'Franklenomics' explains the oil bear market

'Franklenomics' explains the oil bear market
© Getty Images

The fall in U.S. crude oil price is news — outside of the oil and gas patch. Some believe that another widely watched crude oil price index — Brent — could fall below $60, adding to the bearishness.

Through the history of daily, traded U.S. crude oil, settlement prices have been above $50 only 36 percent of the time, and above $60 only 28 percent of the time. That says a thing or two about where expectations should lie.

Traders’ technical analysis and tariff politics aside, industry insiders and close observers are well aware, perhaps acutely, of the prevailing underlying fundamentals. Namely, we are in a periodic era of abundance with respect to supplies of both raw material and the finished products we actually use, like motor gasoline, diesel and jet fuel. 

ADVERTISEMENT

If natural gas is added to the picture, the industry has been in surplus since 2008. This is the opposing side of the “continuous crisis” lamented by Paul Frankel, founder of Petroleum Economics Limited and widely credited with laying out the foundations for why oil supply never was/is/will be in balance. 

Oil prices are in the third or so “breather” since U.S. oil production growth became firmly established, and it has been U.S. production, of course, that altered so many equations. It’s no coincidence that oil prices have been on the low side at a time when political and geopolitical tensions around the world are heightened. 

The savviest U.S. producers will note that opportunities can be best when oil prices are lower rather than higher.  Pressures on costs, including costs to enter new plays or expand existing positions, fall off. Weak players drop out. 

Motivations to find cost reductions, achieve technical and technology improvements and fatten margins are strong. We’ve long known that higher prices tend to induce sloppiness and inefficiencies as well as barrels full of bad judgement.

On the flip side of the coin — demand — the closely watched weekly U.S. motor gasoline barometer is about 18 percent above the January 2012 post-recession low. And that low was about 18 percent below the August 2007 pre-recession high. 

In other words, U.S. motor gasoline recovered from demand erosion with recession. Indeed, more than recovered: The current level is a bit off, less than 5 percent, from the August 2018 high mark. Five percent off a recovery that wasn’t expected in the first place does not suggest much in the way of economic angst. 

ADVERTISEMENT

Overall energy demand in the U.S., apart from recession pauses, has risen steadily since the early 1970s and steadily since 2012. Cheap inputs spawn new investment and jobs as businesses move to take advantage of them. 

Any number of things could threaten U.S. economic performance. The cost of oil and gas and derived products is not one of them.

So what gives? A lot of good questions could be asked. Oil and gas are cheap worldwide. According to "Frankelnomics," producers, unable to self-adjust, excel at giving consumers the price they deserve. 

Why aren’t more economies benefiting? Largely due to cheap natural gas, electricity can be a bargain at the wholesale level. Why are retail customers, including in the U.S., paying more? These inquiries enter "yellow vest movement" territory. 

The fiscal soundness of many oil producing countries is a worry. Why not unload unwieldy statist policies and companies and move on? Cheap oil can trigger many questions about whether alternatives are as good a deal, including on the emissions front, as promised. 

All sorts of things can happen in the world of Frankelnomics.

Michelle Michot Foss is a fellow in energy & minerals at the Center for Energy Studies at Rice University’s Baker Institute for Public Policy.