So, what happens to the price of oil?
We just attended the annual oil and gas show in Odessa, Texas, where "everyone who is anyone in oil and gas" goes. They believe the price of oil will trend upward.
The IEA and the Energy Policy Research Foundation are considered the world's most important sources for information on oil supply and demand. After the financial crash on Wall Street, the IEA and the Energy Policy Research Foundation initially put out reports saying that there were diminished demand elements in the economy. Their reports suggested that due to the economic recession that demand would decrease substantially. Their reports have been repeated by the global press broadly, but, there is a factor they did not stress. Supply. The world supply is decreasing, partly because of old infrastructure, partly because of depletion, and partly because OPEC is cutting production. We at Global Perspectives, believe that this low price of oil is temporary, and represents and excellent buying opportunity.
A detailed review of their internal charts and other data suggests that supply factors are declining at approximately the same rates as in other years. Also, world demand continues. India and China, as well as dozens of other smaller emerging and developing nations still will have growing and aggressive demand requirements for oil.
In our opinion, the markets over reacted to several reports that were released about the price of oil. Some of these reports were based purely on a guess that world demand would immediately and in the future stop. But now, on “second” thought, we see reports coming out, saying things like: “The real economy continues to move forward (albiet at a slower pace) and depends upon oil”.
In our view, the price of oil will continue to show long term gains. Also, industrial demand for oil will continue to grow. Long term historic trends show that world demand for oil has exceeded world production capacity. Plus, existing oil fields show a decline of production capacity of about 5% per year.
How about refineries? Oil companies won't be building more refineries, because there won't be enough oil left to refine by the time new refineries could pay for themselves. There hasn't been a new refinery built in the US since 1976. In 1982, there were 301 operable refineries in the U.S and they produced about 17.9 million barrels of oil per day. Today there are only 149 refineries, and they're producing 17.4 million barrels. This increase in efficiency is impressive but not a miracle. As with everything these outputs are carefully calculated to optimize profitability. Let me explain.Truth be told, new refineries require tremendous financial commitments which take anywhere from 15 to 25 years to amortize. With record oil prices it would make perfect sense to invest in a few refineries today, except... for the lack of oil to be refined 20 years from now.
Trends have predicted that peak oil production, where the production of oil starts to decline, is reached around 2007-2010. After that, there will be less and less oil to refine no matter where drillers look. In this context, building expensive new refineries does not make a lot of sense as existing ones will be sufficient to process whatever little oil is left. So forget about new refineries, except for a few in the northern midwest to process the heavy oil from Canada.
GLOBAL PERSPECTIVES, predicts a price of oil, to increase to an $80 to $100 per barrel range over the next 12 months, and we see factors indicating a continued increase of the price of oil in future years.
Note this information coming directly from public IEA information, Energy Policy Research Foundation as well as other sources. (Bold and underlined are added by us)
"The IEA has noted the OPEC decision to cut its target output level by 1.5 mb/d from 1 November. We are concerned that reductions in supply may ultimately exacerbate what remains a fragile global economic situation. While the trend in global oil demand has been weakening, there remain considerable uncertainties over upcoming winter demand levels and potential non-OPEC supply outages. Non-OECD demand remains robust and importer country requirements also need to be considered. We note that OECD stocks have again moved below higher mid-year levels, just when the onset of winter requires healthier stock cover. We urge all suppliers to keep a close eye on the impact of their actions on the global economy."
Didier Houssin, director of the office of energy markets and security at the International Energy Agency, the world's main forecaster, said there were strong uncertainties about how demand will evolve because of the economic and financial crisis. "That remains a big mystery,"
Faced with slowing growth, the International Energy Agency initially reduced its forecast for global oil demand since the beginning of the year. But its analysts still see oil demand expanding by 400,000 barrels a day this year, to 86.5 million barrels a day. This initial negative report by the Energy Policy Research Foundation, has been repeated and replicated in the press having a major impact in world price decline. But, a closer look, indicates that there is strong evidence to the idea that oil prices, demand, and supply factors will lead to increases in prices, short term and long term.
"Despite the IEA's wishful thinking, demand is disappearing very quickly," said Lawrence Goldstein, an economist who is the most pessimistic at the Energy Policy Research Foundation in Washington. He said he expected global oil demand to fall this year. It would be the first drop since the energy shock of the early 1980s. But a second look at world supply and demand suggests that Mr. Goldstein's initial opinions may not have taken into consideration long term demand, and especially supply considerations, plus the fact that a majority of the world's oil comes from nations thats could have political stability issues. These factors always create multiple risks for production and supply.
Note the pessimism of statements coming from the press such as: "The double impact of record high prices and slower economic growth has been particularly visible in the United States, which accounts for a quarter of the world's total oil consumption and where demand has slipped to its lowest level since June 1999. Americans have been driving less and flying less this year. Automakers are desperate for a government bailout and airlines are losing billions of dollars."
