In mid-2008, crude oil shocked energy markets as it reached an all-time high of $147/barrel (Bbl.) on the New York Mercantile Exchange. (See Figure 0 below.) Within four months, prices had sunk to $50 per barrel. Then, again in 2014, prices hit a high of about $100/Bbl in June only to fall to under $50/Bbl by December. In April 2020, crude oil futures price dropped to about - $40/bbl for the first time in history. How could these happen, and what were the factors causing these levels of price volatility? We will be exploring these questions in Lesson 2.
At the successful completion of this lesson, students should be able to:
This lesson will take us one week to complete. The following items will be due Sunday at 11:59 p.m. Eastern Time.
If you have any questions, please post them to our General Course Questions discussion forum (not email), located under Modules in Canvas. The TA and I will check that discussion forum daily to respond. While you are there, feel free to post your own responses if you, too, are able to help out a classmate.
Before we begin our discussion of the logistics and value chain for natural gas and crude oil, we need to have at least a cursory understanding of the “upstream” processes for the exploration, drilling, fracturing, and production of these fossil fuels. The following readings and video support this learning.
Go to the EIA website and read the following sections from “Nonrenewable Sources [2]”:
Please take some time to review the optional materials. They will give you context for the rest of the lesson.
Economists have long recognized that we are truly a global society and all of our economies are intrinsically tied together. Growth or recession in one region of the world could have a ripple effect on other regions. China and India were emerging as large-scale industrial countries with vast exports of manufactured goods. Both were consuming new, higher levels of energy (Figure 4), and most specifically, crude oil. News of increasing crude imports by both countries sparked buying of the financial commodity contracts.
The so-called “speculators” were blamed for a lot of the price increase that year, but there was a whole new set of players who greatly influenced the market. Investment funds and private investors, both domestic and international, saw the crude market as a “safe harbor” from the ups-and-downs of the stock market and the US dollar. When the stock market fell, they bought crude oil contracts. And when it rose, they sold those same contracts. The dollar is a little more complicated. When the value of the US dollar falls relative to foreign currency, overseas investors have more “buying power,” that is, they can buy more crude with their currency than those holding US dollars. So, to some extent, it is true that “traders” had a major influence on oil prices that year. But the definition of “trader” had changed from the stereotypical “day trader,” who wreaks havoc on markets, to sophisticated investors and real demand from emerging nations.
Today, the economic health of various countries still impacts the volatility in oil prices, and the US dollar and crude prices have a very high but inverse correlation. And geopolitical conflicts involving oil-producing countries and regions always cause concern over potential supply disruptions.
US oil production has been risen over the past years (before the unprecedented situation in 2020) and stayed at about 12.8 million barrels per day in December 2019. This represents an increase from 2008 to early 2015, decrease in production from around mid 2015 to September 2016, and then increase in production again from then to late 2019. Production from 2014 to 2018 has been over 8.0 million Bbl/d. In 2016, U.S. crude oil production represents only about 55% of consumption, with the remainder coming in the form of imports. However, as Figure 3 shows, imports continue to decline as domestic crude supplies increase.
The rise in domestic oil production is mostly attributed to the new, “unconventional”, sources found in shale formations and high levels of oil price make the production from these sources more profitable. Advances in seismology (“3-D”), directional drilling (“horizontal”) and, fracturing methods (“fracking”), have made this once inaccessible resource commonplace today. Contrary to some beliefs, the number one source of imported crude oil in the US is not the Middle East, but Canada. Oil from tar sands in their Western Provinces is shipped via pipeline into the US.
Figure 2 is extracted from the EIA report on the U.S. crude oil production [29]. Figure 2 shows the upward trend in oil production over the (6) years before 2015, downward trend from mid 2015 to late 2016, and upward production trend again from late 2016 to late 2019 (before the unprecedented global pandemic in 2020). (Based on the latest completed study by the Energy Information Agency of the US Department of Energy.) This link from the EIA includes the historical data from the 20th century [30].
Figure 3 shows the downward trend in oil imports for the same time period (2000 - 2020).
Crude oil is produced in 32 states in the United States and as of 2021 about 71% of domestic crude oil production comes from the following five states [32]:
Crude oil is produced in about 100 countries around the world. In 2021 about half of the world oil production comes from the following five countries [32]:
Here are the top five oil consumer countries in the world in 2021 [33]:
According to EIA [34]:
" In 2022, the United States imported about 8.32 million barrels per day (b/d) of petroleum from 80 countries. Petroleum includes crude oil, hydrocarbon gas liquids (HGLs), refined petroleum products such as gasoline and diesel fuel, and biofuels. Crude oil imports of about 6.28 million b/d accounted for about 75% of U.S. total gross petroleum imports, and non-crude oil petroleum accounted for about 25% of U.S. total gross petroleum imports. ”
Here are the top five countries that the US is importing oil from with their share in 2022 [35]:
Figure 4 displays the China and India oil production and consumption since the 90s. As you can see in this graph, oil consumption by these two countries has increased substantially during the past two decades, while their oil production hasn't changed significantly. This gap has created a large oil demand from these two counties in the global oil market.
