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Lower Prices to Come This Winter

As we continue on down the rabbit hole of this farcical financial world we have been living in for the past few years, I decided I would take a moment to explain what many experts see as the underlying reason for our reprieve on gas prices… at the same time, I wanted to throw in my two cents and make a bold prediction for the future.

I’m probably not the only one among us to notice that the price I’m paying for gas is almost a dollar less per gallon today than it was four months ago at the height of summer. In case that fact alone hasn’t made your day, allow me to let you in on a little secret: this is only the beginning.

I’ll show you why. Take some notes, because what I’ll show you today you could very well use to impress every single one of your friends at the next party you go to.

At prices approaching $3.75 last June, I thought for sure the world was ending. Those soul-less corporations had us consumers on the ropes… and I was certain, based on the talk of the liberal media, that the plan of those ruthless, evil speculators on Wall Street was to let us all drown in a pool of self-pity every time we pull up to the pump by perpetually driving the price of a barrel of crude higher with their trading algorithms.

Well, guess what? They haven’t succeeded in that. Oil prices are sitting at around $76 per barrel, down about 29% from almost $107 last June. That’s a huge decline. And it proves that even speculators and corporations can’t always control the forces of supply and demand from their computer terminals. Nor the conniving oil cartel OPEC from their plush armchairs in the Middle East. This indicates there may just be some rational economic forces still at work in the world, despite the irrational nature of the general stock market these days.

So let’s get on with the education. I consider this to be an advanced financial blog, so I won’t bore you for too long with the dry old Reader’s Digest reasons for lower prices. I’ll get into the meat and potatoes of SUPER exciting stuff that could potentially have a huge impact on your financial situation, not to mention any investments you might have in this sector.

What Causes Low Gas Prices?

CYCLICALITY of commodities causes low gas prices

Boring, yes, but important to note. The price of oil is highly cyclical—seasonal, even. Prices move with the season of the year.

For the most part, gas prices are usually lower going into winter, and stay low until spring, due in part to demand. What demand? Summer is the “driving” and traveling season, whereas most everyone stays home in the winter instead of going on vacation. This results in less consumption (demand), and thus, lower prices.

My most recent stats on prices from 2012 indicate that we typically see an average decline in price of 11% from peak to trough (between August and February). That’s about what we’ve seen nationwide over just the last few weeks. Not bad.

TYPE OF FUEL you are unknowingly buying causes low prices

Most people don’t know this, but the types of gasoline being refined and sold in the summer are different from what is sold and produced in the winter. The “blends” or types sold in the winter months are produced in such a way that they evaporate more easily, allowing cars to start easier in colder weather. If this same fuel were sold in the summer, the evaporative qualities of this stuff would result in significantly higher smog and pollution levels.

Summer blends, however, are much more expensive to produce due to environmental regulations, and thus have a lower yield per barrel. As a result, we end up getting our faces ripped off every summer at the pump when we take our long-distance road trips.

A Technological Revolution You Didn't Know Even Happened causes low gas prices

With the boring stuff out of the way, let me pull out my crystal ball…. And introduce my prediction with a little history. Hear me out!!

As Paul Harvey was wot to say: This is the “rest of the story” about lower gas prices… it’s something you won’t hear the media talking about, because they’re too dumb to follow the prints in the sand, and it’s not a story sensational enough for them. So, don’t count on me quoting Jon Stewart or Rush Limbaugh.

For the past several years, there has been a significant macroeconomic trend in motion around energy in the U.S. which, in my opinion, will prove to keep the price of oil going sustainably lower and lower over time.

This trend, or event rather, is the “shale oil” revolution, which I’ll talk more about in a minute. First, a little history.

Back in the early 1900’s, the U.S. started to become an energy giant, and overtook other countries who had led the petroleum revolution, such as Russia. As the industrial age ended, oil became the new gold. Everyone wanted it, and everyone needed it for business. Consequently, supply began to meet up with demand. From 1920 to 1970, oil production in the U.S. doubled in seven, fourteen, and 26-year spans. Then, in 1970, U.S. oil production peaked at about 8 million barrels per day, but began to peter off over the next several decades.

Production levels bottomed out at just under a paltry 4 million barrels per day back in 2008. That’s more than 60% lower than the highs of the 70’s, and even extremely low compared to what we produce today—50% lower. In case you’ve forgotten about the financial crises going back in 2008, this was precisely the period which saw gas prices at all-time highs in the U.S.

I remember it well. That summer, my new bride and I decided to take a trip to Oregon to visit my family—a fifteen-hour drive from our Idaho college town. I remember filling up gas about halfway there—and paid an astounding $4.08 per gallon!

I was crazy to take a trip like that, as a poor college student, when prices were so high.

Ironically, shortly after this time, oil prices absolutely cratered, while the stock market was doing the same. Within just a few months, I filled up my car at a rate somewhere under $2.00. Again, I thought I was in dreamland. Gas hadn’t been that cheap since high school.

What the heck happened?

The economic crisis of course. The turmoil in the financial markets was causing all sorts of misbehavior, especially in commodities. People were fleeing out of the unsteady dollar and into other things, like gold and oil. That’s what caused the all-time highs, in addition to the low production and supply.

A price of $140 per barrel for crude (which was the price back in 2008) is simply unsustainable, and completely irrational, barring some international catastrophe which might block all oil exports from the Middle East to the rest of the world. Nothing like that was going on.

It was almost pure speculation that made prices move this high… that, and the economic pandemonium enveloping the world, which was causing fright and panic to anyone brave enough to have actually invested their money.

Couple these events with the fact that U.S. oil production had been in decline for decades, and you have the perfect recipe for all-time high prices, as you can see. But then things changed.

