The case for lower oil prices
Posted on February 1, 2007 by Richard Beddard
Filed Under Investing |
Last week I claimed the only way is up, for oil! A sentiment that represents the consensus reported in the media; that rapacious Chinese consumption and the notion that oil must run out some time, will keep prices high.
Bob Rankin, a reader, replied that in 1981 he bet on a sustained rise in the oil price only to lose money on Tricentrol. He said:
In the longer term, my mistake was a good-value piece of education. In market terms, nothing seems to be forever.
Instinctively, I think most investors would agree. Possible challenges to the oil consensus are easy to think up; alternative energy sources, say, or problems in China. But do any experts take the possibility of lower oil prices seriously?
Leo Drollas, deputy director of the Centre for Global Energy Studies, does. He wrote a report: ‘Are high oil prices here to stay? A study of oil demand, supply and prices to 2020‘. I talked to him yesterday by telephone.
Far from the $100 plus projections, Dr Drollas forecasts lower prices in future: $43 in 2010, $38 in 2015, and $49 in 2020 for the OPEC Basket. Brent oil prices would be about $4 higher.
This is what Dr Drollas impressed on me:
- Oil supply from non-OPEC countries like Brazil, Angola, and the Caspian will escalate until about 2010.
- Conventional oil supply may decline from the 2020’s but that doesn’t include tar sands in Canada, Venezuelan heavy oils, and shale oil in the USA.
- Oil from unconventional deposits was too expensive to extract in the past but technology will reduce the cost and higher (but not excessive) oil prices will increase its affordability.
- While President Chavez’ socialist revolution is stifling investment in Venezuela, oil companies are sinking $6 to $8 billion a year into Canadian tar. Once the investment is made, it will be worth producing the oil at prices as low as $10 to $15 a barrel.
- Technology will reduce demand, as well as increase supply as hybrid vehicles and biofuels become common, for example.
- Demand from China and India should not be taken for granted. He says:
These two countries subsidise oil products. China subsidises gasoline, diesel and fuel oil across the spectrum. India subsidises kerosene heavily. Take away the subsidies and demand falls. It’s costing a lot as China is importing at international prices.
- Oil is also subsidised in the Middle East. The cheapest gasoline in the world is in Iran where it costs 9c per US litre and demand is rocketing. Again:
Scratch under the surface of demand: in the areas where demand for oil is growing, it is subsidised. In the rest of the world it is dead really.
- The EU has introduced targets for biofuels, and carbon trading. A Democrat government in the US would probably follow suit.
- If OPEC’s current plans for investment come to fruition, it will have more excess capacity.
- If it slackens investment, higher prices mean even less demand. $50 to $55 is unsustainable because individual OPEC members would break ranks and increase revenues by producing more.
- Saudi Arabia is the only OPEC member we “can talk about with clarity”. Kuwait has investment plans. So do the UAE, Libya, Algeria and Angola.
- Even before new investment, Saudi Arabia has 2.4m barrels per day of spare capacity (21%). If that were unleashed, the oil price would fall.
- It’s in Saudi Arabia’s interests to keep oil affordable lest high prices push it’s biggest customers into conservation measures, like London’s Congestion Charge.
- Nigeria would like to invest, but is fighting a guerrilla movement.
- Venezuela is a “huge disappointment”. Investment there will only take it back to where it was in 1999.
- At least three things hold Iran back: It’s industrial model, which deters oil companies from developing its fields, sanctions, and heavy subsidies. Rocketing demand means its eating it’s own exports.
- Iraq has the best prospects of all, but although “everything is tranquil underneath… on the surface it’s mayhem.”
- Even if Iraq were to splinter into separate states after a civil war, those states would still pump oil, “because that’s all they’ve got”. CGES’ base case is 5.5m barrels per day by 2020. Iraq produces 2m barrels per day today.
It’s not the conventional wisdom but “That’s the danger of casual reading,” says Dr Drollas. “Geologists are natural pessimists, economists are natural optimists.” Others, solar panel manufacturers and “eco-nuts”, have different agendas, he says.
Frankly, I don’t know if Dr Drollas has an agenda beyond the objective research CGES says it funds. The Centre has connections with Saudi Arabia through its founder, Sheikh Ahmed Zaki Yamanih, Saudi Arabian Oil Minister from 1962 to 1986. But regardless of that, there is a case for lower prices in the long-term.
Thanks for reminding me, Mr Rankin.
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2 Responses to “The case for lower oil prices”
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Interesting and, I believe, right. Oil will not, in the long term, hit the $100+ “economy destroying” levels the doom poundits depict for 2 reasons; the increasingly efficient use of oil noted in the article and the development of alternatives.
The real problem might, in fact be oil that becomes too low in price. Why? Because the great oil producing countries, with the exception of homeland Russia, have, in the main, not used their oil wealth derived since 1945 to diversify their economies but to either indulge in conspicuous consumption and corruption - Nigeria - or to build grandiose but useless infrastructure symbols such as the highways that lead no where in many Middle Eastern states.
I believe that most of the world’s oil, especially that now supplied from volatile and unstabe regimes, will stay where it is now, in the ground.
The oil price gouge3 of first 1973 and latterly the early parts of this century have frightened the Americans. You may not like them but don’t underestimate them. They have an almost messianic belief in the ability of technology and the $ to solve problems and often, they have been proven right. So what price fusion/fuel cells/pebbel bed fission reactors and wave and wind power being their main source of energy within 30 years?
If that does happen then watch out for real trouble in the Middle East as populations cheated of a sustainable future rebel against those who have failed them.
Steve Oakley
Thanks Steve,
It is interesting. The trouble I have is in weighing up the different scenarios. Dr Drollas is very convincing on the ‘phone and no doubt he has fancy economic models but the assumptions that go into them are still human.