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Shale We Review the 2010s?

By Evelyn Teel and Jim McDonnell

With the decade coming to a close, this is a perfect opportunity to look back at how the energy market has changed over the past ten years. It has certainly been a whirlwind ride, starting shortly after the 2008 stock market crash and continuing through the Great Recession and the subsequent recovery. The decade also saw the shale gas revolution take hold. Arguably the most significant change in the energy market over the past ten years, the shale gas revolution has not only provided great economic benefit within the United States but also reshaped our position on the world stage.

The two technologies instrumental to the shale gas revolution – hydraulic fracturing (i.e., fracking, or inducing porosity and permeability in rock) and directional drilling (greatly increasing a wellbore’s exposure to hydrocarbon bearing formations) – have been around for decades. However, Texan George P. Mitchell of Mitchell Energy & Development Corp., through sheer determination and personal will over seventeen years, was able to advance and combine these technologies, thus enabling the extraction of natural gas from shale formations that are of low porosity (i.e., not much pore space in the rock) and low permeability (i.e., the pore spaces are not well interconnected). These formations underlie large swaths of the United States, and the proven reserves of natural gas have consistently increased over the past decade.

The shale gas revolution is commonly considered to have started in 2008, and in the 2010s, we have witnessed the remarkable changes that have resulted from its growth. As fracked wells have come online, the ready supply of low-cost natural gas has transformed the energy industry in America and the world. The graph below on the left shows the volume of natural gas produced daily in the United States between 1997 and 2010, measured in billions of cubic feet per day (Bcf/day). Production over this period remained relatively flat, averaging about 50 Bcf/day. Compare that to the graph on the right, which shows the volume of natural gas produced in the United States from 2010 to the present. The volume of natural gas produced daily has very nearly doubled to about 93 Bcf/day.

Though demand for natural gas has increased, the more dramatically increasing supply of natural gas has driven down its price. The graph below shows how US natural gas prices at the Henry Hub have declined from about $6 per million Btu (mmBtu) to $2.19 per mmBtu today.  

Due to the increased availability of cheap, abundant natural gas, an increasing number of liquified natural gas (LNG) export terminals have come online, and the United States has become a major exporter of LNG. This reverses a long-term trend of rising LNG imports. The graphs below show US LNG imports and exports from 1985 – 2009 (left) and 2010 – 2019 (right).

In most parts of the country, natural gas prices and electricity prices are strongly correlated. As natural gas prices move so do, generally, electricity prices. Thus, as natural gas prices have fallen, electricity prices have fallen as well. The graph below shows wholesale electricity prices in the Mid-Atlantic measured in dollars per megawatt-hour ($/MWH). Wholesale electricity prices are almost half of what they were ten years ago.   

The abundance of natural gas and the declining prices of natural gas and electricity have been driven by the dramatic increase in shale gas production.  

The map and graph below identify the regions and geological “plays” in the US where shale gas production is occurring. Shale gas production has increased to two-thirds of this rising total US natural gas production from only a minor contribution only ten years ago.    

Source: US DOE EIA

Though many people doubted fracking would work with crude oil deposits, as oil molecules are much larger than those of natural gas, Mark Papa of EOG Resources, Harold Hamm of Continental Resources, and others have been able to adapt fracking technology to the extraction of oil. We have thus seen a shale oil revolution take hold, which has brought benefits similar to those of the shale gas revolution. It has driven down petroleum prices in the United States and dramatically reduced our dependence on foreign oil.  The US recently became a net exporter of oil products (refined petroleum and crude oil). Overall, the US is now the world’s largest producer of natural gas (93 Bcf per day versus 58 Bcf per day during 2010) and crude oil (13 million barrels per day versus 5.5 million barrels per day during 2010). 

