You Make the Call - Oil Edition

The price of gasoline has grabbed the nation's attention, and the political fighting over it has begun. I do not have any expertise on the oil industry, but I don't think you need to be an expert to appreciate the high-level picture. Let's go through some data together, and then you can pretend to be the POTUS or the CEO of an oil company.

First, let's get a picture of crude oil production world-wide. There has been pretty steady increase since about 1985. Back in 2018 the world reached a peak of 84.5 million barrels per day (Mb/d). The pandemic resulted in a significant drop, and now we're back to about 80 Mb/d

Next we have U.S. crude oil production. (This chart shows monthly production, so just divide by 31 to get daily production.) After decades of decline, U.S. crude oil production began to skyrocket around 2010. (I'll bet whoever was the POTUS back then gets lots of credit for that! [1]) The U.S. hit a peak just shy of 13 Mb/d in late 2019, and then the pandemic resulted in a large drop. As of the most recent data, we're back to just under 12 Mb/d.

This one surprised me a bit. Using the most recent data available, I ranked the top 10 oil-producing countries. As you can see, the U.S. came out as #1, with Russia and Saudi Arabia close behind. Those three alone account for 41% of world crude oil production, and no other country comes close to their production. Perhaps you can start to see why oil prices have jumped so high. Russia accounts for 13% of world oil production--that's not easily replaced.

Here we have net U.S. imports. In other words, subtracting all exports from our imports. On a crude oil basis, the U.S. still produces less oil than it imports. If you look at all petroleum products, however, the U.S. has been a net exporter since 2011. (I'll bet whoever was the POTUS back then gets lots of credit for that!) It's not clear to me what the significance of this is, from an oil supply perspective, because it's not like the U.S. has a state-run oil company that only sells within the U.S. Oil produced in the U.S. is sold on the world market. By analogy, Texas produces lots of oil and Virginia doesn't produce any oil. Nobody cares about that. But, I guess in a worst case scenario the U.S. government could seize all oil production and we would be in better shape than if we mostly depended on imports.

Next up are crude oil prices followed by U.S. Regular gasoline prices (not adjusted for inflation). I don't think we need to do any fancy statistical analysis to conclude that crude oil prices are the major driver of gasoline prices. On a side note, I remember that little blip below $1 in the late 90s. I'm pretty sure I was filling up in Salt Lake City, and it was the only time in my life that I remember seeing the gallon gauge increase faster than the dollar gauge. Anyway, I think the takeaway here is that the gas prices of the 90s are gone and not coming back anytime soon (at least on a sustained basis), if ever. Beyond that, you should expect volatility [2]. Plan accordingly.

You're the Boss!
Ok, now it's your turn to make decisions.

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Congratulations, Mr./Mrs. President. This mess has landed in your lap. The pandemic has kicked inflation into higher gear and if oil prices continue to stay high, the U.S. economy could be negatively impacted. 2021 was a great year of economic growth and stock market performance, but now the market is down and you were already being blamed for rising inflation. So here are some questions for you to answer:

What is your plan to bring down world oil prices? If the government were to grant every oil company wish, how much more oil can the U.S. reasonably expect to produce, and will it be enough to impact world prices within the next year or two? What if the U.S. ramps up production only to have other countries pull back? We don't have a state-run oil company. Can you force oil companies to increase production if they don't want to? Should the U.S. ban the sale of U.S. oil to other countries? What would be the broader ramifications of doing that? Should the U.S. subsidize oil production? If so, wouldn't we just be helping to lower the cost of oil for other countries? Should the U.S. subsidize gasoline sold in the U.S.? What about subsidizng the electric vehicle industry instead? Should the U.S. stop economic punishment of Russia so that their oil can continue to flow? Or maybe even decide that Ukraine isn't worth the cost to the U.S. economy and let Putin have his way? Or maybe you should just sit back and let market forces play out. I'm sure that whatever you decide, the voters will judge you fairly.

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Congratulations, Mr./Mrs. CEO of Oil Co. While international events are unfortunate, oil prices are a real wind in your sails right now. Investors, the shareholders that you ultimately answer to, have not been happy with past performance of the oil industry. They expect a decent return on their money, and they haven't liked past trends of increased oil exploration with little profit to show for it. They were especially unhappy when oil prices cratered in the wake of the pandemic. I'm sure you know that a lot of oil operations went bankrupt. If you can't make productive use of their money, then instead of more "drill, baby, drill," your investors would like you to return it in the form of dividends and stock buybacks so that they can invest elsewhere. Capital discipline is what they call it, and making decisions about the use of capital is what capitalism is all about. Here are some qustions for you to answer:

Based on current oil prices, more drilling would probably be profitable. How long do you think that prices will be elevated enough to make these new projects profitable? How much money are you willing to put at risk for future production considering that money invested in exploration and drilling now will not bear fruit for months/years? What happens if an economic recession drives down demand and oil prices fall? Or what if the Russia situation is resolved within a few months? Should your shareholders have to take that risk? Wouldn't it be better to sit back and let the oil you are already producing sell for high profit until demand cools? Like most industries, you have your own supply chain issues. Do you have the capacity to go full-speed even if you want to? I'm sure that whatever you decide, you'll come out this with plenty of money.

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Hopefully this little exercise has revealed that there don't appear to be any easy answers. Oil is a limited and declining resource, and consumers, governments (to say nothing of parties within governments), and oil companies all have different priorities and incentives. If someone claims to have a simple answer, as a first pass try using the above as a reality check.

Notes:
1. I don't know if he deserves credit or not, but people seem to assign credit/blame for all kinds of things outside of the President's control. At least be consistent. 2. As Trump was leaving office, I saw a hand-made sign in a yard thanking him for $2 gas. I highly doubt this person was similarly grateful to Obama in 2015. Like I said, at least be consistent.

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