Cheap Energy for the Holidays: Saudi Arabia handing out Christmas presents?

Chances are that in your part of the world gas prices are lower than they have been in a long time. Less widely noticed, unless your hobbies include scrutinizing utility bills or obscure commodity markets, is that natural gas prices are in the same state of affairs. While producers of these commodities spend th holidays counting loose change with a terrified look on their faces, the general population is enjoying a freebie courtesy of a global petroleum trade war and the after effects of the latest economic bubble. Few people know about this bubble, which sent well drilling into a frenzy of activity, but they will in a few years when the aftereffects of its popping are felt.

Oil prices, and hence gasoline prices, are low because OPEC feared that ongoing high oil prices would lead to production increases from other parts of the world they don’t control. High oil prices mean companies can afford to develop more sketchy oil reservoirs that they’ve known about for decades, but never bothered developing because the cost was high and it was too hard on the head and pocketbook to try figuring it out. Globally, it was easier to just let OPEC produce extra oil when needed, and the world was happy. Well happy is a stretch, but the oil flowed in sufficient quantities to keep the peace (except in the Middle East, where peace is sneered at).

But gradually even OPEC couldn’t keep up with the world’s demands, and prices started rising. That initially made OPEC very happy, because money flowed in relentlessly and undeveloped countries like Dubai could finally build ski hills in the desert like any wisely governed nation would.

Rising oil prices led to development of previously known but expensive oil deposits. Canada could finally afford to develop the huge oil sands region and US shale deposits suddenly became economic to develop. These enormous oil reservoirs hold several hundred billion of barrels of oil, and the frenzy to develop them was not unlike a gold rush. In Canada’s northern wilderness, oil sands companies faced such price escalation that truck drivers were earning $150,000 per year, a sure sign that a doomed frenzy was underway. Similarly in the United States, North Dakota sprouted improbable boomtowns where housing became scarce despite 1,000 miles of uninhibited (and mostly uninhabited) development potential in every direction.

The result of the boom in oil and natural gas was hundreds of billions of dollars flowing into the sector, chasing development of these large, expensive petroleum reservoirs. The result was predictable; production growth swamped demand and kept growing as prices stayed high. In some sectors prices respond quickly and the balance returns quickly; in the petroleum sector the party lasted much longer.

What we are left now is the remants of the boom, as the industry burns through the last of its cash and racks up credit cards to maintain production in a frantic effort to survive. It’s like watching a weasel chew its leg off to get out of a trap. Falling production is to be avoided at pretty much all costs, because it creates a death spiral for companies – cash flow decreases if production falls, the effect of which is magnified if prices fall as well. So we are now seeing the final death throes of a bubble not dissimilar from the housing boom.

It will end similarly, with lots of tears and a smashed up industry, which will then be unable to meet demand once called upon sometime down the road, and prices will rise again. Enjoy the fruits of the latest boom, which is doing to your energy costs what the housing bust did to housing affordability. The storm cloud to watch out for is what happens when demand rises again, and all the drilling rigs have been converted to play structures or cut up for scrap metal, and OPEC will once again hold all the cards in their cranky claws.