The shale revolutions have significantly changed the US energy landscape over the past decade. They have brought online abundant sources of low-cost domestic energy, which have driven down consumer prices, boosted our economy, created jobs, improved America’s energy security, and increased revenue to state and local governments and the federal government. Fracking and directional drilling require a smaller footprint than traditional drilling, and have helped reduce CO2 emissions as natural gas is being substituted for coal in electricity generation. Low cost, abundant natural gas complements intermittent sources of energy such as wind and solar.

In addition to all the benefits noted above, low energy prices in the United States have expanded the manufacturing sector and made the country more attractive to companies willing to relocate from overseas. Indeed, the shale revolutions have done nothing less than improve the United States’ geopolitical position, reducing our dependence on foreign oil and shoring up our export capacity.

Like any fuel source, shale gas comes with trade-offs. There are concerns about induced seismicity, water and air pollution, and health impacts. Further technological advances and refinements in the field may alleviate these concerns, and we look forward to seeing how this industry progresses in the 2020s.

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Copyright 2019 by Avalon Energy® Services LLC

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NCAC – 22nd Annual Washington Energy Policy Conference


Secure your spot here:

Energy Technologies and Innovations: A Disturbance in the [Market] Force

Thursday, April 12, 2018, 8:30 AM to 6:00 PM

The George Washington University

Keynote speakers:

Mark P. Mills, Senior Fellow, Manhattan Institute

Gil Quiniones, President and CEO, New York Power Authority

In addition to these keynote speakers, the following panels will be held:

PANEL 1: The Grid Awakens: Electricity Generation and Demand
Phil Jones, Executive Director, Alliance for Transportation Electrification
Bryce Smith, Founder and CEO, LevelTen Energy
John Zahurancik, COO, Fluence
Barney Rush, Board Member ISO New England, Rush Energy Consulting (moderator)

PANEL 2: Hydrocarbons Strike Back: Innovations to Maintain the Status Quo

John Eichberger, Executive Director, Fuels Institute
Sid Green, President, Enhanced Production Inc.
Mike Trammel, Vice President for Government, Environmental, and Regulatory Affairs, Excelerate
Rita Beale, CEO and President, Energy Unlimited (moderator)

PANEL 3: Innovation: A New Hope in Energy

Bill Farris, Associate Laboratory Director for Innovation, Partnering, and Outreach, National Renewable Energy Laboratory
Elisabeth Olson, Economist, Office of Energy Policy & Innovation, FERC
Christopher Peoples, Managing Partner, Peoples Partners and Associates
Devin Hartman, Electricity Policy Manager, R Street Institute (moderator)

PANEL 4: Return of Energy Policy

Adele Morris, Policy Director for Climate and Energy Economics, Brookings
Jason Stanek, Senior Counsel, House Energy & Commerce Committee, Subcommittee on Energy
Pat Wood, Chairman, Dynegy
Kevin Book, Managing Partner, ClearView Energy Partners (moderator)

Note: Chatham House Rules apply.

Full Agenda and to register –>

RSVP: Required

Conference Information:

Organizer: Michael Ratner, NCAC-USAEE Vice President ( / 202-707-9529
Venue: The George Washington University, The Marvin Center, 3rd floor, Continental Ballroom, 800 21st Street, NW, Washington, DC 20052

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Peak Oil – A Dramatic Turn of Events

In our May 20, 2015 article, we wrote that “Concerns and worry about Peak Oil are overstated and irrelevant.”  The article concluded, “With crude oil supplies increasing and the demand for crude oil slowing, and likely to continue to slow more, demand for crude oil will peak long before dwindling supplies of crude oil become a concern.”  Read the full Avalon Energy Peak Oil article here.

Yesterday, eighteen months later, the Wall Street Journal reported that major and state-owned oil companies are beginning to plan for the “mind-bending scenario” when global oil consumption crests and begins a permanent decline.  In response to this “peak oil demand,” these companies are beginning to increase their investments in petrochemicals, natural gas, cost reduction and alternative energy sources like solar and biofuels.

