We’ve seen this before…

Are low gas prices going to stick around? Will Congress use this opportunity to raise taxes? When will gas prices go back up?

I’ve been thinking about oil and gas prices a lot lately. It’s hard not to with all the talk on the TV news shows, comments on the radio and the seemingly endless stream of financial experts and economists noting that the fall in gas prices is good for other parts of the consumer economy. I even heard some knucklehead saying we might be in for a multi-year period of low gas prices.

These low prices even have Congress considering an increase in the federal gas tax. I hope all those Republicans that ran on a distaste for taxation will win the day on this debate, because if they don’t we will all suffer under higher gas prices plus higher gas taxes.

However, the idea of a multi-year run of low gas prices seems highly unlikely to me, and here is why.

Most of the overproduction of oil is because of the Shale boom in the United States. Many of the companies drilling in the shale formations are doing so by way of leverage. They borrowed money in order to pay for their drilling operations. Some of this credit is pretty expensive, as high as 25% interest. Much of this credit also was set up on assumptions that the price of a barrel of oil would be higher than it is today. Most of this credit is on the assumption of $60 per barrel or higher from what I’ve read (I haven’t read much because oil and gas are not my field of expertise).

What all this means is that smaller drilling operations will not be able to sustain operations with depressed oil prices for very long before they can no longer repay the debt they incurred to drill in the first place. Some have already succumbed to the fragility of their financing, many more will follow. The result is that only the larger, more financially secure/diversified rig operators will be able to weather this storm.

In other words, the small players will collapse under bankruptcy while the larger players will be able to buy up their assets at bargain basement prices. The little fish will be eaten by the big fish. And once the glut of oil filters through inventories, prices will rise again. This time with less competition, and less appetite for speculation from the recently burned energy credit providers. To make a long story short, higher gas prices are coming, and with a vengeance.

This will probably last for just a few more months, and then prices will rise, probably just in time for summer.