Friday, April 16, 2010

Oil production is driven by real oil prices


I offer this chart to illustrate just how much the dollar value of commodities can affect the commodities market. What it shows is that the real price of crude oil (in dollars) has a significant impact on oil production via changes in the number of oil and gas rigs that are operating around the world. There is a long lag involved, of course, between increased oil drilling and actual production (several years I believe), but the response from oil producers to changes in the real price of oil is strong and quite obvious.

For example, note that real prices fell sharply from late 1996 through early 1999. In response, the active rig count started falling in late 1997, dropping fully 52% by mid-1999. Real prices then shot up, and that was followed by an eventual tripling in the number of active drilling rigs by 2008.

There's good news and bad news here. On the one hand it's good to know that the price signal does play an important role in the oil market. With real prices relatively high these days, producers are ramping up the exploration and production efforts and this should keep prices from climbing too high. But on the other hand, erratic monetary policy, to the extent it influences oil and other commodity prices, can result in a real roller-coaster ride for the industry over time. First, prices rise, which then encourages more exploration, which eventually results in increased supply, which then helps prices decline. Lower prices then discourage production, which then results in less supply, which eventually helps prices rise.

We would all be far better off without this tremendous price volatility. This is one reason why the Fed should pay more attention to commodity prices, since I do believe they are quite sensitive to changes in monetary policy, as I tried to point out in yesterday's post. If commodity prices were an important input to monetary policy decision-making, we might have not only less volatile commodity prices, but also lower and more stable inflation.

11 comments:

Benjamin said...

This chart is more accurately entitled, "Rig count is driven by oil prices."

Unfortunately, the truly prolific fields are not in the USA. The rig count in the USA goes way up when prices are higher, but global production hardly budges--and oil is a global market.

USA production, even from many new rigs, just edges up. The USA struggles to just stay even in production.

Global oil production responds very slowly to price signals, and is heavily clouded by politics. The politics of thug states such as Venezuela, Iran, Iraq, Nigeria, Mexico, Kuwait, UAE and Saudi Arabia. And Russia.

Sadly, it is a roll call of thug states. Production is falling in Iran, Venezuela and Mexico for political reasons--even as the price goes up. Chavez does not respond to price signals. He responds to the need to crush political opponents (and democracy). Mexico responds to corruption. Nigeria is a basket case. Iran a nuthouse. Iraq--well, we can hope. Some say Iraq could go to 12 mbd there, a huge 15 percent increase in global production. The could eclipse the Sauds. If, if if.

The Sauds are maintaing a OPEC level of production that has removed 4 mbd off the market, in OPEC;s last big move.

The oil market dances to a lot of tunes--OPEC, thug state politics, real demand, speculators and manipulators on the NYMEX. It makes sense that Putin would play games on the NYMEX--Putin's political survival depends on high oil prices, as does Russia's economic health.

Egads, the oil market is not driven by monetary policy. M2 is just one of many, many factors.

Paul said...

Too bad the Left won't let us drill in promising areas like ANWR and the Chuckchi sea. Tens of billions of barrels of oil lie there. Other off-shore areas were last examined decades ago with relatively primitive equipment compared to the technology today. In Santa Barbara, oil seeps out of the ground naturally and washes up on shore. Such a waste.

Public Library said...

We should be asking the Fed to do less, not more.

By adding more stats to the mix, the fallacy of their ability to control the financial economy carries on with boom and bust after boom and bust.

Lets start talking about reducing the size and power of the entire government apparatus.

Benjamin said...

Paul-
The Santa Barbara channel is heavily drilled, if you drive up the coast you will see the rigs offshore (especially at night).
I agree with you--it was a shame when Gov. Bush of Florida won a permanent ban on offshore Florida drilling. A lot of oil in the Gulf, offshore Florida.
But rich people own homes along the coast. You are not going to put an oil rig up in front of Palm Beach, jack.
Personally, I like oil drilling offshore, as there are few blowouts, and the rigs seem to create habitat for fish.
Brt try drilling off of Calafia Beach. See how the Newport Beach crowd goes for that.

In any event, even if we brought on more US production, it would just about keep us even at best. The global market for oil is huge, and prices are set globally.

I think a real wonderful fix is all the shale gas we are hitting in the USA, that can be converted easily to methanol. The supply of shale gas is gigantic, and we could run our cars on methanol or CNG, or my fave, a PHEV-methanol car.

First, we have to hurdle the ethanol industry, but they have incredibly strong support from red state Senators. There is a reliable red bloc of 30 Senators that will crush any option to ethanol.