And, no less an industry player than Saudi Arabia is at the forefront of this trend.  Saudi Arabia’s energy minister, Khalid al Falih is quoted in the WSJ article as stating at a recent conference, “Peak demand will be later than the common dates that are being thrown around, but if it does happen, because we’re building multiple engines for the economy and we’re planning for an economy beyond oil, we’ll be ready.”

A dramatic turn of events.  Predictable, but dramatic nonetheless.

Reference – “Oil Firms Anticipate Day of Reckoning,” The Wall Street Journal, November 28, 2016.

Evelyn Teel contributed to this article.

The Avalon Advantage – Visit our website at www.AvalonEnergy.US, or call us at 888-484-8096.

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Copyright 2016 by Avalon Energy® Services LLC

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Peak Oil

Concerns and worry about Peak Oil are overstated and irrelevant.  Many articles and books have been written on the topic and many lectures given.  Dire predictions have been made and many people have concluded that because of peaking of crude oil production, the future of the human race is bleak.

Peak Oil theory seems so intuitive.  There is a finite amount of oil contained within the crust of the earth.  As the human population increases and the global middle class expands, we have used, and continue to use, more and more crude oil.  The amount of crude oil remaining, therefore, dwindles with each passing day.  Therefore, it is inevitable that crude oil production will peak and then begin to decline.  As production declines, bad things will happen.  The price of crude oil will certainly rise dramatically, and geopolitical conflict will develop over access to the remaining pool of crude oil.  The good life that we live now will come to an end.

As intuitive as this logic is, it has a large problem.  It is flawed.

Why?  Because we live in a market economy and because technology keeps advancing.

Crude oil is but one form of energy available to the human race.  As the price of crude oil rises, exploration companies are incented to find more supply.  Shale oil reserves are developed.  Also, substitutes to crude oil become more viable.  Natural gas displaces fuel oil and also begins to be used more and more as a transportation fuel.  Renewable energy sources become more economical.  Energy markets adjust.  Alternatives are found.

Peak Oil theory focuses on the perceived inevitability of dwindling supplies of crude oil.  What the theory ignores is the possibility of declining demand for crude oil.  There are more and more indications that the demand for crude oil is slowing and will begin to decline.  The energy intensity of our economy is declining as efficiency and productivity improvements permeate our homes and industry. The world population is becoming more urban, lessening the need for gasoline as a transportation fuel.  Cars and trucks are more energy efficient.

With crude oil supplies increasing and the demand for crude oil slowing, and likely to continue to slow more, demand for crude oil will peak long before dwindling supplies of crude oil become a concern.

In the words of Sheikh Zaki Yamani, the former Saudi Arabian oil minister, “The Stone Age came to an end, not because we had a lack of stones, and the oil age will come to an end not because we have a lack of oil.”[1]

[1] Fagan, Mary, “Sheikh Yamani predicts price crash as age of oil ends,” The Telegraph, June 25, 2000,

Evelyn Teel contributed to this article.

The Avalon Advantage – Visit our website at www.AvalonEnergy.US, call us at 888-484-8096, or email us at

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Copyright 2015 by Avalon Energy® Services LLC

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Urban Oilfield

Los Angeles is an urban oilfield.  Within its limits are more than 50 oil fields, 3,000 active oil wells, and numerous tar pits (actually asphalt seeps).  During the 1920s, a quarter of the world’s crude oil production came from California, and the Los Angeles Basin was responsible for a large portion of that production.  It continues to be a major production area today.

Inglewood Oil Field

One of LA’s oil fields, the Inglewood Oil Field, is located in the Baldwin Hills area and covers a thousand acres.  Oil was first discovered in the field in 1924.  Since then, more than a thousand wells have been drilled and it has produced over 400 million barrels of oil.  According to the field’s largest operator, Freeport McMoRan Oil and Gas, the field now produces between 2.5 to 3 million barrels a year.