In the late 1990’s to the mid to late 2000’s, new oil drilling technologies, known as hydraulic fracturing, or “fracking,” gained wider application and popularity, owing much to the process allowing oil companies to not only gain access to previously unknown oil reserves, but also enabling them to more easily and economically extract these resources from areas believed to have been sucked dry of oil long ago.

This chart shows the decades-long decline in U.S. production, and the subsequent rise over the past five years.

As you can see, U.S. oil production is going through the roof, thanks to fracking technologies. The so-called “Peak Oil” theory spoon-fed to us kids of the 90’s was clearly nothing but a myth. Oil reserves are not being depleted imminently, and prices are not going through the roof… there’s just too much oil sloshing around for that to be the case, and there’s only going to be more.

Many companies, drilling in areas they have been for decades, are making new discoveries in shale every day, and the more they drill, the more they find, and the higher their reserve estimates grow.

The rest is history. As you can see from the chart, the U.S. is again nearing its previous high production levels, which had not been matched since the late 1970’s. There is more oil than ever before, and it’s easier and cheaper to get now than it ever has been. This means lower prices for consumers.

We have so much oil in the U.S. now that our production is being referred to as a “glut.” This supply glut has broad-sided everyone from proponents of Peak Oil theories, to politicians. The latter group has sided with several industry-leading companies to push for legislation which now allows us to export surplus oil from the U.S. for the first time in forty years…

Hence, I’ve seen some oil commentators calling the U.S. “Saudi America” recently.

Before you started reading this article, you probably thought Saudi Arabia was still the world’s biggest exporter of oil. Well, that title was handed over to the U.S. this year. So, not only are domestic oil supplies increasing and being exported, but as any green-energy lover will tell you, oil is supposedly falling out of “vogue,” in everything from transportation to home energy production.

If this is true, it can only mean even lower gas prices, as demand decreases. Yes—according to the

data I’ve seen, these new technologies are making a dent in the consumption of oil domestically. But is it sustainable?

The way I see it, the allure of these alternative technologies are twofold. First, people “go green” out of good conscience—they “care deeply” about the environment. Second, if these technologies are more economical than gas (“cheaper”), people are happy to jump on board.

Based on forecasted production over the next twenty years, I don’t think that gas will continue to be as expensive in the future as it has seemed to be over the past three or four years. Which means oil is re-emerging as a genuine competitor on price to alternative energy.

Solar, wind, and electric power generation are still in the “fad” stages. In other words, “green” energy lovers like to talk all about how these are the technologies of the future, but the falling prices of oil make it difficult to make the case that these alternative sources of energy are going to be overcoming the popularity of oil anytime soon. It’s sad, but true.

Oil Isn't Going Away For At Least 100 Years

I want sustainable, renewable energy just as much as anyone else. But it has to be cheap for me to use it. And right now, these technologies are not cheap by any means. The only way they become affordable for consumers is in cases where companies piggy back off government grants and tax cuts, essentially relying on handouts to remain in business.

So the answer is—yes, lower prices are sustainable, because supply is there, and the U.S. has more incentive than ever to cut its reliance on Middle Eastern oil.

This trend is going to be awesome for the U.S. economy over the next decade. Here’s my prediction: oil is going below $60 over the next year. This may be out of industry consensus, but I think the perfect storm for lower prices is upon us.

You might be thinking—what about the oil cartel OPEC, which controls much of the world’s energy supply? OPEC announced just yesterday plans to cut supply, to keep the price from dropping below $75. Doesn’t that mean prices will go back up?

Perhaps. But consumers these days have learned to adapt to higher prices by decreasing consumption. We’re well-trained at “sticking it” to OPEC. Factor in the increased U.S. consumption, and I think OPEC will continue its decreased relevance in the world. In any case, OPEC has become somewhat dysfunctional as of late, and has trouble reaching consensus on action. That will impede its ability to control prices, which is good for us.

I can guarantee you that, despite what I think of Mr Obama’s presidency, this man will go down in history as the savior of the U.S. economy for this time period, and he will get all the credit for the gains we make compared with other countries in the energy sphere. The U.S. dollar has already gained some serious ground compared with other world currencies over this past year, due in large part to the markets finally factoring in the potential that US energy will have on the world markets.

As more of the world has begun seeing the potential for the U.S. economy, its faith in the U.S. dollar and the U.S. economy is being restored. A strong dollar will enable commodity prices to remain lower as well. Add that to my reasons for my prediction.

On the other hand, states like Russia and Saudi Arabia, whose economies are dependent on high energy prices, are already showing signs of extreme weakness. Things will only get worse for them, and for other countries who are chasing the pipe dreams of solar and wind energy, when oil is so cheap.

Summary

To sum up everything I’ve said, here are the takeaways:

The US is in a period of energy revolution—shale oil
This energy revolution is enabling companies to get oil cheaper and easier than ever
Cheaper, plentiful oil is leading to higher supply. Higher supply is contributing to lower prices
The higher supply and production, thanks to the shale oil revolution, is a tremendous boon to the US economy. The world is beginning to restore its faith in the US economy
Although OPEC can step in to cut supply and cause price increases, the cartel’s dysfunctionality in recent years is making it less relevant on a world scale
More faith in the US economy has led to a stronger dollar. A strong dollar further contributes to lower commodity prices, including oil—meaning, perpetually lower prices at the pump as long as this trend continues

So back to my prediction.

Sub-$60 oil, here we come. I’d be surprised if it didn’t happen by the middle of next year.

So when you’re filling up your gas-guzzler for about $2 per gallon, remember me. And tell your friends that you heard it here first.

Live long and invest,

Jeremiah

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