Politics is a lot more complicated that the good guys and the bad guys.

Paul said...

Benji,

ANWR alone would produce about a million barrels a day. Add in the coasts and the other fruitful parts of Alaska and we're talking significant capacity at its peak. Further, Santa Barbara is drilled in some areas, many other lease areas are off limits.

Yes, former Gov. Jeb Bush is against off-shore drilling. Change the royalty formulation to favor states and see what happens. In fact, current Gov. Charlie Crist came out in favor of offshore drilling in 2008.
You're right though, it's not always Liberals, just 90% of the time. I would say my broad brushing is more accurate than your
Red State Socialists bilge. Case in point:

"...but they have incredibly strong support from red state Senators. There is a reliable red bloc of 30 Senators that will crush any option to ethanol."

According to Opensecrets.org, ADM gave 52% of their contributions in the 2010 election cycle to Democrats. In 2006, Sen Dick Durbin (D) Il, led the effort to defeat attempts by the Bush administration to abandon the Brazilian ethanol tariff. Co-signers of a letter Durbin sent to Bush were Senators Tom Harkin (D-IA), Barack Obama (D-IL)*cough*, Tim Johnson (D-SD) and Byron Dorgan (D-ND).

And yes, the clown you voted for, Mr Hopeandchange, has few peers when it comes to ethanol whoring.

So, red bloc, Benji?

Benjamin said...

Paul-

When I refer to the Red Bloc, or the Red State Socialist Empire, I am referring to any Senator or Congressman from a rural area. Many times I have referred to the Founding Father of Red State Socialism, LBJ.

There are Dems who put on red coats when they represent the Red Bloc.

The basic point remains the same: Rural America has become a vast welfare empire, propped by huge and growing infusions of federal money, into ag businesses, infrastructure and military installations.

If you want to cut federal income taxes, you have to get past this hurdle: 70 percent of federal income taxes are eaten up by the DoD, VA, USDA, Homeland Security-Civilian Defense, debt, Commerce and Interior.

This is what is so laughable and lamentable about the Tea Partiers. They literally do not understand the nature of the federal budget.

Strident calls to shrink entitlements are fine, but the vast entitlement programs (SS and Medicare) are funded by payroll taxes.

"Get Washington out of Lives"--but keep it totally dominating the ad business.

I think we could shrink the federal government to 16-17 of GDP, and we should. We could eliminate the Dep't of Education, USDA, and cut DoD in half. All other departments should take a 10 percent across the board whack.

Remember this: We just spent $50,000 for every man, women and child in Iraq. I guess we plan to match that for Afghanistan, under Obama.

You just sent about $6,600 to DC to finance those two occupations, as an average citizen. If you pay taxes, you sent about double that.

Yes, I want a tax cut, and I know where to cut.

Paul said...

"When I refer to the Red Bloc, or "the Red State Socialist Empire, I am referring to any Senator or Congressman from a rural area."

Oh, bullshit. You said just a couple days ago that agricultural socialism was the hallmark of the Republican party, or something like that. Further, farm states Wisconsin, Minnesota, and Illinois are typically blue, as example, and Iowa went blue in 2000 and 2008. I believe Iowa went for Clinton as well. If you call them "red" just because they're "rural" then you're simply out of your mind. In truth, however, you now realize your Red State Socialist smear is so far off base that you just pulled that genius "rural=red" equation out of your rear end.

" 70 percent of federal income taxes are eaten up by the DoD, VA, USDA, Homeland Security-Civilian Defense, debt, Commerce and "Interior.

I don't know where you get your statistics. From FY 2010, I count at least half a trillion in other departments. Alot more if you dig into "other mandatory spending." There was $105 billion alone marked "other." Besides, who exactly is saying we can't cut into some of the departments you listed? Besides the nitwit President you voted for, I mean.

"This is what is so laughable and lamentable about the Tea Partiers. They literally do not understand the nature of the federal budget."

Again, you haven't a clue what you are talking about. The Tea Partiers I know are highly educated. The NY Times poll bears out my anecdotal experience. A good example of their intelligence is almost none of them were stupid enough to vote for Barack Obama.

"Strident calls to shrink entitlements are fine, but the vast entitlement programs (SS and Medicare) are funded by payroll taxes."

Social Security is expected to run deficits between $20-$30 billion over the next couple years, about the size of the Ag Department, so once again you're wrong.

Paul said...