Crude oil in the field is trapped in a series of anticlinal structures that express themselves on the surface as hills – thus the name Baldwin Hills.  Below the surface, oil wells in the field produce from six producing horizons.  Below is a cross-section of the field.

Here’s what the Inglewood Oil Field looks like from above:

Flower Tower

Oil production facilities in the LA Basin are often hidden in plain sight.  The photos below are of Venoco’s “flower tower” production facility at 9865 Olympic Blvd., on the campus of Beverly Hills High School.  Inside is a rig that services 18 deviated wells that draw crude from the Beverly Hills Oil Field.  In exchange, the high school receives royalties that, reportedly, cover most of its teachers’ salaries.

Tar Pits

Also found within the Los Angeles Basin are numerous tar pits or, more accurately, asphalt seeps.  During the formation of the LA Basin, immense quantities of organic-rich sediment were buried that, over time, decomposed and accumulated as hydrocarbon deposits.  Liquid (crude oil) and gaseous (natural gas) hydrocarbons are lighter than interstitial formation water.  The resulting buoyancy causes these hydrocarbons to migrate upwards where a porous medium or migration path exists.

Hydrocarbons often become trapped in anticlinal structures that are overlain by a non-permeable barrier such as shale.  The Inglewood Oil Field is an example of this.  A small portion of the hydrocarbons may continue to migrate upwards, reaching the Earth’s surface along faults.  As liquid hydrocarbons migrate upwards, they lose their volatile components and slowly convert to asphalt.

When the volatile components reach the surface they dissipate into the atmosphere.  The City of Los Angeles has designated a number of “methane zones.” Structures within these zones must be properly ventilated in order to prevent the accumulation of methane.

Asphalt that reaches the surface oozes out and accumulates in low-lying areas.  Living creatures that find their way into the asphalt may become stuck and die, and they are often then preserved for future ranchers, farmers, and scientists to uncover as fossils.  Fossil finds in these asphalt seeps are common.  These seeps are the surface expression of the hydrocarbon reserves below the surface and in fact, the first oil wells in Los Angeles were drilled near asphalt seeps.  The most famous asphalt seeps are the La Brea Tar Pits on Wilshire Boulevard, minutes from Hollywood Boulevard and Rodeo Drive.

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  • Map of oil wells from the California Department of Conservation.
  • Inglewood Oil Field cross-section from PXP investor presentation, June 2005.
  • Satellite image from Google Earth.
  • Photos taken personally.

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Copyright 2015 by Avalon Energy® Services LLC

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Are Crude Oil and Natural Gas Reconciling?

Crude oil prices have dropped 38% since June for two reasons.  Shale oil production in the US Bakken, Eagle Ford, and Permian basins has increased dramatically – by more than 4 million barrels per day since 2008.  At the same time, worldwide demand for crude oil has declined as a result of slowing economies in China and Europe.

Starting in January 2012, the US crude oil benchmark, West Texas Intermediate (WTI), bounced around $100/Bbl (dollars per barrel), rose above $105/Bbl in June this summer, and is now trading below $65/Bbl.  Natural gas prices fell below $2.00/mmBtu (dollars per million British Thermal Units) during April of 2012, rose above $6/mmBtu during the Polar Vortex during January of this year, and have since fallen below $4.00/mmBtu.

The graph below presents crude oil and natural gas prices on an energy equivalent basis in common units of $/mmBtu.  Starting in January 2012, crude oil bounced around $17/mmBtu, rose above $18/mmBtu in June this summer, and is now trading below $12/mmBtu.

We reported previously on the once wide gap between crude oil and natural gas energy equivalent prices:  Crude Oil and Natural Gas Get a Divorce and Crude Oil and Natural Gas Move To Different Hemispheres.

During April 2014, crude oil reached more than nine times the energy equivalent price of natural gas.  That ratio is now 2.8X.  The graph below shows how this ratio has fallen over the last three years.

