How Technological Innovations Allow the U.S. to Keep Oil & Gas Prices Low
An old saying in the trading business goes… “The cure for high prices is high prices.” In other words, when prices are high, producers continue to produce, which increases supply, typically surpassing demand, which then lowers prices. On the flip side, this is true for low prices also.
About 15 years ago when oil cost more than $100 per barrel and gas cost more than $10 per MMBtu, opportunities for drilling in the United States were limited. During that time, Russia and Iran were discussing a cartel for natural gas – such as the Organization of the Petroleum Exporting Countries or OPEC – in order to keep prices high. Even our president at the time, George W. Bush, stated that the U.S. had an unhealthy addiction to oil. At the time, we were sending over a trillion dollars per year overseas to countries that produced oil to meet our demand, and we were vulnerable to interruptions in supply.
High prices coupled with dependence on other countries for our oil and gas supply encouraged and incentivized new innovations. George Mitchell at Mitchell Oil, which is now owned by Devon Energy, nearly bankrupted his company trying to figure out how to horizontal drill and frack rock to extract oil and gas, but eventually he succeeded. His success has revolutionized the energy business. An article in The Economist discusses his achievement: “Big oil and gas companies were interested in shale gas but could not make the breakthrough in fracking to get the gas to flow. Mr. Mitchell spent ten years and millions of dollars to crack the problem (surely the best-spent development money in the history of gas). Everyone, he said, told him he was just wasting his time and money.”1
Innovation’s Impact on Gas Prices, U.S. Imports and Exports
Mitchell’s efforts transformed the oil and gas industry. Instead of being the largest gas producer in an OPEC-style coalition for natural gas, Russia has changed its pricing structure to attempt to keep market share. The U.S. has gone from being an importer of gas to a liquefied natural gas (LNG) exporter. The U.S. now exports oil and is less energy-vulnerable, although calling ourselves energy-independent is a stretch. We have the largest oil field in the world, the Permian, and prices for oil have not been near $100 since 2014. Two aircraft carrier groups that were deployed to ensure safe passage of oil out of the Middle East have been moved and now there are just a handful of naval ships ensuring passage. This saves both money for the U.S. and untold lives of Americans.
Why am I discussing oil and gas when we are primarily a power company? Because it’s all interwoven. After the recession of 2008-2009, the energy business contributed to pulling the country out of the recession with drilling activity. The money we save on oil and gas exports keeps our currency strong and enables the U.S. dollar to remain the reserve currency.
Low Gas Prices Mean Low Power Prices, Cleaner Alternative to Coal
Lower gas prices have led to lower power prices as the price of electricity is set generally by natural gas. Natural gas can be 50% less carbon-intensive than coal, enabling a cleaner, better future and allows the U.S. to control its energy destiny into the future. For example, coal burns in the U.S. peaked at 1.2 billion tons just five years ago. Today, they are under 500 million tons and still falling. Clean, cheap gas has saved the U.S. from burning almost 700 million tons of coal a year, and total coal jobs have dropped to less than 60,000 in the U.S. For comparison, the fast-food chain, Arby’s, employs more people.
Natural gas can be viewed as a step in the right direction towards a cleaner environment and is a cleaner alternative to coal until nuclear energy and renewable energy become more accessible. Innovations in oil and gas have stabilized the energy market and lowered prices, making natural gas an affordable buy for commercial and industrial businesses.
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Guest Author: Ed Fortunato, Managing Director – Fundamental Analysis
Ed Fortunato is the Managing Director of Fundamental Analysis at Constellation, an Exelon Company and responsible for providing fundamental views of the economy, oil and natural gas. Ed has spent more than 15 years with Exelon having begun his career managing the proprietary trading book, the short-term analytics group and has lead the implementation of trading strategies in both the prop and hedging books since his arrival. Ed has an MBA with high honors in finance from Boston University and a BBA from Baruch College.