And, oh yeah, Scott mentioned here he's a tea partier. Why do you bother to read and comment on a blog written by someone so "laughable and lamentable?" I have to admit I am surprised to learn, given his regular in depth analysis, he literally does "not understand the nature of the federal budget."

Benjamin said...

Paul-

You are making the classic Tea Partier mistake of lumping in payroll taxes with income taxes.

Payroll taxes, which prior to 1968 (I think) were not counted in the regular federal budget, finance the huge entitlement programs, such as Social Security and Medicare.

If you wish to cut those entitlement programs, that is fine, in order to generate a sustainable cut in payroll taxes. I am all for cutting these programs, by raising the retirement age, cutting benefits, and, in general, refusing disability claims. I never liked the idea of taxing people for working or businesses for hiring workers.

If you wish a sustainable cut in federal income taxes, you have to look at DoD, VA, USDA, Commerce, Interior, Homeland Security-Civilian Defense and debt payments. They eat up 70 percent of federal outlays not financed by payroll taxes. I would also add in federal Dept of Ed., as I think in the day of the Internet, all we need is suggested course curriculum and studies online.

If any school district or student wants to go online and learn, they can. Such a website might cost $10 million to $20 million a year to maintain. It strikes me as a perfect way to allow every student access to studies that will make for a good basic high school education.

I stand by my statement that the R-Party has completely embraced socialism, when it comes to rural America and farms. If you can point to a single R-Party Senator who has called for an elimination of Red Bloc Welfare Empire, please cite it here.

Scott Grannis may or may not understand the nature of the federal budget. Just being a member of the Tea Party, or being educated, does not mean someone understands the federal budget. For a period of my life, I worked in the Congressional Budget Office, and have retained an interest in the topic to this day.

The federal budget is constructed sometimes to be oblique, and the mainstream media has not sorted through the sources of revenues and outlays. Usually, federal revenues are clumped together, despite the fact that payroll taxes are explicitly earmarked for Social Security or Medicare.

I think Grannis is aware of the huge panoply of rural welfare programs, and has called farm subsidies an "abomination," but Grannis can speak for himself, and very well.

Spurces of federal revenues:

http://www.census.gov/compendia/statab/2010/tables/10s0463.pdf

Federal outlays: http://www.census.gov/compendia/statab/2010/tables/10s0460.pdf


BTW, you may notice that payroll taxes came to $899 billion in 2009, while corporate income taxes came to $146.8 billion.

Indeed, payroll taxes nearly rival federal personal income taxes.

This is why I am certain the Tea Partiers and the R-Party cannot balance the federal budget, nor has a R-Party president proposed a balanced budget in more than 50 years. Rural America would blow away without more and more federal subsidies, for roads, water systems, power systems, phone service, postal service, airports, rail stops, and farm subsidies. Farmers in Montana make more from Uncle Sam than from farming.

The R-Party simply cannot balance the federal budget, and cut income taxes. They would have to cut programs that benefit the rural Red Bloc. Ain't going to happen.

I think a half-century is long enough to wait for fiscal responsibility. So, I decided not to wait anymore, and will cast a vote for other parties henceforth.

I hope Ron Paul runs in 2012.

Paul said...

"You are making the classic Tea Partier mistake of lumping in payroll taxes with income taxes."

Uh, no I'm not. Nothing I wrote would indicate that.

"If you can point to a single R-Party Senator who has called for an elimination of Red Bloc Welfare Empire, please cite it here."

I do know Senator John McCain has fought Big Ag his entire career. You voted for the other guy who flew around on ADM jets and in 08 called for the "special interests" to stand down so the farm bill could be passed. You know, the real socialist President currently gobbling up other industries.

"I stand by my statement that the R-Party has completely embraced socialism, when it comes to rural America and farms."

And I stand by my statement that you are full of crap. There are bad Republicans. There are no good Democrats. Show me where the Democrat party has NOT completely embraced socialism when it comes to rural America and farms. In fact, the Minnesota Democrats are officially named the Democratic FARMER Labor Party.

"This is why I am certain the Tea Partiers and the R-Party cannot balance the federal budget,"

The "extremist" Gingrich Congress DID balance the federal budget with Bill Clinton kicking and screaming the entire way until he decided to take credit for it.

"..nor has a R-Party president proposed a balanced budget in more than 50 years."

And I'll put any R-Party President up against the guy you fell in love with in 2008.

"I think a half-century is long enough to wait for fiscal responsibility."

That's what's so laughable about you. You claim you want fiscal responsibility yet you voted for...Barack Obama.

Benjamin said...

Paul-

I get the sense you disagree with me.