While crude oil prices and natural gas prices exhibit little correlation, crude oil prices are highly correlated with fuel oil and diesel prices.  Implications of a declining crude oil to natural gas price ratio include:

  • As natural gas prices spike in pipeline capacity constrained markets this winter, it may be more economical to use fuel oil for power generation than natural gas.
  • The economics associated with converting residential fuel oil furnaces to natural gas become less compelling.
  • The economics associated with converting diesel or gasoline fueled vehicles to compressed natural gas or electricity will worsen, and the payback period associated with existing conversions will be extended further out in time.
  • US liquefied natural gas (LNG) exports will become less competitive in overseas markets where natural gas prices are contractually tied to crude oil prices.
  • Petrochemical facilities that can use both crude oil and natural gas as feedstock may switch more and more to crude oil.

It now appears that crude oil and natural gas may be moving back to the same hemisphere and, possibly, reconciling.

The Avalon Advantage – Visit our website at, call us at 888-484-8096, or email us at


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Copyright 2014 by Avalon Energy® Services LLC

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Natural Gas Market Update

The above graph looks at natural gas prices going back to January 1997.

Natural gas prices have retreated from the Polar Vortex bump and remain relatively low by historical standards.

The prices plotted above are not adjusted for inflation.  If they were in 2014 dollars, the left side of the curve would be more elevated.  In real dollars, today’s prices are lower than they appear on the graph.

Looking to the futures market, the effects of the Polar Vortex lingered into the summer over concern about whether or not there was sufficient supply of natural gas to refill storage after the dramatic drawdowns during January and February.

This is highlighted on the left side of the blue line above which plots the 36 month futures curve as of 4/29/14.  This curve is backwardated, meaning the months close in time were priced above the months further out in time.

The near dated months have since retreated as concerns about storage refill have diminished because of (a) greater natural gas production than expected, and (b) unusually mild summer weather reducing summer time electricity load and the related reduced demand for natural gas.

This is highlighted on the red line above which plots the 36 month futures curve as of 10/24/14.  The months closer in time have declined significantly with the December ’14 contract down $1.26/mmBtu or 25%.  The entire curve has declined as well, though to a lesser extent.   The futures curve is no longer backwardated.

The table above shows the simple average of the monthly prices of the 36 and 48 month forward curves as of 4/29 and 10/24.

Overall, the 36 month futures curve is down 14.7% while the 48 month curve is down 12.7%.

The graph above looks further ahead at the 60 month futures curve which indicates that the market expects prices to rise.

While the curve is upward sloping, five years into the future, natural gas is trading well below $5/mmBtu.


Over the past six months, market sentiment has swung from concerns that natural gas supply cannot keep up with storage injections – and upcoming winter demand – to the reverse.  Now the talk is more about an oversupplied market.  While there is low correlation between crude oil and natural gas prices, the recent decline in crude oil prices has contributed to overall bearish sentiment.  Generally, the best time to go long is when the market sentiment is most negative.  We may be approaching that point for natural gas.

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Time to Draw Down the Strategic Petroleum Reserve? – Part 2

It has been argued that there is too much crude oil in the Strategic Petroleum Reserve and that it should be drawn down.  Arguments have been made that one should “tie the amount of insurance you carry to the size of the need.”  By that argument, because domestic production is up and “hit record levels in 2011,” and imports “have dropped by more than 20% since 2006,” the reserve is “just too big and full” (see note 1).  It has also been claimed that over the first 30 years of the SPR’s existence, “its volume averaged fewer than 550 million barrels – 75% of capacity” (see note 2).


The creation and stocking of the US Strategic Petroleum Reserve was enabled by the Energy Policy and Conservation Act of 1975 (EPCA).  The EPCA stated that the purpose of the Act was “…to provide for the creation of a Strategic Petroleum Reserve capable of reducing the impact of severe energy supply interruptions.”    See previous discussion concerning the SPR here.  The SPR can hold a total of 727 million barrels of crude oil and is currently at 96% capacity.

