The Price of Oil: What You Need to Know.

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On Fox News, we read:

With the price of oil now below $56 a barrel, drivers are smiling at the gas pump. However, American oil producers and the states whose economies rely on them are bracing for tougher times ahead.

“If oil drops five dollars a barrel, that’s about a $17 million loss to our general fund and $17 million to schools in Wyoming — a total of about $35 million,” Wyoming Gov. Matt Mead told Fox News. He said, depending on various factors, the oil industry makes up about 30 percent of the state’s revenue.

…Mead acknowledged that in the short term, lower gas prices will benefit businesses and residents in his sparsely populated state, where distances between towns are often calculated in hours instead of minutes.

But, he pointed out, “If we see low prices continue for some time, we’ll see rigs start to lay down. And it’s not just the direct revenue. It’s the hotels, restaurants and all that goes with that.”… Plans for new drilling likely would be the first casualty of a sustained slump in prices, according to Kathleen Sgamma, spokeswoman for the Western Energy Alliance. “There is a point at which the lower commodity price combined with the increased regulatory cost will put new wells out of business — they just won’t be drilled,” she said.

Here’s what you need to understand about the current oil market in America: it’s all a huge bubble. Just like real estate, just like the stock market; it’s a huge bubble. All of this madness has been engendered by the Federal Reserve, which caused these bubbles to appear by providing massive amounts of basically free money to large multinational banks through the process known as Quantitative Easing. Recipients of this money, eager to make a return, have been gobbling up real estate and financial assets in the stock markets. The madness doesn’t stop there. Speculation regarding the presence and viability of shale oil drew a huge amount of investment. Unfortunately for the shale oil market, this investment was based mainly on the flowing spigot of free money offered by the Federal Reserve. Investors desperate for a return have piled into the oil clown car, riskiness be damned, buying up insane numbers of shale oil bonds. This has left the oil companies with a huge amount of capital to invest into drilling, but also with a huge amount of debt. Of course, the investors expect to get their money back. They expect this debt to be paid off. But this debt won’t be paid off. The Law of Supply and Demand is working against the oil companies.

Shale oil production in the United States has introduced a large amount of supply into the system. In turn, this has brought oil prices down. This is great for consumers. I love cheap gas. But you know who doesn’t love cheap gas? The companies producing it. When the oil booms in North Dakota and Texas began, oil was trading over $100 per barrel. Therefore, at the time, investing in a shale oil well seemed like a great idea. $100 bucks a pop! That’s some sweet action. Investors love sweet action, so they dumped huge amounts of capital into upstart oil wells throughout North Dakota, Colorado, and Texas. When I say “dumped huge amounts of capital”, I mean that investors loaned money to oil companies. I’m sure it seemed to make sense to them at the time. After all, $100 bucks a pop! The profits to be had were unimaginable.

Somehow, a lot of these guys never seemed to connect the dots. Apparently, they never took the time to really think about what would happen if the oil markets suddenly had a bunch of extra oil on their hands. It’s too late for them to figure it out, because it’s already happening: the price of oil is plummeting. As of writing this, the price per barrel of oil is approximately $56.  From over $100 in August, to $56 today. That nearly a 50% decrease in price. What do you think this is doing to the profits of oil companies? I’ll give you a hint: think George Costanza in taking a brisk swim in ice cold water.

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Maybe you’re the kind of person who thinks “Yeah! To hell with Big Oil!” That is not the point. The point is that large amounts of money have been invested into the oil industry, leaving the oil companies with huge amounts of debt. If the profits aren’t there, the debts won’t be affordable. What does this mean for the oil companies eyeballs-deep in the shale oil boom? Collapse. The oil industries that have built up around shale oil in N. Dakota and other states are going to experience a massive bust. Production at most wells is going to be scaled back considerably, because running them at full capacity will be neither profitable nor viable at such low oil prices. Many other wells are likely to cease production entirely. What does this also mean for the huge employment boom that has transpired in these areas? It means that a lot of people are going to lose their jobs when the whole charade comes to a close.

The geographical regions that have seen a huge influx of workers and capital due to local oil drilling are going to see an almost equally large outflow when the oil bubble bursts. This, of course, isn’t restricted to just oil. What about the lively real estate market in these areas? The shale oil boom regions have been huge for real estate investors, as large numbers of workers move to work the wells in these areas. When the money dries up, what’s going to happen to the prices of homes and the availability of sound renters? Both are going to collapse. Real Estate investors who have gleefully poured a bunch of money into the oil boom regions are going to find that they’re losing a fortune as the bubble bursts. Furthermore, what about all the retail chains, hotels, restaurants, and service industries that have built up around the oil boom populations? What’s going to happen to them when the locally major industry collapses and employment dries up?

In the long run, this means the price of oil is going to climb back up. Just as Supply and Demand drove the price of oil way down, the same law will drive prices back up again as oil production is heavily scaled back. What we are seeing now – oil less than $100 per barrel – is a temporary phenomenon.

Do not mistake this for me saying that oil prices should be kept artificially high to avoid the popping of the bubble. I have always maintained, and will always maintain, that falling prices are good for consumers. I love cheap oil, and I love cheap gas. I will enjoy it while it lasts. Considering how hard the Federal Reserve has worked to destroy my purchasing power over the past few years, I think I’ve earned some relief for once.

The oil market is going to experience a massive bust soon enough. This is absolutely a result of the Federal Reserve’s zero-interest rate policy, which has basically meant free money for investors. The cost of capital has fallen essentially to zero. The spigot of seemingly free money has produced a series of bubbles in real estate, the stock market, and now the shale oil industry.

Leading the Federal Reserve are people whom many would refer to as our nation’s best and brightest economists, Ph.D.’s educated in the most illustrious of institutions across America. And yet, this is the best they can do: blow bubbles and inflate the currency. Why is this the case? Because no person or committee can ever match the productive power of millions of cooperating individuals making voluntary deals with each other; also known as the “Free Market”. And the Free Market does not like to be mocked. When government bureaucrats start thinking that their schemes and machinations are smarter than the Free Market ever could be, that’s when you can expect the Free Market to reassert itself at any moment.

Long story, short: Enjoy cheap oil while you can. It’s only temporary.

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