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The Chairman’s Blog 11/7/2020

The oil and natural gas industry is a vital part of the economy. It is especially essential in rural communities and small towns throughout the Southwestern states of Texas, New Mexico, Oklahoma and Louisiana. It also affects other parts of the country such as the states of Ohio and Pennsylvania. Currently the oil industry is under sustained pressure due to low prices. First, I want to point out the extent of the problem and then discuss some of the underlying issues that have exacerbated this problem.

On Friday afternoon, November 6, 2020, near month futures pricing for WTI was $37.24, Brent was $39.55, and Natural gas futures were $2.88. A year earlier, for comparison, oil futures were about eighteen or twenty dollars higher per barrel. Henry Hub natural gas spot prices averaged $2.65 per MCF, not much lower from where prices are today. If we look at historic highs from 2008 (note that I am using annual average prices rather than daily prices since this gives a better overall picture of what is occurring in the market), we see the markets have dropped substantially in the last 12 years. In 2008 oil prices averaged (Cushing – WTI spot prices) $99.67 and from 2011 to 2014 average prices were above $90. In 2008 the well head price per MCF averaged $7.97. From the 2008 high point to present, oil prices have dropped about 63% and natural gas prices have dropped about 64%. Natural Gas prices are even more manic in the way they move, on a daily basis, since natural gas usage is far more dependent on the weather and heating and air conditioning demand. As a practicing CPA with many of my clients having oil and gas interest, I see many check stubs where the producer is being paid for his natural gas production. This summer, I saw many sales for less than $1.50 per MCF, quite a few for less than a $1 per MCF, some for less than 20 cents per MCF and a few even at negative pricing.

Now for the big question I want to try to answer in this blog, “Why are oil and natural gas prices about two-thirds lower now than they were in 2008?” There are several factors to take into account when answering this question. This is how free enterprise – supply and demand work. In some respects, the oil industry is its’ own worst enemy. The hardworking enterprising men and women of the industry figured out how to produce more product primarily by applying new techniques – horizontal drilling and hydraulic fracturing. The resulting huge increase in production increased the supply of oil there by decreasing the price. In 2008, average daily US production was 5 million bbl. In 2019, US average daily production was 12.23 million bbl. Of course, the world-wide increase in petroleum production was not this dramatic but the US example shows what the free market can do when allowed to work. The primary beneficiary of free markets is the consumer not the producer. Producers especially commodity producers (which oil and natural gas producers certainly are) have no pricing power and are totally at the mercy of supply and demand. Over the last decade while the supply of oil was growing rapidly, the worldwide demand for oil was increasing at a much slower rate.

In the next installment of this blog we are going to continue to explore the factors affecting the demand for oil and natural gas. Are they strictly economic factors or is something else involved?

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