Why Oil And Gas Are Different

Peak Oil occurred in the US in 1970, but a new record for natural gas production may be set soon. This divergence explains why oil’s value grows while natural gas’ value declines.

Oil prices have bounced back from lows in the 30’s earlier this year to around $80 per barrel today. Natural gas prices, meanwhile, have recovered less from summertime lows, from below $3 per Million BTU to $4 today. Oil and gas prices are historically correlated, as the two fossil fuels are often produced from the same wells and share overlapping uses in industry, residential heating, and other sectors. Why have prices for these commodities decoupled, and will this continue in the future?

Here are two graphs, depicting long term US production of oil and natural gas:

US Oil Production

Since its peak in 1970, US oil production has declined from 9.6 million bpd (barrels per day) to 4.9 million bpd, a decline of 49%.

US Natural Gas Production

Natural gas production set a record of 22.65 TCF (trillion cubic feet) in 1973, but 2009 is on pace to reach within 3% of the old record, and 2008’s production of 21.26 TCF is only 6% less than record.

The long term histories of the two fossil fuels show a fundamentally divergence in path. Domestic oil production peaked decades ago, while natural gas production is poised to set a new record if  the market demands it. While Peak Oil is now in the rear-view mirror in most countries, and could be quite close worldwide, Peak Natural Gas has yet to even occur domestically. In addition, oil status as the world’s primary transport fuel is proving difficult to change [1], while natural gas competes against coal, nuclear, and renewables in the market for electricity production. This situation explains the breakdown of the historic price relationship between oil and natural gas, which is unlikely to return soon.

[1] The EIA projects that 3% of new car sales in 2030 will be PHEVs, or plugin hybrid electric vehicles. Even if PHEV sales accounted for 100% of all new car sales, it would take twenty years to replace all existing cars on the road (since the US has over 200 million vehicles and annual car sales around 10 million). The EIA’s projection makes it clear the PHEVs won’t have a significant impact absent an oil price shock that forces a change in behavior.

Is Oil and Gasoline Demand Rising Again?

The media is filled with reports that Americans are driving less, and that gasoline demand and oil demand continue to drop. What’s the reality of the situation? Is demand continuing to drop, has it leveled off, or is it rising again? The graphs below tell the story:

Figure 1: US gasoline demand dropped off in 2008. US Gasoline demand is highly cyclical, and figure 2 corrects for this.

2007 vs 2008 Gasoline Consumption

Figure 2: To eliminate seasonality, 2007 demand is subtracted from 2008 demand to measure the difference week by week. This shows that demand crashed in September and October, but has subsequently begun to recover. Low gas prices may be responsible for the demand rebound.

2008 Second Half US Oil Consumption

Figure 3: US oil demand also dropped sharply during September and October, but has since recovered to mid-2008 levels. In addition to rising gasoline consumption, residual fuel oil demand is rising since oil is now price-competitive with natural gas.

Figure 4: The long term EIA graph shows that demand growth has leveled off, and that after a sharp drop in late 2008, demand is recovering.

Gasoline and crude oil demand seem to have recovered from the levels experienced during the heart of the financial market meltdown. Intuitively, gasoline demand should rebound a bit, since gasoline price deflation over the past year makes driving a very inexpensive activity for consumers. With the recession curtailing further oil exploration, we may be in for a price shock when economic growth returns!

Note: All data used in the graphs can be found by clicking on the EIA graphs, which link to the appropriate EIA data pages.