We would pose two basic questions;
If Americans "stopped flying" why are airlines reporting "full flights" and at highest occupancy in years?
If Americans "stopped driving" why are the freeways and highways so crowded and bumper to bumper daily across this nation?
This general statement does not mention that driving habits of Americans, in truth, did not show major changes, even with high oil and gas prices. Plus the population and number of vehicles on the road continues to expand, not contract in the USA and in other nations around the world.
"As a result, U.S. oil demand will probably decline by 5 percent this year, said Stuart, the UBS energy economist." In our opinion the truth is, that the "growth in demand" may slow somewhat, but in our opinion there will continue to be demand, and even growth in the demand for oil and gas. Furthermore, don't forget diminishing "supply".
The reason, is that there are basic growth/demand factors and the true productive capacity of the world is declining, not increasing. If typical existing production declines at an accepted industry standard of about 5% per year, and experts are quoting a 5% decline in demand then production and demand would be equal. This does not take into account population growth, and pure physical needs that demand production.
While declines are also taking place in some developed economies, in Japan, for example, oil consumption in August tumbled 12 percent from a year earlier, while oil use in France has declined 10 percent, yet in developing countries, such as China and India there is still huge demand. Those economies make up nearly 1/2 of the world's population and have been showing growth in GDP of 7 to 10% per year. They will continue to grow, perhaps at smaller rates. But the fact is that both China and Inda will and can take any "excess production" (if available) that comes on the world. Current price declines have been a bonus opportunity for China and India. Reports will show that they are buying by the millions of gallons.
"There is no question the physical oil market has weakened," Stuart said. "The credit crisis has dried up commerce and halted trade, and that has effectively pushed down demand for oil. The trouble is that no one can predict when this is going to end." This sentence shows the kind of language spin that the press is carrying. Credit is still available, and demand for oil has a level that is stable.
Where prices go next year hinges greatly on what happens in developing countries, especially China. Over the past decade, Chinese oil demand has surged by 85 percent, or 3.5 million barrels a day, and has been the main engine that has driven up oil markets. China accounted for a third of the world's extra oil demand last year.
In the past decade, oil companies and producers have been unable to increase their production fast enough to meet demand. For a variety of reasons, including tougher access to resources, political volatility or violence in many oil-producing states, and steadily rising costs throughout the industry, the growth in oil supplies has been disappointing.
Simply, it is getting harder for oil companies and some producing countries to increase production. Over the next two decades, some experts predict oil production will peake at 95 million barrels a day.
One big problem is that oil fields have a natural rate of decline as oil gets pumped out. The rate varies widely from field to field, but the global average is about 5 percent a year. So, just to maintain output, producers around the world must find and develop about six million barrels of oil a day. To increase global oil production by 1.5 million barrels a day, that figure rises to 7 million or 8 million barrels a day, or at least 2.5 billion barrels a year - a monumental task that gets tougher as production grows.
"The energy crisis is fundamentally a problem of supplies, not of energy demand," said Frederic Lasserre, the head of commodity research at Societe Generale in Paris.
Meanwhile, big producers are struggling. Russian production has been declining in recent months. In Russia, the problems are corruption, inefficiency and beurocracy. Mexico's biggest oil field, Cantarell, is in a free fall, with problems similar to Russia; Nigerian output has been curbed significantly by rampant violence; and any increases in Iraqi production are contingent on improving the country's security. Production in Iran has been hurt because of infrastructure and needs for modernization. Mixture of "religion" and "politics" in Iran has created great inefficiencies in the oil industry. Clerics would rather spend money on pet projects, than rebuilding oil industry infrastructure, pipelines, and refineries.
"Global oil supply is also falling short of prior expectations," said Arjun Murti, an analyst at Goldman Sachs. "The problem, though, is that investors appear to be placing greater weight on the demand concerns rather than the supply shortfalls; it may require a clear bottoming in global growth sentiment before supply shortfalls are again recognized as a bullish factor."
As prices fall and demand slows, because of incorrect perceptions, a new concern in the industry is whether oil producers will reduce their investments as prices decline.
Andrew Gould, the chief executive of Schlumberger, the world's largest oil-field services company, has said that producers will probably reduce spending on field development if low prices persist for more than a year. That view is widely shared in the industry, but as oil prices increase and as the credit crunch goes away many companies will continue to invest. With the corrections of the bail out, credit crunch considerations should gradually go away.
Meanwhile, the cost of producing extra barrels of oil is rising. As prices fall, this might cause high-cost producers, like those working Canada's vast oil sand deposits, to shut down production or curb their expenses. On the other hand, with new technology, those drilling in areas such as the Barnett Shale, might find that it is a wise idea to "nail down" new production and keep it in place as prices rise.
"Investments in exploration and production are very much linked to the price of oil," said Houssin of the International Energy Agency. "What we can fear is that the financial crisis leads to delays in many projects. This would create problems for some operators, while the slowdown in demand would not encourage investments in the short term." As the price increases, the oil industry will expand operations.
