The PLUMMETING PRICE OF OIL

The week I wrote this column, several gas stations around town were selling gasoline for $2.39 a gallon. The reason for the lower price is that oil has fallen from $115 a barrel last June to less than $70 today, and the price plunge may not be over. When OPEC met in Vienna recently, its members rejected calls to prop up oil prices by restricting their oil production. What’s behind the falling price of oil and how is it likely to affect us here in Southwest Louisiana? One take on OPEC’s inaction is that Saudi Arabia wants to wage a price war against U.S. shale oil production with the intent of driving oil prices so low these wells will no longer be profitable to operate. The Saudis flooded the world with oil back in 1986, and succeeded in shutting down much of the U.S. oil industry. But in 1986, most U.S. oil production came from high-cost stripper wells or offshore wells, whereas the new shale oil wells opened up by hydrofracking have a relatively low operating cost of around $40 a barrel. A price war would bankrupt a number of oil-producing nations dependent on oil revenue, including some of Saudi Arabia’s allies and other members of OPEC, before it bankrupts the U.S. shale oil industry. An alternative explanation is that the rise of ISIL has rattled Middle Eastern oil regimes, including Saudi Arabia, that are concerned about the security of their oil fields. Oil in the ground is like money in the bank: if people think a bank may fail, they rush to pull their money out of that bank. Similarly, when oil regimes fear they may lose control of their oil fields, they want to extract the oil as fast as they can and convert it into safer, portable dollars or gold.   The graph shows the roller coaster ride oil prices have taken since the OPEC embargo following the Yon Kippur war in 1973. They plunged following the Iranian revolution in 1979 and the ensuing eight-year war between Iran and Iraq. They fell again following the 9/11 attack on the World Trade Center. And the current price drop began in June, when ISIL forces captured Mosul, the second largest city in Iraq and a center for oil production. But regardless of the reason, once oil prices begin to fall, it sets off a snowball effect: First, lower oil prices mean less revenue for oil-producing countries. Their tendency is to try to close their budget gap by producing and selling more oil. Second, when oil prices are falling, producers want to sell their oil as soon as they can before the price falls further. It was these reactions that OPEC was unable to halt at its recent meeting in Vienna. Cheaper gasoline may be a nice Christmas present for drivers. But the big question for people in Southwest Louisiana is how falling oil prices may affect the economic boom we have been anxiously awaiting. Low oil prices have a negative impact on the “upstream” oil industry (exploration, drilling and extraction). But the economy of southwest Louisiana is based on the “downstream” oil industry (refining and petrochemical production). Cheaper oil, regardless of where it comes from, increases the profit margin of refineries, and low prices at the pump increase the demand for their products. Petrochemical plants also benefit from cheap oil because oil derivatives are a basic feedstock for them. The local projects that could be delayed or cancelled due to low oil prices are the planned gas-to-liquids (GTL) plants; their products, such as diesel fuel, compete directly in the market place with products made from oil. The projects in question include Sasol’s pending $14 billion GTL plant, Juniper’s GTL plant in Westlake, and G2X Energy’s planned $1.3 billion GTL facility at the Port of Lake Charles. But before you panic and cancel your Christmas parties, consider that LSU economist Jim Richardson points out that the decision to build these multi-billion dollar GTL plants is not based on what the price of oil will be next week. A lot of very smart people are involved in the decision-making process for these projects, and they are very aware of the up-and-down history of oil prices. I am not inclined to second-guess them. If oil prices drop further, I suspect they will not remain there long.