Oil Market Remarks by Spencer as Taken from Comments
Lifted from comments from this post, Angry Bear Spencer England further explains oil and markets:
Oil production is an unusual business in that virtually all of the cost of getting crude to the refiner is fixed costs while variable cost or current spending is insignificant.
Economic theory, at least what you will learn if you take some economics courses besides intro, shows that as long as a producers are covering their variable cost, even if they are losing money, it pays to continue production. Thus, what you hear from so many economists and analysts that lower prices will lead to lower output and so balance supply and demand is not quite true. Consequently, lower oil prices will only leads to oil firms not undertaking new drilling. So only with a long lag will lower prices lead to lower output.
Currently, the marginal supply of oil is oil from fracking. At $70 to $80 dollar oil about half of the current supply of fracked oil is unprofitable to bring to market. But oil from wells already drilled will continue to flow.
But next year oil drilling will collapse and with a short lag that will lead to a sharp drop in US oil production. Traditional oil, or non-fracked oil has been falling about 5% annually already. Moreover, fracked oil wells have a relatively short life span — on average maybe about three years. To offset these natural rates of decline in US oil output new fracking has to grow sufficiently to offset these two factors. So in 2015 when new drilling for fracked wells fall sharply most people will be surprised to finally see US oil output drop sharply.
Interestingly, the optimal pricing strategy for an oligopolist like Saudi Arabia is to set the price just below the price that will allow major new sources of oil come to market. Over the years Saudi has not done a very good job of following this strategy, but it sure looks like that is what they are trying to do now.
This argument seems to apply to labour, with bells on.
“… as long as a [workers] are covering their variable cost, even if they are losing money, it pays to [continue to work.] Thus, what you hear from so many economists and analysts that lower prices will lead to lower output and so balance supply and demand is not quite true…lower [labour] prices will only lead to [labour] not [raising and educating more children] …only with a long lag will lower prices lead to lower output…”
Controlling the the price is what monopolies do to keep out competition.
“This argument seems to apply to labour, with bells on.”
Yep, in spades: John Maurice Clark, Studies in the Economics of Overhead Costs.
Ya think? I always used fixed and variable costs unless you are going to take your wallet out. Is Clark implying Labour (Direct Labour) is Overhead? I probably should read it myself.
This sounds a lot like the way it played out last time. We fell for SUVs and 3500 square foot houses. Maybe this time the Chinese will punt on solar power and move away from mass transit.
You are right. Understanding economics requires understanding business. Most decisions are made on the margin, which is why strategic thinking is rare, but often lucrative.
Clark: “The overhead cost of labor is a collective burden upon industry in general, but the market does not allocate to each employer the share for which his own enterprise is responsible.”
“With labor, the locus of the problem is that to a private firm the cost of hiring labor is a per-unit accounting cost. Today’s economists, taking as they almost always do the perspective of the business firm, categorize labor as a “variable cost.” Yet from the perspective of society, labor
is an overhead cost. This divergence between the firm’s and society’s perspectives on the cost of labor was once widely understood and discussed in the economics literature. Institutionalists invoked this distinction when they referred to the “Social Cost” of Labor, or the “Social Overhead Cost” of Labor (Kapp 1971; Clark 1923).”
I hate calling Labor Overhead as one would place it is the same category as electricity, rent, vacation, etc. I do understand what Prasch means though. I would call it a fixed cost giving Labor an unavoidable cost designation. Just mine, Druckers and a former boss’s terminology. Usually, you burden Labor with Overhead.
I will go read Prasch here shortly.
I think Clark’s point (and Kapp’s and Prasch’s) is that different methods of cost categorization “make sense” from different perspectives. For a firm to unilaterally adopt a “social overhead cost of labor” accounting method would be ruinous to that firm. But by the same token, for society (or economists) to take the firm’s accounting method as the last word is faulty. There is an enormous difference between entity accounting and social accounting that is very poorly understood, especially by economists who should know the difference. This is why “microfoundations of macroeconomics” is such utter crap.
Ok, I understand now.
Read any Dickens and Christmas Carol? Fezziwig was an Institutionalist who was bought out by a Neoclassicalist Jorkin who in turn hired Scrooge.
