The oil industry is undergoing a major structural change.

Lifted from comments from this post US to be leading producer of oil is Spencer England’s comment about structural change in the oil markets. Obvious to some but bears repeating for a lot of us, as we discuss environmental issues or gasoline prices in the media more than structural economic impacts:

Spencer says:

The development of fracking and the tar sands means that the oil industry is undergoing a major structural change.

Use to be that one of the thing that made the oil industry very unique was that virtually all their costs were sunk or fixed costs and variable costs were relatively insignificant. Under this cost structure if prices fall it still pays to produce oil when prices fell as long as revenues covered the variable costs. So falling prices did not lead to falling output.

But now the marginal supply of oil is from tar sands or fracking where variable costs are very high. Moreover, the marginal costs of bringing in new oil from these sources is now in the $80 to $100 range.

So now, when prices fall, at the margin some producers will withdraw from the market and output will fall.

This is creating a fairly solid floor, the price for oil at about $80 — where oil bottomed last year and again this year.

Very few people are incorporating this structural change in the oil market into their analysis.

Spencer

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