We Can Lower Gas Prices Now If We Drill, Drill, Drill

SPOT PRICE + CARRYING COST = FUTURES PRICE

Harvard economist Martin Feldstein explains in yesterday's WSJ that the relationship between future and current spot oil prices (see equation above) implies that an expected change in the future price of oil will have an immediate impact on the current spot price of oil.

When oil producers concluded that the demand for oil in China and some other countries will grow more rapidly in future years than they had previously expected, they inferred that the future price of oil would be higher than they had previously believed. They responded by reducing supply and raising the spot price enough to bring the expected price rise back to its initial rate.

Hence, with no change in the current demand for oil, the expectation of a greater future demand and a higher future price caused the current price to rise. Similarly, credible reports about the future decline of oil production in Russia and in Mexico implied a higher future global price of oil – and that also required an increase in the current oil price to maintain the initial expected rate of increase in the price of oil.

Once this relation is understood, it is easy to see how news stories, rumors and industry reports can cause substantial fluctuations in current prices – all without anything happening to current demand or supply.

Also note that the spot price of oil will fluctuate even without speculators playing a role. After all, speculators have no control over the global supply of, or global demand for, physical barrels of oil. Speculators respond to market conditions, they don't create market conditions.

Now here is the good news. Any policy that causes the expected future oil price to fall can cause the current price to fall, or to rise less than it would otherwise do. In other words, it is possible to bring down today's price of oil with policies that will have their physical impact on oil demand or supply only in the future.

Increasing the expected future supply of oil would reduce today's price. Any steps that can be taken now to increase the future supply of oil, or reduce the future demand for oil in the U.S. or elsewhere, can therefore lead both to lower prices and increased consumption today.

Comments

[john s. gordon:]

anybody have a spare drill rig that is not currently in use ?
> jack

2008 Jul 02 08:06 AM

[oldfolkdancer:]

Support offshore USA drilling! Think of all the great jobs it will create. Most of that money will stay in the USA. The need for more drilling rigs could create jobs for our manufacturing plants. More money can stay in the USA.

2008 Jul 02 09:10 AM

[Tmalan:]

Any increase in future supplies would be good, however to reduce the current price it would have to be a very very significant supply increase. And, just recently, Saudi Arabia announced significant future production increases. Additionally, there has been demand destruction in the US. None of these factors has had any impact on prices. This leads me to believe that the contracts are being artificially inflated to keep the market profitable. Also, I think oil producers are and can reduce production to keep supplies "tight" when they receive demand reduction data, thus controlling the market psychology.

2008 Jul 02 09:59 AM

[mixter:]

You might find a rig capable of drilling 5,000' by calling:405-615-5500. It would be located in Oklahoma.

2008 Jul 02 10:07 AM

[Brian Pursley:]

Americans want lower gas prices?

2008 Jul 02 10:38 AM

[Dr. No:]

If there is any truth to the hypothesis of "more drilling = lower oil/gas price", then yesterday's announcement by the Iraqi's to increase oil production from 2.5 million barrel to 4 million barrel by accessing four new oil fields (as in NOW) should have sunk the oil price like a stone.
Lemme go check at the gas station right a way....

2008 Jul 02 11:19 AM

[jackooo:]

Dr. No....

You are right on!! Congrats.
You can drill all you want and the prices will not go down because of it. WHY?
OPEC is a monopoly.... For every extra barrel we produce, OPEC just lowers their production and we have the same pricing. Duhhh.
If we found new oil would the producers lower their prices per barrel? Of course not. They would try to sell it to the highest bidder and I am not talking the highest bidder from the USA, I am talking about the highest bidder in the world.
That leaves us with more pollution spills from tankers. Two weeks ago off the coast of South America. Have we forgotten about that? Bet no one even heard of that spill?

