Sudden Decline of Prices a Surprise

When oil prices rocketed past $100 a barrel on their way to $147 a barrel, economist Karr Ingham believed they would remain at that level.
“I did think prices were going to retreat,” Ingham said.
Ingham measures the state’s oil and production economy and reports a monthly Energy Index for the Oklahoma Independent Producers Association.
The energy sector remains huge because the exploration and production industry makes up 3 percent of the state’s total employment, 15 percent of the state’s economy, and pays 30 percent of all state taxes.
The commodities market remains cyclical, said Mike Terry, president of the Oklahoma Independent Producers Association.
“If you look at the history of oil prices in Oklahoma, historic high prices have always been followed by lower prices, often with disastrous results,” he said.
Many may recall the bust of the early 1980s and the financial failures faced by the entire state. Even 10 years ago, oil sold for as little as $8 a barrel and Oklahoma government faced a financial shortfall.
“We don’t want that to happen again,” Terry said.
In fact, Ingham predicted prices would approach, but not reach, $150 before peaking and declining. He predicted gasoline prices would approach, but not reach, $4 before peaking and declining.
“I was fortunate with the price levels, but I had a good idea prices were going to peak and then decline at some point,” Ingham said. “I suspected that decline would be back to, say, the $100 to $110 range.”
What was unknown at that time was the how suddenly the U.S. economy would tank.
“No one was really factoring in the effects of a dramatic, rapid slowdown on energy demand and prices,” Ingham said.
The drilling sector hopes to see a leveling of oil prices that benefits both producers and consumers.
“Higher energy prices benefit producers, but hurt consumers. If prices go too low, new drilling stops, wells are shut in and tax revenue evaporates. Somewhere in between, there is a price for oil that allows for affordable transportation fuel while also providing the necessary capital for independent oil and gas producers to continue to explore for new resources,” Terry said.
The energy industry certainly hopes a floor reveals itself soon, Ingham said.
“I am not sure where that might be, but intuition suggests to me that there may indeed be room for prices to fall further,” he said. “Until the U.S. and global economies begin to right themselves, I think, all bets are off in terms of how far down prices may go.”
Prices continue to fall even today based on deep concerns about the overall economy and the effects on demand.
The easy-to-reach oil has been drained from Oklahoma’s oil fields, Terry said.
If crude oil prices continue their decline, expect crude oil production in the state to diminish, too.
“Many wells will become uneconomical to produce,” Terry said.
Drilling permits, an indication of future activity, remained high through October, Ingham said.
“However, that could easily be a reflection of a backlog of applications, and I expect to see permits declining in short order,” Ingham said.
The rig count appears to have peaked, approaching 220, but recently, it has slipped below 200.
“Drilling activity is typically quite price-sensitive, so even though prices remain historically high (compared to all but very recent history), activity levels are relative, so lower prices will likely result in a decline in drilling activity,” Ingham said. “Part of the reason is that costs have risen dramatically in recent years. Sixty-dollar oil would have been much more profitable five years ago than it is today. Ultimately, those costs will come down, of course, but prices are going to lead the way, meaning prices are presently falling and costs are not yet falling.”
Much of the attention is focused on oil prices, but in Oklahoma, roughly 80 percent of all drilling rigs are searching for natural gas, Terry said. Gross production taxes on natural gas production account for about three-fourths of the state’s total gross production tax intake.
“Oklahoma’s natural gas producers are getting paid as little as $3 for their natural gas. At a price that low, natural gas wells that are difficult and expensive to drill like the horizontal wells in the Woodford Shale and deep wells in western Oklahoma could become uneconomical to produce,” Terry said.
The U.S. economy remains the wildcard.
“If I knew which was going to be the case, oil and gas price trends would be much easier to predict,” he said. “In that period of time, I guess I would expect little improvement in the economy as a whole, and therefore not much in the way of price stimulation,” he said.
Ingham expects the Oklahoma Energy Index to peak in the next month.
“How far and how fast depends on prices, which depend on the economy — and on and on it goes,” he said.
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