daniel Fine is the associate director of the New Mexico Center for Energy Policy at New Mexico Tech, and energy policy analyst for the state of New Mexico. The views and conclusions are his own and not expressive of institutional positions.