Price of Oil has collapsed along with the US domestic production fantasy

A Saudi Oil Minister is widely credited for saying, "The stone age did not end for lack of stone.  The Oil Age will end long before the world runs out of oil."  Now, no one is sure that the recent turbulence in oil markets is the "beginning of the end" for black gold, but there are some very interesting things happening right now that are worth tying together.  First and foremost, the oil market is very much getting a crash course in Economics 101: Supply and Demand.

It is news to nobody that new oil extraction techniques such as hydraulic fracturing have expanded oil production volumes in areas and countries once thought to forever be minority producers.  The clearest example of this is domestic US production in areas such as the Bakken formation.  But, as is with any "new" technology, it is generally more expensive than traditional technology, at least to start, meaning it only makes business sense when the market for oil is high (say ~$100/barrel).  But have you seen the pumps recently?  The price of oil at the end of the trading day today was $43/barrel. Well, that is quite a deep hole (pun intended) in the business plan.

So whats happening?  Well, first, lets talk about demand.  In a world driven by constant stable growth for goods and services, a strong, steady demand for any product is more then desired, it is necessary.  Oil is no different, and unfortunately for oil producers the global demand for oil has not been all that great.  There are a few reasons for this, but one I feel is worth mentioning is the relationship between emissions and economic growth.  Historically, the level of global emissions from fossil fuels and amount of economic growth have been closely correlated.  Cheap energy is used as fuel for industry which produces more goods and services, raising more revenue and thereby increasing total economic output.

But in 2014 there was a blip.  In a recent report from the International Energy Agency states,"Data from the International Energy Agency (IEA) indicate that global emissions of carbon dioxide from the energy sector stalled in 2014, marking the first time in 40 years in which there was a halt or reduction in emissions of the greenhouse gas that was not tied to an economic downturn."  Well, that's kind of a big deal, because a "halt or reduction" in emissions implies less fossil fuel is being burned, which implies lower demand for fossil fuel.

Now on to supply.  Usually when demand for a product wains, the supply must also slow down as not to collapse the market for the product.  But, this is really not possible for oil, partly because it is not just businesses who are producing and selling the product.  Governments produce oil too.  Like Saudi Arabia.  And what is the primary goal of a Government?  To stay in power.  Therefore, a government who is also an oil producer does not act with the same motivations as a business, but with the motivations of a government.  Case in point is Saudi Arabia, the biggest power player in OPEC, has decided that even with the wain in oil demand, they will not be cutting production.  Supply will stay ample.  Therefore, supply trumps demand.... and prices fall.

And now we get to explore the effect of this situation on various oil business.  Here are a variety of links on the various effects.  First, oil companies are now trying to inventory their oil in hopes of a stronger market (relatively soon) where they are not losing as much money (or maybe even making money).  This has caused a boom in storage companies.  It has also caused a recent "rally" (or what you could call a dead cat bounce) to fizzle leading to even lower prices.

Oil Price as of March 19, 2015

So what does all this mean?  Simple, if your oil production business plan is built around $100/barrel oil, then your business plan is currently ruined and it makes no sense for you to operate.  The enhanced recovery techniques that once promised a resurgence of domestic energy independence are currently very very noncompetitive.  There is no way a consumer of oil would pay top dollar for American production with international oil at these price levels.

I hope your 401k is devoid of fracking companies.  If not then you better sell, right NOW.