Over time, how much crude has been held in the SPR?   

The graph below shows the stock of crude oil in the SPR since its creation.

Over its life, the SPR has held an average of 519 million barrels of oil, which is 72% of its capacity.  As you can see on the graph, it took many years to construct and fill the SPR.  In fact, it was as recently as December 27, 2009 that the SPR actually reached its full capacity of 727 million barrels.  However, the many years it has taken to fill the SPR isn’t relevant concerning the working level for which it was designed.  The SPR was intentionally filled slowly so as to not appreciably affect the market price of petroleum products.   This has been accomplished in part by using royalty-in-kind crude oil from US Outer Continental Shelf leases.  In 2005, EPCA was amended to increase the size of the SPR to one billion barrels, in part as recognition that US crude oil consumption has increased since 1975.  Efforts to expand the SPR to one billion barrels were suspended in 2011.

How exposed are we to foreign imports?

Today, crude oil imports represent 42% of US consumption.  The graph below shows the ratio of net imports to US consumption plotted over time.

In 1975, when the Energy Policy and Conservation Act was enacted, crude imports represented 36% of total US consumption.  After that, imports rose to 47% during December 1977, declined to 27% in October 1985, and then generally rose again to a peak of 66% during October 2005.  Since October 2005, imports have fallen to 42%.


While it is accurate to say that imports have fallen from a high of 66% to 42% today, imports are still above 36%, the level of imports that existed at the time EPCA was enacted in 1975.  While US dependence on crude oil imports has dropped over the last seven years, today it is greater than it was in 1975.  Relying on the original intent when the SPR was established, there is no need to draw down the SPR.

Note 1 – Opinion piece by Austan D. Goolsbee in the The Wall Street Journal, April 10, 2012.

Note 2 – IBID.

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Copyright 2012 by Avalon Energy® Services LLC

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Keystone XL Pipeline – Where’s the Noise?

As the author notes below, on September 5, 2012, TransCanada (NYSE: TRP), the Canadian energy company hoping to build the controversial Keystone XL pipeline, submitted its final re-routing plan to the Nebraska Department of Environmental Quality (DEQ) and the U.S. State Department.  This submission represents the latest step in what has become a more than four year approval process to build the 1,700 mile, $7 billion pipeline stretching from Alberta, Canada to the Texas Gulf Coast.  If completed, this pipeline would transport up to 830,000 barrels of heavy crude per day from oil sand (or tar sand) deposits in western Canada to Steele City, Nebraska and from the Cushing, Oklahoma oil trading hub to refineries in Texas.  It would be integrated into the existing Keystone pipeline system, which currently extends from the Canadian deposits to refineries in Illinois, Oklahoma, and other Midwestern states.  The new project would both increase the Keystone’s transport capacity and link it with Gulf Coast refineries more technologically suited to process the heavy crude produced from oil sands.

The Keystone XL Pipeline was very much in the news a few months ago.  Lately, there has not been much reporting on the pipeline.  Here’s an interesting write-up on the history and current status of the Keystone XL Pipeline – click here.

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Time To Draw Down The Strategic Petroleum Reserve?

What is the Strategic Petroleum Reserve?

The Strategic Petroleum Reserve consists of a number of large underground caverns created in naturally occurring salt diapirs (domes) along the Gulf Coast of the United States.  The caverns were created by drilling wells into the salt domes, dissolving the salt with water, pumping the salt water solution to the surface and disposing of the solution.

The creation of the SPR was enabled in 1975 by the Federal government in response to the 1973-74 Middle East oil embargo.   More specifically, the Energy Policy and Conservation Act of 1975 stated the purpose was “…to provide for the creation of a Strategic Petroleum Reserve capable of reducing the impact of severe energy supply interruptions.”   Maintained by the US Department of Energy, the SPR, with about 700 million barrels of capacity, is the world’s largest government-owned emergency crude oil stockpile.

