Are Gas Prices in Your Area Set to Skyrocket?

By Conway MacKenzie Capital Advisors July 28, 2015 News
    By Hen Chang

    NEW YORK (MainStreet—The higher production of oil in the U.S. from new and remote locations could affect gas prices in the near term as extraction costs are ramping up, said industry experts. While exploration and production companies are now selling oil for $100 a barrel, their profit margins have not kept up and earnings are sliding.

    Chevron, ExxonMobil, Shell and other major oil companies reported weaker earnings recently as they tackle the same problem as many other producers. The cost of producing oil from newer and remote areas from tightly packed formations and deep waters is expensive and not likely to decline soon. Producing oil from some of the formations takes several years and is costly, even with the advent of newer technology as fracking and horizontal drilling.

    Gasoline and oil prices could be affected by the higher costs companies are paying to produce the oil. "The easy oil has been found," said Brian Youngberg, a senior energy analyst at Edward Jones in St. Louis. "The oil we are producing is more expensive to get to and at the same time you have demand picking back up post recession. These factors are helping keep prices high." Unconventional oil that is being extracted is coming from shale formations that needs fracking or horizontal drilling, deep ocean waters or in Canadian sands that require heat to remove the hydrocarbons, which are both costly and time consuming.

    Drilling in the Gulf of Mexico costs about $60 per barrel while production in the Canadian oil sands goes up to $81 a barrel. An onshore field in the U.S. costs about $70, but can go as low as $45 or as high as $95 depending on the location and amountofoil flowing, said Chris Faulkner, CEO of Breitling Energy Companies, a Dallas oil and gas exploration and production company. Production costs vary by location and some areas can be relatively cheap, said Youngberg. The Canadian oil sands require a more complex method to extract the oil and are usually in remote areas where it is more expensive to get equipment there. To process the oil, steam is used to process and remove the heavy tar. Extreme weather also adds to costs.

    The most "attractive" region to drill is the Eagle Ford in South Texas because "shale is not as complex," he said. Oil shale is becoming a "leading source for growth in domestic oil production,"Youngberg wrote in a recentreport. "Oil shale is essentially rock containing crude oil, but until recently it was both too expensive and too difficult to produce. We view oil shale as the new frontier for U.S. oil production."

    The price of oil is likely to remain at $100 a barrel for the next couple of years as production increases, Youngberg said. Demand for oil appears to be "relatively robust." "People are used to $100 for a barrel of oil and gasoline over $3, so it does not cause people to scale back their usage anymore," he said. In 2009, U.S. oil production increased to nearly 5 million barrels per day in 2009 and now has risen to 7 million barrels per day and is expected to continue to increase, he said. While production costs are rising for many oil companies, gasoline prices are not likely to rise soon and instead could fall because of the increased supply, said Jeffrey Huddleston, a managing director in Houston for Conway MacKenzie, a restructuring and financial advisory firm.

    "We may see a pullback in prices based on too much supply," he said. "We have seen it happen with natural gas. Right now I believe there is potential some downward movementon oil prices." Projections indicate that the U.S. could be a net exporter of oil because of the overabundance of oil by 2020, he said. "What's going on today in oil production is something we have not seen before, Huddleston said. "It's high times for oil producers."

    When oil prices crossed the $100 a barrel threshold, costs from vendors such as drilling rigs also rose, making development more expensive, said Faulkner. Vendors charged Breitling Energy Companies 8% for production costs, he said. It costs the company about $50 per barrel to drill in the Bakken. Oil prices could reach $110 in the next few weeks, Faulkner said. "I wouldn't be surprised," he said. For 2014, Faulkner predicts that oil will average $95 to 98 per barrel and continue to rise above $100 in the future.

    "I am not a fan of $100 oil because it makes the costs go up," he said. "It just creates some timing hardships. I'm still very bullish on oil. Oil is at a very high price and will continue to go north."

    —Written by Ellen Chang for MainStreet