The exchangeable value of all commodities rises as the difficulties of their production increase.
~ David Ricardo

Crude Oil as the Next Commodity Supply Shock?

A friend who manages a a good deal of trade of agricultural commodities recently spoke to me about how the increase in domestic oil production has complicated movement of agricultural commodities  In particular, he talked about how the boom in oil drilling in North Dakota has made it hard to procure trucks.  Trucks are used into North Dakota to haul sand to oil rigs for use in hydraulic fracking and used to haul the oil out of North Dakota toward refineries.  One large oilseed processing plant in western North Dakota has had to operate at less than full capacity because it can’t get the trucks and rail cars it needs to operate.

Is oil the next commodity set to experience a supply shock?  Natural gas is already there (see past post), with futures now trading at about $2.00/btu as opposed to $10/btu a few years ago.  Shale technologies may not result in a comparable drop in crude oil prices, but these new technologies can still compete even if crude oil dipped below $50/barrel.  Long term, if the technology continues to progress and can compete with Middle Eastern oil, the world could look different in many ways.

The Bakken Formation, spanning western North Dakota, eastern Montana and into Canada, is thought to be the largest oil deposit in the lower 48 states.  It covers 15,000 square miles and holds more than 4 billion barrels of oil.  New technologies involving hydraulic fracking and horizontal drilling have made it possible to extract oil from rock as thick as concrete.

Other areas will also become more intensive oil producers.  There is much activity currently in Kansas, for example (see Kansas Prepares for Gold-Rush Style Oil Boom)

The U.S. won’t be alone in tapping new oil supplies.  China, currently another major oil importer, has the world’s second-largest store of shale oil.  Countries on every continent have shale oil, making oil a ubiquitous commodity that gives every region of the world the wherewithal, at least theoretically, to be energy self-sufficient.

Search the phrase ‘peak oil’ and you’ll find any number of past and recent articles on the sure eventuality of the world running out of oil.  Prices may not reflect it right now, but contrary to peak oil ideas, it seems that new technology may leave the world awash in crude oil.  For all the bashing fossil fuels take in the media as a non-renewable resource, it seems that they remain throughout history a fuel source with continually replenishing supplies.

So what?  Does this matter to agriculture?  Certainly it does, as agriculture is an energy-intensive industry up and down the value chain.

At an micro level, changes in energy prices can drive changes in costs and technology.  For example, diesel irrigation engines in parts of Nebraska (and likely other places as well) are being replaced this spring with natural gas powered engines because per hour fuel costs will drop from about $12 to under $4.  A center pivot in Nebraska will, on average, put on 600 to 800 hours run time each summer.  The reduction in variable fuel costs by switching from diesel to natural gas reduces expenses by about $42 per acre or 20 cents per bushel.

At a macro level, changes in crude oil prices will have a significant impact as well.  For instance, the economics of ethanol production are liable to be impacted if crude oil prices fall.  Given that more than 5 billion bushels of corn are forecast to be used for ethanol production from the 2012 U.S. crop, almost 40 percent of production, there are significant implications if ethanol production is impacted by lower crude oil prices.  Corn prices are linked to ethanol prices which are linked to crude oil prices.

It may be unwise to proffer a bearish outlook for crude oil and other commodity prices at a time of a weak dollar and the continuation of low interest rate, easy money policies by the U.S. Federal Government.  Commodities are denominated in dollars, and insofar as the dollar remains weak, commodity prices will remain high.  As the current market for natural gas depicts, however, supply shocks are eventually reflected in prices, even in dramatic ways.

Natural Gas Prices 2007 to 2012

‘Brown revolution’ needed to improve soil health