The Energy Policy and Conservation Act defines “severe energy supply interruption” as “… a national energy supply shortage which the President determines – (A) is, or is likely to be, of significant scope and duration, and of an emergency nature; (B) may cause major adverse impact on national safety or the national economy; and (C) results, or is likely to result, from (i) an interruption in the supply of imported petroleum products, (ii) an interruption in the supply of domestic petroleum products, or (iii) sabotage or an act of God.”

The SPR currently holds about 700 million barrels of crude oil and is about 96% full.  With a maximum draw down rate of about 4.5 million barrels per day, at the US’s current consumption rate of 18.7 million barrels per day, the SPR could supply about 24% of our domestic needs for a little more than five months.

There have been seven petroleum sales from the SPR, four of them significant:

In addition, there have been 10 petroleum loans made by the SPR.  Loans are made to oil companies to help resolve logistical problems.  Oil is returned to the SPR along with additional oil as interest.

Stocks of crude oil in the SPR over time are graphed below:

What do the fundamentals look like in the crude oil market?

Currently the US market for crude oil is adequately supplied.  According to the Energy Information Administration, demand for crude oil in the US is expected to decline again this year to a 15 year low of 18.7 million barrels per day.  At the same time, US crude oil production continues to rise.  Crude oil production in North Dakota alone was nearly 700,000 barrels per day this past June, up from 350,000 barrels per day in January 2011. For a strong indicator of how adequately supplied the market is, look at the market’s response to Hurricane Isaac.  Crude oil prices rose some, but not much.  Previous hurricanes in the US Gulf Coast, or even the threat of hurricanes, have driven prices up significantly.

Are there any supply disruptions in the world oil markets?

Sanctions against Iran have led to a decline in Iranian output to about 2.5 million barrels per day, down from 3.5 million barrels per day at the beginning of 2012.  At the same time, Iraqi oil production continues to recover.  For the first time in over 20 years Iraqi production this summer was greater than Iranian production – 3 million barrels per day versus Iran’s 2.9 million barrels per day.  Last month Saudi Arabia produced as much as 9.9 million barrels per day, and has indicated that it may increase production to 10 million barrels per day, a 30-year high.

International supply disruptions have become less of a threat to the US economy.  The US currently imports about 42% of its crude oil.  This is down from more than 60% as recently as 2006.  And, the EIA expects imports to drop again in 2013 to 39%.  This would be the first time US imports have been below 40% since 1991.

So, if the market is adequately supplied, and supply disruptions are not an issue, why are crude oil prices elevated?

First, monetary easing on the part of the Federal Reserve has led to higher crude oil prices.  Crude oil is traded in dollars.  As the US money supply increases, the value of the US dollar relative to other world currencies declines.  Non-US oil companies have to raise their price in dollar terms just to keep the economics even in their home currencies.

The second driver is geopolitical risk.  Tensions in the Middle East play a role as oil consumers and traders tend to increase inventories (increase demand) as a protective measure in the event that there is a disruption of supply.  This risk tends to drive up spot crude oil prices as well as the short end of the crude oil forward curve.

A good way to see the interplay between the seemingly opposing states of (a) adequately supplied crude oil markets and (b) elevated crude oil prices is to look at the forward curve.  Only the short end of the forward curve has risen.  Beyond May 2013 (8 months), the forward curve is downward sloping, meaning the market expects crude oil prices to decline in the future.  Interestingly, the short end of the forward curve fell more than 7% over the past trading week.  See graph below.

Is there good reason to draw down the SPR?

There are no “severe energy supply interruptions,” and market fundamentals are supply heavy.  US crude oil production is up and continues to rise.  Imports to the US have declined and continue to do so.  There is more than adequate supply in the market to offset reduced exports from Iran.  While there may be many political reasons to draw down the SPR, there are currently no strategic reasons to draw down the SPR based on market fundamentals.

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Copyright 2012 by Avalon Energy® Services LLC