Oil Prices and Drones

My home sale recently took a weird turn when the original buyer came back to the table. Expressing regret, he has offered to make a deal better than the one I have on the table, close earlier, and remove all requests for repairs.

I’m tempted, and not just because the terms make better sense.

This is Oil Country

Living in the heart of oil country, we’ve got a front row seat to the ebbs and flows of energy in the U.S. By all accounts, these are years of plenty.

According to preliminary data from the International Energy Agency, the U.S briefly upended Saudi Arabia as the largest oil exporter in the world in June. This comes after the U.S. became the largest energy producer in the world last year. Our exporting prowess is courtesy of the Obama administration, which lifted a ban on exporting oil that reached back to the days of Jimmy Carter.

We’ve built numerous natural gas liquefaction plants in the U.S., which allow us to export that fuel as well.

But I’m not bullish on energy companies, which confused one of our subscribers. He asked if so much energy was flowing through and out of the country, then why won’t energy companies benefit?

It all comes down to price.

The Effect of Fracking 

For most of my life, we bought ever larger quantities of oil from other countries, and built refineries tailored to handling their grades of crude. The more we bought, the more money we shipped out of the country, which increased our current account deficit. Because energy was a net cost to the nation, we cheered when oil prices plummeted, like in the late 1990s when the price touched $10 per barrel. Pain at the pump was shared by pain as a country.

But fracking changed all that.

As we found new ways to extract oil, we dramatically increased our proven reserves and drove the growth of domestic energy companies large and small. We still import oil for various practical reasons, but imports are down and exports are growing, which helps our current account deficit and reduces our dependency on other nations

Our newfound oil riches also put consumers across the table from energy companies. As prices fall, consumers pay less at the pump, but energy companies earn less revenue, which brings me back to my house.

The Energy Sector

Our area lives and breathes with the energy sector. Sure, we’ve got a few NASA types hanging around because Johnson Space Center is across the lake, but the main driver of prosperity is energy. When prices fall, employers scale back, workers get fired, and home prices get mushy.

The growing U.S. energy sector has capped prices on the international market, ruining the plans of OPEC-plus, the oil-producing nations that are trying to prop up prices by restricting supply. It’s not hurting my feelings that bad-acting nations around the world, which we used to send cash by the boat load, are suffering with lower prices for their exports. But we have to keep an eye on our local companies as well.

Harry has long pointed to fracking companies as a weak link in the economy because many of them don’t earn profits, they just plow revenue back into drilling. If prices drop significantly, these firms won’t earn enough to pay their debts, which could drive returns in the sector even lower than they have been for the past year.

Donald Trump and Iran

President Trump threw the oil markets into turmoil last week when he suggested he might ease some of the sanctions on Iran. The nation has some of the largest oil reserves in the world, and before U.S. sanctions it exported more than three million barrels of oil per day. That number has dwindled to less than 200,000 by some estimates.

If Iran is allowed to sell oil, which it desperately needs to do so it can obtain hard currency for trade, then we’ll see even more supply hit the markets.

On the flip side, there’s always the prospect of war, even if on a very small scale.

Yemen vs. Saudi Arabia 

Houthi rebels in Yemen took responsibility for a drone attack deep inside Saudi Arabia last weekend, although U.S. officials believe it was the work of Iran. The 10 drones targeted two oil facilities that process almost 8.5 million barrels of oil per day. Saudi officials said that 5.47 million barrels of daily production were offline after the attacks, and could remain so for months.

This is obviously a big deal and drove prices higher by 20%, although they later pulled back. The world will have to pull oil from reserves, like the U.S. Strategic Petroleum Reserve, unless we want to see oil shortages and price spikes before Saudi production fully resumes or other producers make up the difference.

But the strike did more than cause an immediate issue, it revealed a vulnerability in the industry.

The countries that make up OPEC-plus are giving up $600 million per day in revenue as they try to drive up prices. A rag-tag rebel group showed that it could be done for less than $15,000 worth of drones. If other groups start using such tactics, they could wreak havoc on the international oil markets, leading to volatility at the pump, and even affecting real estate prices in my neighborhood.

Then there is the aftermath. If frackers increase supply to fill the hole left by the Saudis, what happens to oil prices when the Saudis come back on line? The price of oil could drop dramatically in a few months when we once again find ourselves awash in the black gold.