Jorkin: “Mr. Fezziwig, we’re good friends besides good men of business. We’re men of vision and progress. Why don’t you sell out while the going’s good? You’ll never get a better offer. It’s the age of the machine, and the factory, and the vested interests. We small traders are ancient history, Mr. Fezziwig.”
Fezziwig: “It’s not just for money alone that one spends a lifetime building up a business…. It’s to preserve a way of life that one knew and loved. No, I can’t see my way to selling out to the new vested interests, Mr. Jorkin. I’ll have to be loyal to the old ways and die out with them if needs must.”
Do you know how many times I have argued what the Prasch paper discusses? Enough times to almost get kicked out of Economist View and other places as well. My livelihood has been understanding the manufacturing process or throughput and improving it. Unfortunately and as Spencer and other have pointed out, the gains from increased productivity are not necessarily passed down in part.
Thanks for showing me the Prasch document.
since i’m sitting out here in an earthquake prone corner of Ohio that overlays both the Marcellus and Utica shales, i have been participating, mostly by email, with our county anti-frack group for the past two and a half years…since i was already aggregating links on energy and the environment, it wasnt too much of a stretch for me to expand that into a weekly fracking newsletter, with a bit of a focus on Ohio…each week i send out a package of linked paragraphs to articles that have crossed my newsfeeds, preceded by a brief synopsis…i’m going to try to post what i wrote last night here (excluding that on Ohio bill H490), mostly because the graphics i cited would be useful to this discussion, and hope that the Akismet spam catcher you’re using dont throw me into moderation for too many links…
the most important news of the year with regards to new horizontally fracked wells, tar sands exploitation, ultra-deepwater drilling projects and arctic exploitation came early Thursday morning when OPEC concluded their scheduled semi-annual meeting with a decision to keep their oil output quotas unchanged, rather than cut back in the face of a global oil surplus…. Saudi Arabia’s oil minister Ali al-Naimi specifically argued that OPEC members must tolerate depressed prices for the time being to combat our shale oil boom, telling the other oil producers that a cutback in output and higher prices would just allow US oil producers to grab a larger share of the market…the reaction in the US oil markets was immediate; oil prices dropped a dollar and a half in the first few minutes after the announcement, and were down $6 dollars a barrel by the end of the day…by mid-morning on Friday, prices for US crude were down another $2 dollars to $68 a barrel, where they appeared to steady, only to weaken again at the end of the day and end the week near $65, down from as high as $78 a barrel the week before….worldwide prices followed a similar pattern, with the benchmark world price ending the week near $69 a barrel, and with Western Canada Select, the Alberta tar sands benchmark, trading at $48.40 a barrel, the lowest in the world….
as we’ve discussed several times in general terms, complex & energy intensive methods of oil extraction such as fracking become uneconomical with prices at these levels…we’ve often cited a widely quoted "break even price" for horizontally fracked wells averaging around $80 a barrel, but averages conceal as much as they reveal; ie, some wells in the Bakken shale have produced oil with costs below $40 a barrel, while a percentage of marginal wells in that area have costs exceeding $90 for each barrel of oil they produce….with the falling prices, there has been considerably more analysis into the financial costs of projects in various oil fields, including tables and graphs, and since the modus operandi of my own links blogging omits the graphics, it seems it would be most useful to include a couple of them here, so you all can get an idea what’s in play and what’s at stake…
first, from a Reuters survey of oil analysts and consultants, we have a short table showing us the average break-even price of producing an additional barrel of oil or oil equivalent by geographic region:
we can see here that producing oil in the arctic is most expensive, and certainly prohibitively at current oil prices…EU biofuels are also cost prohibitive, but they’re probably subsidized, a policy that may not be too smart environmentally if a lot of that cost is in energy….this table shows the cost of extraction from oil sands at $89 to $96 a barrel, which is not much different than the $85 to $105 we quoted from a Canadian source two weeks ago, which makes new projects there a capital sinkhole with current Alberta prices below $50 a barrel…and remember again, these are broad averages; other sources put the cost of the three most expensive Shell and Conono Phillips tar sands projects at over $150 a barrel…similarly, although deepwater oil wells may have an average cost under $60 a barrel, current projects under study off the coasts of Brazil, Nigeria, and Cote d’Ivoire are all expected to cost more than $120 a barrel…
we also see here that average costs of US shale oil plays are listed at between $70 and $77 a barrel, a bit less than the widely quoted $80…but with the present oil glut, they’re up against middle east producers who can bring oil out of the ground for as little as $10 a barrel…similarly, their is no indication that Russian producers, with costs below $21 a barrel, will slow production any time soon, with Russia’s ongoing budget problems..
