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I read an article about the recent fall of gas prices in the US claiming that the fall in gas prices was due to the expansion of fracking within the US. The article said that, over the past few months, the oil harvested from fracking had come onto the market reducing the price of gas at road-vehicle refueling stations.
Obviously, I realize that an increase of supply with a constant demand will decrease prices. But, is there any way to validate the article and conclude that the decrease in oil prices was due to fracking? The article I read did not go into detail on how they reached their conclusion.

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I don't think this question satisfies the requirement of expert-level questions, as stated in the private beta mail. – FooBar Nov 28 '14 at 22:03
Why would you not apply a standard Hotelling model that predicts no increase in price? In the absence of immediate fracking, does that gas stay in the ground forever? – Steven Landsburg Nov 28 '14 at 22:18
@FooBar I think this is a simple question that invites an expert-level answer. There's a lot of input into energy pricing and putting to bed a naive one-to-one correlation between raw material supply and final consumer price is certainly something in our scope. A good answer could delve into factor inputs, sunk costs, volatility, inventory buffering, and other things often overlooked in news releases. – Jason Nichols Nov 29 '14 at 5:27
Which gas price - Henry Hub spot or something else? What oil - what grade? – EnergyNumbers Nov 29 '14 at 9:08
@EnergyNumbers I believe that we are talking about crude oil since the article speaks a little on the implications for OPEC in the future. I put the article in the question if you want to look at it further. – Mathematician Nov 29 '14 at 15:21
up vote 1 down vote accepted

The best way to get into the various factors at play on this is to look at the Oil Import/Export & Consumption figures for the USA, which the EIA provides in glorious detail (click on the expand button to see the individual charts):

US Oil Consumption - Import/export

It´s not the case as some have claimed that the US has become a net exporter, but Oil imports have significantly declined from their peak in 2006, and the situation with natural gas is equally dramatic. Interestingly though, there has also been a drop in consumption, which I would speculate is partly due to the 2006 recession, and may be a contribution from other energy sources, and may also be increasing energy efficiency developments triggered by the high oil price.

As Brythan quite correctly points out below, this doesn't include the time series data for production/consumption in the rest of the world, which can be found here:

World Oil Production

we can see that total world production has increased by around 6,000 barrels a day since 2005, about 4,000 of which would be the US production increase.

Since the US is still the largest consumer of oil on a per country basis (approximately 2x the Chinese who are currently #2), the combination of this with the drop in imports by the US can be expected to have a significant knock on effect on the price of oil, reducing it globally.

Over the long term it really depends on what you are prepared to believe about the increasing efficiency of solar power, how long the new fields remain competitive, and what other sources of fracking may be available outside the USA, which can be exploited, as to what will happen to the price of oil. Certainly for the next few years though, and ceteris paribus of course, I´d expect oil prices to stay down.

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-1: I like that you provided links to relevant data. However, it is a little concerning that the economic analysis provided here does not even mention Hotelling's rule (or any similar analysis)---this is usually the first model you should go to when analyzing the price of a non-renewable resource. – jmbejara Dec 23 '14 at 10:24
Hypotheses such as Hotelling´s have to be viewed in the context of their time and the knowledge of the monetary system´s behaviour extant at that time. I appreciate it may be necessary to cite it get through badly set exams, but that´s the only purpose I could recommend it for. – Lumi Dec 31 '14 at 2:50

over the past few months, the oil harvested from fracking had come onto the market reducing the price of gas.

Obviously, this makes no sense insofar as the oil harvested from fracking displaces oil harvested by other means.

Absent changes in supply or demand, the price of oil has to rise at the rate of interest.

The development of a new extraction technology is a one-shot increase in supply, which should lead to a one-shot fall in price, followed by a resumption of the ongoing increase at the rate of interest. It can't (by itself) explain an ongoing fall in price.

