- The Death of Oil Production is Highly Exaggerated
- The Laws of Supply and Demand
- Drill Baby, Drill?
- Read Part 2
The other night, I happened to catch a brief clip of economist Larry Kudlow on the news. If you don’t know Kudlow, don’t worry about it. He’s a minor celebrity economist with a weekly TV show. Anyway, Old Lar’ was getting all worked up about how Biden policies had cut U.S. oil production by 3 million barrels a day.
His point was clear: the blame for high gasoline prices should be laid right at the president’s loafer-clad feet…
I’ve seen this refrain — that Biden policies are responsible for lower U.S. oil production and high gasoline prices — repeated many times.
Maybe you’ve seen those little stickers on gas pumps with a smiling Joe Biden pointing at the pump’s price display and saying, “I did this.”
While I hate to put the lie to this delightfully elementary explanation of cause and effect in the oil markets, the simple fact is U.S. oil production isn’t down by 3 million barrels a day.
Truth is, U.S. oil production isn’t down this year at all.
The Death of Oil Production is Highly Exaggerated
So far in 2022, U.S. oil companies are pumping an average of 11.8 million barrels of crude oil a day. In 2021, U.S. oil companies pumped an average of 11.2 million barrels of oil a day.
I suspect any grade school kid could tell you that 11.8 is more than 11.2.
Indeed, U.S. oil production is currently lower than it was in 2019. That year was a record year for U.S. production. U.S. oil companies pumped an all-time high of 12.3 million barrels a day in 2019.
It is also true that U.S. oil production fell by 8% in 2020. And that’s the biggest year-over-year drop in production ever recorded. But we can’t blame this massive drop in production on Biden — he was sworn into office on January 20, 2021.
I know it’s not a pleasant memory, but 2020 was the year of COVID lockdowns. So yeah, oil production took a hit, just like every other sector of the U.S. economy.
For the argument, let’s say that U.S. oil companies came into 2020 pumping 12.3 million barrels a day. Then let’s say they were forced to shut production down for a month because of a global pandemic. And then let’s say that companies resumed pumping at that record 12.3 million barrel a day pace….
Well, guess what? That one month off would lower annual production rates byyyyy… wait a minute… lemme see…. that can’t be right… 8%!!!
Math. Frickin’ amazing…
The Laws of Supply and Demand
Before I go on, I want to be very clear about something. I am not here to attack or defend Biden’s policy on energy or anything else. Like any president, he’s got some good ideas, and he’s got some bad ones. So for the sake of balance, I’ll go on the record and say that the tax on corporate stock buybacks Biden included in the Inflation Reduction Act is completely misguided.
The bottom line is that sitting presidents love to impose various regulations on Corporate America that sound great to their constituents and will have zero impact on how companies actually do business.
Like when President Trump lowered the federal fuel efficiency standards for automobiles…The “drill baby, drill” crowd loved it.
But automakers? They’d already made the investment to produce more efficient engines. What, they’re gonna spend billions to retool their factories so they can make less efficient engines just because they’re allowed to? Of course not. That would be a bad and costly business decision…
And that’s the reason I’m writing to you here on The Profit Sector. I love digging through the decisions that businesses make in order to grow their revenue and profits – because investing in companies that are good at growing revenue and profits is how you make money in the stock market. I like making money in the stock market.
And I know you do too…
So let’s get back to the oil sector and the decisions that U.S. oil companies are making to grow revenue and profits. We’re gonna talk about supply and demand because that explains why U.S. oil production is where it is, and as a bonus, I get to make fun of Kudlow again.
Last November, Kudlow wrote the following:
“Want to see gasoline back to $2 where it was a year ago? Or crude oil back to $45 or $50 where it was a year ago? Then drill, drill, drill. I never understood why the left does not understand supply and demand curves. It's the basis of microeconomics. It's called price theory. It's not even political or ideological. Any old textbook will tell you that.“
As consumers who cringe every time we fill our cars up with gas, we would like to see oil at $50 a barrel and gasoline at $2 a gallon. But do U.S. oil companies want to see oil prices get cut by 40% and fall back to $50 a barrel? Ummmmm….probably not.
And by the way, oil averaged $64 a barrel in 2019, when the U.S. supply was hitting records. That was $7 less than the $73 per barrel average price from 2018.
I know that’s just one example of how increased supply lowers prices. We could also go back to 2014 when Saudi Arabia tried to punish US oil production by maxing out its production and crushing prices.
Saudi Arabia was successful in crushing oil prices. Costs per barrel dropped 50% in less than a year to under Kudlow’s $50 a barrel. And those low prices drove over 100 marginal US companies into bankruptcy and cost a lot of oil jobs.
I’m sure Kudlow is well aware that if oil falls back to $50, the cycle will repeat, and jobs will be lost. But that outcome doesn’t fit his narrative, so he simply ignores it.
Drill Baby, Drill?
Oil production is a tough business. It’s expensive to drill oil wells. And the nature of shale oil wells (which account for 60%-65% of all US production) is tricky.
Because of the inherent nature of shale formations, shale oil wells suffer from high depletion rates. Shale wells start out gushing. But output falls an average of 50% during the second year of a shale well’s life and another 30% in the third year.
Think about it like this: if a shale oil company drilled every well they could at one time, yeah, the first year of revenue would be amazing. But the second and third years would look pretty bad.
Investors do not invest for one-year spikes in revenue.
That means shale oil companies have to manage their production curves very closely. They have to make sure that they have new wells to bring online every year to offset depletion and bring more oil to market to grow revenue and profits.
Remove all the regulations you want, U.S. oil companies aren't simply going to “drill baby, drill” because it’s not a sustainable business model.
Plus, it takes about two years to develop an oil well. This means that regardless of how many permits were issued last year, those sites would not be online and pumping oil today.
I’m going to finish this discussion on Monday by looking at how to value U.S. oil companies, which metrics to pay attention to, and look at a couple of U.S. oil companies that could be solid long-term investments.
So have a great weekend, and I’ll talk to you on Monday.
Until next time,
The Profit Sector
P.S. Be sure to read Brit's follow-up article The Truth About Oil Prices: Part II where he gives away 3 U.S. oil companies to buy right now.
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