Many, many factors can influence the price of crude oil either directly or indirectly. Some of the major factors influencing US crude oil prices are:
The following videos go into greater detail about the factors which can influence crude oil prices. Please note that some of the statistics might be a bit out of date, but please do not worry about that. These are just examples and are meant to teach you about how the various factors influence the market. You will not be responsible for the example details.
(The lecture notes can be found in the Lesson 2 module in Canvas (Lesson 2: Supply/Demand Fundamentals for Natural Gas & Crude Oil.)
(9:04 minutes)
(9:29 minutes)
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Extracted natural gas [38] is mainly composed of methane, with small amounts of hydrocarbon gas liquids (HGL) and nonhydrocarbon gases. After natural gas is produced, it has to be processed and impurities have to be removed to meet the pipeline standards and become marketable. The infrastructure of natural gas delivery (before distribution) can be divided into three main categories [15]:
In 2021, U.S. dry natural gas production was about 34.5 trillion cubic feet and about 13% more than total U.S. gas consumption. This year, five states produced about 69% of total U.S. dry natural gas:
Natural gas is used in more than 50% of US homes for space heating and hot water. In addition, it is the largest source of energy for electrical generation at the moment (2021), see Figure 5. Natural Gas is also widely used in industrial, commercial, and industrial sectors. Figure 6 illustrates the breakdown of natural gas consumption by sector.
Domestic production in the US (see Figure 7) has grown dramatically in recent years due to the same advanced technologies that have allowed crude oil production to increase: “3-D” seismology, horizontal drilling and new “fracking” methods. All contribute to successful recoveries from hard formations such as the new “shales.”
Figure 8 illustrates the growth in the production of the currently active shale basins in the US. As you can see in the graph, natural gas production from Marcellus Shale formations, located mostly in Pennsylvania, West Virginia, Ohio, and New York, has been increasing during the past decade and has the largest portion of gas production among the shale formations.
Due to the increasing demand since the late 1980s, the US also imports natural gas (see Figure 9). Canada represents the largest source (more than 97%) of imported natural gas, with Mexico contributing a minor amount. The export of natural gas had been very limited through pipeline export points into Canada and Mexico. However, the export changed dramatically since 2016 due to the skyrocketing LNG export. In 2017, the U.S. became a net exporter of natural gas and in 2021, the LNG export exceeded pipeline export for the first time since 1990.
Figure 11 displays the U.S. average annual natural gas wellhead, city gate, and residential prices (1995-2019). Please note the increasing trend before 2008 and decreasing prices after. In order to fully understand these trends, have a look at Figure 7 (U.S. annual natural gas marketed production [40]) and U.S. GDP [43]from 1995-2019.
In contrast to crude oil, natural gas was almost strictly a domestic North American commodity* whose price is more influenced by weather and the health of the US economy. It is gradually becoming a global commodity in recent years due to increasing LNG export capacity [44]. Other factors, such as the level of US natural gas inventory, impact prices on a weekly basis. While US economic indicators, such as the stock market, employment figures, housing and, manufacturing indexes, are deemed to be indicative of demand for natural gas, global economies and the US dollar do not have much effect on pricing in this country.
Among the major factors influencing US natural gas prices are:
The following video goes into greater detail about the factors which can influence natural gas prices. (The lecture notes can be found in module 2 in Canvas. (Lesson 2: Supply/Demand Fundamentals for Natural Gas & Crude Oil.)
As we explore pricing for crude oil and natural gas in a later lesson, we will consider the major influential factors for each and define their individual impact. We will also have a weekly activity about the market prices for crude oil and natural gas and the factors we believe affect them.
Note: When commodity price is expected to go up, the market is called bullish [46]. In this case, an investor will invest in the commodity. On the other hand, if prices are expected to go down, then it’s called a bearish [46] market. In this situation, an investor is expecting the commodity to lose its value. Consequently, the investor sells the financial commodity.
Now that we have examined production and consumption in the United States as well as the energy “mix,” we will focus on the fuel sources that comprise over 57% of the energy used in this country. Crude oil, with refined products, and natural gas and related natural gas liquids (NGLs) make-up this large sector.