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While in theory you could add the entire new supply of oil made available by fracking at the time of development, in practice it doesn't work like that. They don't know how much oil they can recover that they couldn't previously. Until the supply is actually pumped, it doesn't have that much impact. This is why OPEC can increase oil prices by restricting the flow. If only the overall supply mattered, then OPEC would be irrelevant. They can't change supply, only the rate of flow. – Brythan Dec 2 '14 at 4:02
@Brythan: You are right that there is uncertainty about how much additional oil can be recovered as a result of fracking --- but presumably it's about equally likely that the estimates will be too high or too low, so that the current price could be either too low or too high, but should be about right on average. – Steven Landsburg Dec 2 '14 at 4:19
Fracking increases uncertainty because it's new. They don't yet know how much more oil they will be able to get with fracking. As a result, they can't fully include future supply in their pricing (or even as partially as they could pre-fracking). Another issue is that if the rate of flow is increasing but demand is stable, the best time to sell is now. This drops current prices. But it can't drop current prices too much, as they need to actually be able to supply the gas. Some of that flow isn't available yet. So prices drop until the actual flow catches up to the potential flow. – Brythan Dec 2 '14 at 4:45
A factually incorrect counter-example. – Brythan Dec 2 '14 at 23:37
+1: This is the only answer here that provides some analysis based on reasoning along the lines of Hotelling's rule---the goto model for analyzing the price of non-renewable resources. (I mean, it needs to be at least acknowledged.) It's a little concerning that perhaps so many people don't see that (this answer currently has 3 downvotes!!). – jmbejara Dec 23 '14 at 10:27

This started as a comment on Stephen Landsburg's answer but was getting too long for the comment format.

When a new supply of oil is discovered, it increases the potential new supply. This will cause prices of oil fields to fall (if everything else is constant). However, gasoline costs are determined not by the future supply but by current supply. Gasoline is mildly unstable and will spoil if kept for months or years. Therefore, there is less time shifting once the gasoline is refined than there is while the oil is still in the ground.

Most gasoline will be pumped to an end user within a month or two of refinement. Therefore from the standpoint of day to day prices, it's the amount of gasoline that is currently available that is important.

Assume that the oil field prices fell due to new supply being discovered. This can happen quickly. What takes longer though are actual changes to the end user. The issue is that you can't just produce as much gasoline as you want immediately. Since prices are falling, it's to your advantage to sell as much as you can as soon as you can. But you can only increase current flow if you have slack capacity. If you don't, you need to add new capacity. This restricts how much additional flow can be added immediately by existing participants.

Over time, both existing and new participants can produce oil. If current participants have a cartel to keep supplies down and prices high, they can either increase their production to take advantage of current prices, keep production the same, or decrease production -- possibly so as to keep overall production (including new participants) the same. Cartel members may be reluctant to decrease production though. They are already facing less income due to lower prices. If they also decrease production, they may increase prices in the near term, but they still face lower prices as more new participants join.

Cartel members are engaged in monopolistic pricing. They are producing less than they could in order to maximize profit. Assuming the new participants do not join the cartel, they will price at competitive pricing. They'll produce up to the point where the cost to supply including their profit requirement reaches the demand price.

Note that the actual price will depend on what people do and how the supply is impacted. My point is that price changes won't necessarily be fully realized immediately. There's a difference between short run prices and long run prices and the uncertainty of what's actually happening in the long run. Prices can decrease over time due to a supply shock. They may not though. They could also be combined with a demand change. Or other supply changes. Or external events unrelated to oil that make people more or less risk averse.

I am suspicious of Moore's model. It's plausible but nowhere near definitive (and it aligns with his pro-fracking views, which makes it suspect in my eyes). I'm also suspicious of Landsburg's model. I'm concerned that it skips past short term effects to a long run result. Both models seem overly certain to me. Unfortunately, I have more questions than answers. Lumi's link is interesting, but it leaves out demand and supply in the rest of the world.

The worst part is that any answer should be taken with a grain of salt. We don't know what the world would be like without fracking. All answers here are speculating. Gas prices might have fallen regardless. Or stayed the same. Or even increased.

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You´re right, those are some good points about petroleum liquidity. The only thing missing is financial speculation - algorithmic trading has played a certain amount of havoc with oil pricing in the past, but that tends to sort itself out over a few months - and it´s next to impossible to quantify. – Lumi Dec 3 '14 at 0:55
You mention "Moore's model." What is this model that you're referring to? – jmbejara Dec 23 '14 at 10:18
@jmbejara Model may be the wrong word. Moore's assertion is that the use of fracking has shifted the supply curve such that prices have decreased. I don't know that Moore has a formal model that can be examined. – Brythan Dec 23 '14 at 10:28

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