so to further break down those domestic shale costs, we have a graphic from Zero Hedge
showing selected shale oil breakeven prices for individual projects, apparently sourced from a Barclays’ analysis of Wood Mackenzie data…the circles on the graphic represent the average costs for producing oil in various US fields, accounting just for the cost of extraction, & not including other costs such as interest, corporate overhead and advertising, nor any environmental remediation….note that in the lower footnote, the Barclays researchers note that producers would need a 25% to 30% return at these prices to earn 10% on a given project if full cycle accounting were applied…two lines are drawn; one at $80 a barrel, such that those more expensive projects are above that line, and one at $70, close to prices we’ve seen this week…from the left, we see the Eagle Ford Karnes Trough producing oil at $50 a barrel, with Utica shale core wells at $55, running all the way to some projects such as Bone Spring and Eddy County with half cycle costs over $100 a barrel…note that prices for selected Bakken fields are labeled A through E, somewhat difficult to read in this viewing (you can click on the graphic for a large view)….what’s pretty clear from this is that at $70 a barrel just for costs of drilling, much of the US shale industry is not economically viable at today’s oil prices
Fixed this one and deleted your other post
ISIL oil sales may be a drop in the bucket, but are estimated to be in the ~50,000 to ~200,000 BD. We also have this estimate: “ISIL currently controls as much as 350,000 bopd in pre-war capacity in Iraq and Syria but IHS estimates that it is only able to produce between 50,000-60,000 bopd with the amount varying on a day-to-day basis.” http://www.worldoil.com/ISIL-oil-production-worth-an-estimated-800-million-per-year-IHS-says.html
For those who were concerned about an oil-driven Iraq war, you have the real world result of how BAD ACTORS controlling oil will act.
thanx, Bill, i only half know what i’m doing with html, so i tried to set it up by copying it from my gmail & pasting it into live writer, then grabbing the html from there…obviously, that didnt work..
Use the “img” tab and place the jpg there and then the description after you hit “ok.”
i can see how your code differs from the comment i originally posted, which as i said originated from my email…obviously gmail coded the images differently, a code that didnt work in comments here…i’ll have to study the difference, because almost everything i write starts off in a mailing, which have always transferred without alteration to blogger and wordpress posts, but obviously will not work for comments…
just a bit of news:
Exclusive: New U.S. oil and gas well November permits tumble nearly 40 percent (Reuters) – Plunging oil prices sparked a drop of almost 40 percent in new well permits issued across the United States in November, in a sudden pause in the growth of the U.S. shale oil and gas boom that started around 2007. Data provided exclusively to Reuters on Tuesday by industry data firm Drilling Info Inc showed 4,520 new well permits were approved last month, down from 7,227 in October. The pullback was a “very quick response” to U.S. crude prices, which settled on Tuesday at $66.88
The drop in permits is an indication that the oil companies expect the price of oil to remain low (relatively) for a while.
also note that the collapse in prices to below $70 a barrel came after the OPEC meeting on the 27th of November, and that for most of the month prices were a few bucks on either side of $80…for there to have been a 40% pullback in permits over the entire month, much of it had to be precipitated by oil prices in that latter range…
“40% pullback in permits over the entire month, much of it had to be precipitated by oil prices in that latter range” Quelle Surprise! I think everyone on AB knows this would happen. The only fools are the general public who are going to wonder why it will double in price several months out. Then we will here “conspiracy” theories.
doubling in price several months out might be right, Bill; i expected a long attrition in the oil patch as low prices wore down the participants…seeing a 40% pullback in drilling plans in one month was quite a surprise…with an average 40% annual depletion rate on already fracked wells, production could drop pretty quickly, leading to a tight supply that would drive prices right back up again..