A Welcome Calm for Oil and Gas

There are few economic sectors as volatile as energy. That volatility is why oil and gas price fluctuation is not counted as part of core inflation by analysts. The rapid changes make it all but impossible to compare numbers from one month or one year to another. The motivations for these radical changes are also extremely varied. It could be some geopolitical event such as the sanctions on Russia, an ill-placed hurricane in the Gulf of Mexico, or simply a surge (or decline) in demand.

The U.S. is currently North-American-independent when it comes to oil supply. The U.S. consumes around 20 million barrels of oil per day and is capable of producing about 16 million barrels if needed. The remainder of the oil consumed in the U.S. comes from Canada and Mexico (93%). That which is purchased from elsewhere is a matter of seeing a bargain here or there, or it is a special blend. At the moment, the U.S. has come very close to its minimum operational capacity in terms of inventory. When the capacity gets this low, the expectation is for oil prices at or above $100, but they have stayed in the 70s for months now, and the expectation is for these per-barrel prices to remain in the 70s and 80s through the bulk of the coming year (unless there is some unexpected development).

The U.S. now relies on productive capacity that can react quickly to demand and supply issues. Fracking operations set up quickly, and output can be adjusted as conditions warrant. That allows more price stability than was the case even a decade ago.

There has been a shift in investor attitude when it comes to energy, and this will have implications for the oil and gas sector. There was a rush to invest in alternatives such as wind, solar, EVs, and the like. That enthusiasm was based on the promise of extensive government subsidy and support. That interest was propelled by legislation such as the Anti-Inflation Act and others. Now these subsidies are threatened as they are not popular with the GOP.

The S&P alternative energy fund has been down by 25%, and the fund focused on fossil fuels is up by 25%. There is still interest in EVs, but the pace of adoption has been slow, and the Energy Information Agency still asserts that fossil fuel will account for over 75% of U.S. fuel consumption by the year 2060. The bulk of this new investment is directed at fracking technology, as well as improving efficiency in existing drilling operations as well as refineries.

The oil business has long been a political target. Big oil is blamed for nearly everything when consumers confront higher gas prices. The reality is that the oil business is determined by international markets, and the companies have very little control over the per-barrel price. At the moment, the price per-barrel has been in the low 70s and has only occasionally reached into the 80s despite the drivers that usually affect oil (tension in the Middle East, Russian sanctions, etc.).

Profits have been reasonable this year, but there is always intense volatility. For example, in 2021 the annual average was 4.7%, but in the fourth quarter that profit margin jumped to 37.0% before falling back in 2022. In 2023, the average has been between 3.0% and 5.0%. The investment community had been focusing on alternative energy until this year, but they are back to oil and gas now. The majority of the investment interest is now focused on fracking and offshore development, but new technology has allowed more development in older wells.

The challenge now is that producers are not sure what demand will look like in 2024. The U.S. has returned to consumption levels from before the pandemic (around 20 million barrels a day), but consumption in China is still far below levels prior to the pandemic lockdown, and consumption in Europe is expected to be much reduced in the coming year as recession has become a major issue in Germany as well as the U.K.

The price per barrel for oil has been pretty stable and lower than expected, and that has been reflected in the price of gasoline and diesel. Gasoline prices nationally are at $3.05, and that is down from last year. The lowest prices are in the Midwest ($2.79) and the Gulf Coast ($2.54) while the highest prices have been on the West Coast ($4.05). Diesel prices nationally are at $3.89.

The highest prices are in California ($5.23) and the West Coast in general ($4.15). The prime driver for diesel demand is trucking, but there has been a surge in demand from the rail sector as well. The expectation is for diesel prices to spike a little as the farm sector starts to consume during planting season. It is important to note that oil prices only account for 50% of the cost of a gallon of gas. 25% is refining, 14% is tax, and 11% is marketing. Much of the variation in pricing across the country is down to taxation. Alaska has the lowest rate for gas (.08) and diesel (.08). The highest taxes are in Pennsylvania (.57 for gas and .74 for diesel). The expectation is that many states will continue to hike gas prices as a means by which to steer people to the EV market.

What Does This Mean for Manufacturers? The bottom line for the manufacturer is that oil prices will likely remain stable, and that will have an impact on logistics costs as well as operational costs. This is not to say that something could happen to affect this balance, but for now the expectation is an extended period of calm.