2008 Jul 02 12:59 PM

[oldfolkdancer:]

The benefit of extracting oil from USA soil and off its shore is that most of the dollars paid for it would STAY HERE instead of Saudi Arabia, Mexico, Venezuela and Canada. Canada especially is benefiting immensely from this commodities boom and won't mind that much if we get a bigger part in the World Play. I agree, the price at the pump won't come down that much, if at all. But it will keep it shooting up to dizzying new heights. And I want those wages to go to union workers here in the USA. Those poor people in Saudi Arabia don't get much in the way of a fair wage.

2008 Jul 02 03:15 PM

[Mmarrkk:]

First: most folks working on drilling rigs or in the oil and gas industry aren't unionized...thank the Lord!! If they were unionized we'd be paying $10/gallon. Just ask the carmakers and the airlines. Bloated benefits, inefficiency rewarded with guaranteed pay increases, etc etc. Just what the oil industry does not need.

Yeah, there are some unions in the drilling side but not many.

2008 Jul 02 03:46 PM

[Lou1927:]

We can't drill our way out of a shortage. China and India will purchase all we can produce. We should divert the oil now being pumped in Alaska and sold to Japan to our shores. Any oil pumped from our country and shipped out must have a value added tax equal to 50% of a barrel. This would make sure our oil stays in the U.S. market.

2008 Jul 02 07:18 PM

[thedozer:]

Dr. No,

While I can't verify your claim of Iraq increasing oil production, you failed to mention the TIME STAMP of this increase in supply. per day, week, month???

While you are going down to the local Texaco to check gas prices, you should ask the attendant what they think about oil prices... it sounds like you already get most of your information from the 'gas station'

86.7 million barrels of oil per DAY (Demand)
85 million barrels of oil per day (Supplied)

I can explain it for you, but I can't understand it for you!

2008 Jul 02 07:22 PM

[Paul Killinger:]

Let's start with some misconceptions here...

First, the overwhelming majority of oil spills occur NATURALLY (...ie. oil seeping to the surface of the world's oceans - it is visible from satellites). Second, other than ultra-deep drilling ships, don't worry about the rig supply - they're building them 24/7. Third, no one works offshore for $10 an hour - their workmens comp insurance alone costs about that much.

Well, guys, 3/4 of the American people agree with us about increasing domestic oil exploration. Now all we have to do is convince the Greens in Congress.

They keep making stupid excuses, what are they so afraid of? They're scared we're right, and it will lower prices. If it doesn't, so what - that's still $ X BILLIONS we won't be sending overseas each year!

2008 Jul 03 12:35 AM

[crudeoilcra...:]

This article is of limited use. The author is incorrect when he implies that there is one solution to the current situation we find ourselves in. Quite simply drilling is not the solution. The solution includes drilling, conservation, solar power, wind power, geothermal power, better fuel effeciancy, and nuclear power. There isnt a magic bullet to solve this problem, but there is a great cocktail for it.

2008 Jul 03 02:57 AM

[Paul Killinger:]

You're right, but I don't believe you can accuse the "drill, drillers" of opposing the domestic expansion of other forms of energy. Unlike the anti-drillers, who are against oil, gas, nukes and coal. We need ALL OF IT, including the developent of renewables, if our economy and way of life are to survive in future years.

2008 Jul 03 10:05 AM

[rford:]

Lower Gas Prices Now Sign our petition to demand Congress take action to come up with a meaningful energy policy now.

Go to thepetitionsite.com/4/...

2008 Aug 03 04:04 PM

[Indepedia:]

Lets say we double domestic oil production. This will add about 10% to the global supply. At that point OPEC or Russia could (I'm guessing will) counter our increased production by decreasing their own. Thereby protecting profits. Does anyone think oil companies can or will sell oil to America at a discount when China and/or India will buy it at a premium? I don't think the stockholders are going to buy that.
The quickest way to lower gas prices is to send the futures markets a clear signal that we intend to use less. We are the biggest consumer of oil. That is where we have leverage. But even that influence becomes weaker as China's consumptive rate increases.

2008 Sep 04 04:39 PM