You have reached the end of Lesson 2. Double-check the list of requirements on the first page of this lesson to make sure you have completed all of the activities listed there before beginning the next lesson.
Links
[1] https://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=RWTC&f=M
[2] https://www.eia.gov/energyexplained/index.cfm?page=nonrenewable_home
[3] https://www.eia.gov/energyexplained/index.cfm?page=oil_home#tab2
[4] https://www.eia.gov/energyexplained/index.cfm?page=oil_home#tab1
[5] https://www.eia.gov/energyexplained/index.cfm?page=oil_refining#tab1
[6] https://www.eia.gov/energyexplained/oil-and-petroleum-products/refining-crude-oil-the-refining-process.php
[7] https://www.eia.gov/energyexplained/index.cfm?page=oil_where
[8] https://www.eia.gov/energyexplained/oil-and-petroleum-products/where-our-oil-comes-from-in-depth.php
[9] https://www.eia.gov/energyexplained/index.cfm?page=oil_imports
[10] https://www.eia.gov/energyexplained/index.cfm?page=oil_offshore
[11] https://www.eia.gov/energyexplained/oil-and-petroleum-products/offshore-oil-and-gas-in-depth.php
[12] https://www.eia.gov/energyexplained/index.cfm?page=oil_use
[13] https://www.eia.gov/energyexplained/index.cfm?page=oil_prices
[14] https://www.eia.gov/energyexplained/index.cfm?page=oil_environment
[15] https://www.eia.gov/energyexplained/index.cfm?page=natural_gas_delivery
[16] https://www.eia.gov/energyexplained/index.cfm?page=natural_gas_where
[17] https://www.eia.gov/energyexplained/index.cfm?page=natural_gas_imports
[18] https://www.eia.gov/energyexplained/index.cfm?page=natural_gas_use
[19] https://www.eia.gov/energyexplained/index.cfm?page=natural_gas_prices
[20] https://www.eia.gov/energyexplained/index.cfm?page=natural_gas_factors_affecting_prices
[21] https://www.eia.gov/energyexplained/index.cfm?page=natural_gas_environment
[22] https://www.eia.gov/energyexplained/index.cfm?page=hgls_home
[23] https://www.eia.gov/energyexplained/index.cfm?page=coal_home
[24] https://www.eia.gov/energyexplained/index.cfm?page=nuclear_home
[25] https://www.e-education.psu.edu/ebf301/sites/www.e-education.psu.edu.ebf301/files/Transcripts/Lesson2_Transcript/Oil%20and%20Gas%20Formation%20Transcript.docx
[26] https://www.e-education.psu.edu/ebf301/sites/www.e-education.psu.edu.ebf301/files/Transcripts/Lesson2_Transcript/Oil%20Well%20Drilling%20Process%20Transcript.docx
[27] https://www.e-education.psu.edu/ebf301/sites/www.e-education.psu.edu.ebf301/files/Transcripts/Lesson2_Transcript/Hydraulic%20Fracturing%20Transcript.docx
[28] https://www.e-education.psu.edu/ebf301/sites/www.e-education.psu.edu.ebf301/files/Transcripts/Lesson2_Transcript/How%20does%20fracking%20work_Transcript.docx
[29] https://www.eia.gov/petroleum/production/
[30] http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=pet&s=mcrfpus2&f=m
[31] https://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=pet&s=mcrimus1&f=a
[32] http://www.eia.gov/energyexplained/index.cfm?page=oil_where
[33] https://www.eia.gov/tools/faqs/faq.php?id=709&t=6
[34] https://www.eia.gov/tools/faqs/faq.php?id=727&t=6
[35] http://www.eia.gov/tools/faqs/faq.php?id=727&t=6
[36] https://www.eia.gov/international/analysis/country/CHN
[37] https://www.eia.gov/international/analysis/country/IND
[38] https://www.eia.gov/energyexplained/index.cfm?page=natural_gas_home
[39] https://www.eia.gov/tools/faqs/faq.php?id=427&t=3
[40] https://www.eia.gov/dnav/ng/hist/n9050us2A.htm
[41] https://www.eia.gov/naturalgas/weekly/
[42] https://www.eia.gov/naturalgas/importsexports/annual/
[43] https://fred.stlouisfed.org/series/GDP
[44] https://www.eia.gov/todayinenergy/detail.php?id=53719
[45] https://www.eia.gov/dnav/ng/NG_MOVE_EXPC_S1_A.htm
[46] https://www.youtube.com/watch?v=AIAyCgtEWws