Econ 101...The Law of Supply and Demand

Yesterday, near Terrell, TX, I filled my car’s gas tank for ONLY $1.99 a gallon. That sounds cheap doesn’t it? I suppose it does to those of you a little younger than I. The problem is, I can still remember paying less than 25 cents a gallon for gasoline. I am not an economist and will not or cannot presume to make any economic predictions. But I did take Econ 101 in college and can make a few comments on what happened.

We know that the price of oil has dropped tremendously. Here are a few facts. Yesterday, December 18, the median price was right at $57 per barrel. Back in June the price of oil was around $115 per barrel and most of this decade has seen oil prices hovering around $100 per barrel. In 2008, the U.S. oil production was 5 million barrels a day. By November of this year production was 9 million barrels per day, almost double that of 2008. The price of oil in 1998 was only $17 per barrel.

So, why has the price of oil crashed? All you really need to know comes from Econ 101 and is known as the Law of Supply and Demand, which I do not believe has been rescinded. There are four parts to this Law:

1.     If demand increases and supply remains unchanged, a shortage occurs, leading to higher prices.

2.     If demand decreases and supply remains unchanged, a surplus occurs, leading to lower prices.

3.     If demand remains unchanged and supply increases, a surplus occurs, leading to lower prices.

4.     If demand remains unchanged and supply decreases, a shortage occurs, leading to a higher price.

So, for the answer to what happened all one needs to do is to look at the four parts of the Law. Specifically, read part 4. Supply outstripped demand, leading to lower prices That’s right, high oil prices had the oil and gas companies pumping and hydraulic fracturing, or fracking, as hard as they could. They were making a killing at those prices (just check their stock prices). Unfortunately for them, this created the oil glut in which they currently find themselves. They simply produced more oil than we were using or were willing to purchase.

Is this good or bad? That depends on who you are. Obviously, if you are dependent upon the profits of the oil and gas industry, it is not so good. On the other hand, if you are a farmer, trucking company, airline, railroad, or customer of any of these businesses, then the crash in the price of oil is a good thing. A drop in manufacturing and transportation costs could lead to a drop in retail prices, which would benefit all consumers.

From a strictly personal point of view, one of the best things that could result from these lower oil prices would be the death of fracking. Fracking is a severe threat to the ecology of the earth. It pollutes the air, soil, and water. It also requires millions of gallons of fresh water per well and that water is lost forever. Fracking renders the water too toxic to be recycled for reuse. Large portion of the U.S. oil producing areas  are currently in the third or fourth year of one of the most severe droughts on record. We should not be destroying this precious, life-sustaining, and irreplaceable resource.

The cost to pump oil from a fracked well in the U.S. today is about $65 per barrel. The industry can’t continue to pump oil at a cost of $65 per barrel and sell it for $57 per barrel and stay in business (I learned that in Econ 101 also). However, fracking will continue as long as the price of oil is high enough to cover the variable costs of pumping from wells already drilled, but once they have sucked the existing wells dry I do not imagine there will be many, if any, new wells fracked.

No one knows how long oil prices will remain low. But from your Econ 101 lesson you can guess what will, in all probability, occur eventually. If you aren’t sure, just check out part 4 of the Law of Supply and Demand.