Thursday, September 30, 2010

Oil is likely to remain somewhat expensive

Changing the subject, here's an updated version of an interesting chart I haven't shown for a long time. It compares the real price of crude oil with the total number of oil and gas drilling rigs operated worldwide (including offshore rigs). Not surprisingly, drilling activity responds to changes in the real price of crude with a lag. What stands out for the recent period is that while crude prices in real terms are back to the levels of the early 1980s, there are still far fewer rigs operating today than there were back then. Rig counts are still rising, however, so maybe the industry will eventually catch up. But the relatively low level of exploration activity today may help explain why crude prices are still quite high from an historical perspective. This further suggests that crude prices could remain in their current range of $70-80/bbl for quite some time.

This second chart is a reminder that the relatively high price of oil in real terms is much less burdensome for the economy today than it was in the early 1980s. That's because, thanks to conservation efforts and improved technology, the U.S. economy today uses about half as much oil per unit of output as it did in the early 1980s.

Caveat: I'm not an expert on the oil and gas market by any stretch; I'm just making some informed guesses based on a simple analysis of historical patterns.


Frozen in the North said...

Interesting commentary, as usual. May I suggest that the changing nature of the american economy may also have a very important impact on the amount of oil required to generate a unit of output.

Nevertheless, it shows clearly that the American economy is less sensitive to changes in oil prices than it was in the 1970s

Charles said...

There is oil underground. It is an asset. It will be pumped at a price that on the margin equates the return on financial assets and the return on holding oil in the ground. Low returns on paper investments increase the price of oil. The price of oil increased over the last ten years because monetary policy has been very loose. This is why "core inflation" is a poor target for monetary policy.

Why drill for oil today if you are content to leave it stored underground?