Commodities Obey Supply and Demand (It’s a Law)

American Association of Petroleum Geologists (AAPG)

As I have traveled to AAPG conferences during the past year-and-a-half I have been impressed by the number of symposia on shale gas.

I am not struck by the fact that they are held, but rather by the fact that they have all drawn capacity crowds. It is as if 80 percent of our members are working in shale plays or, at the very least, expect to be working in shale plays in the near future.

The most recent of the conferences to feature a session on shale gas was the recent European Region conference in Kiev, Ukraine (see related story, page 39). The interest in shale gas plays is certainly high in Europe, but since the surface owners typically do not own the minerals in Europe, the sight of a drilling rig is much less appealing to the farmers.

As strange as it may seem, I also have been struck by the similarity of the shale gas play to dairy farming. I will stipulate that I personally have not been involved in dairy farming since my youth, but the basic technology and the economics have not changed much in the last 40 years.

Both industries require a substantial capital investment, are labor intensive and are seven-day-a-week operations. The products of both industries are sold at posted prices, and the laws of supply and demand govern the magnitude of the posted price. Therefore, in both markets, there is a penalty for success. The greater your success, the more product you make available to the market – and the lower the price is likely to be.

Both industries are dominated by large corporations, but there is still room in each of them for the small independent.

Depletion is a significant factor in both industries. As the means of production age, the volumes decline.

While dairy farmers do not have the luxury of shutting in production until the price improves, they do not face the need to invest additional capital with the inevitable result of increasing supply in order to maintain their acreage position.

There is nothing unique about milk. Any natural resource is subject to the laws of supply and demand. The exception to that rule may be diamonds, where the supply and price seem to be fairly well controlled.

Before you fire up the computer to send me an e-mail noting that prior to 1973 there was a limited natural gas market and the market price of oil was essentially controlled by the Texas Railroad Commission, I will grant that, at the very least, crude oil market forces were substantially constrained prior to 1973. The entire energy industry experienced a major change in 1973. Texas was able to influence crude oil price prior to 1973 because approximately 38 percent of the U.S. oil production from 1935 through 1970 came from Texas.

For those of you outside of Texas who wonder what a Railroad Commission has to do with oil and gas production, the Texas Railroad Commission was established in 1891 to regulate – as the name implies – railroads. However, in 1917 they were given jurisdiction over oil and gas pipelines, and in 1919, they were given jurisdiction over “the conservation of oil and gas, forbidding waste.”

In 1920, the production and sale of natural gas in Texas was deemed to be a public utility – and the Railroad Commission was given jurisdiction.

As they say, the rest is history.

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President's Column - David G. Rensink

David G. Rensink, AAPG President (2010-11), is a consultant out of Houston. He retired from Apache Corp in 2009.

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