The wild card in the oil deck next year will hinge on what actions OPEC takes. As oil fell below $60 a barrel the cartel called an emergency meeting, agreeing to cut output by 1.5 million barrels a day. The price of oil dropped further, but since has creeped back up, into the $60's.
But our prediction is that oil will gradually increase in market value, simply because the world demand, just to keep things rolling, is enough to absorb supply, at current levels.
Just a few years ago, $60 oil would have seemed high. In our view, $60 in a few months will seem low again.
GLOBAL TRENDS AND EVENTS THAT LED OIL MARKETS FROM POSITIVE TO NEGATIVE EXPECTATIONS
Iraq: Produced 2.4 million b/d 1999-2002. The US invasion in 2003 offered promise of rapid investment in Iraqi oil sector as economic sanctions were removed. Turmoil in Iraq drops output to 1.8 million b/d in 2003-06. Investment in field rehabilitation and new fields postponed. Lost production between eras, 600,000 b/d, plus unrealized additional output from postponed investment and inability to perform field rehabilitation. U.S. military leadership there has been poor in energy. Iraq has over 80 billion dollars in cash, that should be invested back into infrastructure. Future "Post USA presence" in Iraq, will see continued conflict in Iraq, and the oil production is a target.
Cambodia: Has a new off shore discovery that looks substantial, and while numbers are not yet in, it could lead to long term economic progress for that nation.
Nigeria: Production rose to 2.4 million b/d from 2.1 million b/d during 2000-05, with expectations of achieving up to 4 million b/d by 2010 commonly accepted prior to 2005. Civil strife and attacks on oil infrastructure has hurt production and investment. Oil production declined in both 2006 and 2007 (2.11 million b/d) after 2.4 million b/d in 2005. 500,000-700,000 b/d due to shut-in production, political instability, and fighting, plus unrealized additional output from postponed investment.
Mongolia: Continues to work with China and tries to attract new investors for it's new oil fields. Infrastructure needs are of major concern. The US has lost it's advantage in Mongolia due to slow response to this opportunity. China will be major beneficiary of Mongolian oil and gas.
Venezuela: In 2002 oil production surpassed 3 million b/d, and showed growth potential after several years of relatively consistent production. A strike at year end 2002 at PDVSA sent production into a nosedive. As of 2007 the country had recovered to slightly less than two thirds of 2002 peak production. In 2008 the nation has shown amazing stability. Recent nationalization has hurt foreign investment from the USA, but has encouraged investment from Russian and China. Venequela is rapidly becoming the leader of Latin America. A new foreign policy by the USA should be put into place to repair relationships there.
Russia: Russian production skyrocketed during 1999-2005, to 9.51 million b/d from 6.31 million b/d. Privatization of Russia's energy industry brought in western investment and more-efficient production and management methods. Output was projected at 10 million b/d by 2006 and expected to grow to 12 million b/d by 2010. Re nationalization of Russian oil companies, most notably Yukos in 2004, scared off investment and slowed production growth. Russia failed to reach 10 million b/d production as of January 2008 but has seen slight growth over the past few years. Russia's major fields in Western Siberia remain in decline; Eastern Siberia is not yet producing oil.
Sudan: A peace treaty signed in 2005 to end the country's civil war was expected to allow for development of previously inaccessible fields. The Sudanese government said in 2005 production would reach 600,000 b/d by 2006. Oil reserves were in the billions, rather than the previously known 560 million bbl of provenreserves. Fighting has continued and rebel groups launched attacks against oil facilities in Sudan, mostly run by Chinese companies. Production has yet to reach 600,000 b/d and has fallen about 200,000-250,000 b/d short of expectations over the past few years, but grew to 570,000 in 2007. New production slow to come online as many new fields remain inaccessible due to fighting, and many western countries have launched divestment initiatives. 200,000-250,000 b/d of additional output not realized, investment outlook remains limited, and access to known reserves has declined.
Argentina: During 1991-98 Argentina's crude oil production grew by 80% to 917,000 b/d. After 2 years of slight decline, production picked up again in 2001. During the 2 years following 2001, production remained constant. In 2004 Argentina nationalized the country's oil industry and created state oil company Ensara. Ensara has been poorly funded by the government. State company, Ensara controls all oil projects; oil production has been declining since 2004 and dropped below 800,000 b/d in 2007.
Kazakhstan: After the fall of the Soviet Union, Kazakhstan opened its borders to oil and gas exploration. A major discovery was made in the Caspian Sea of an estimated 13 billion bbl. Production from this field, Kashagan, was expected to begin in 2005 with a consortium of foreign oil companies and Kazakhstan's KazMunaiGaz. The government has implemented several restrictions against foreign oil companies over the past several years as it seeks to strengthen control of its energy resources. It currently is renegotiating the Kashagan deal it made several years ago with the consortium of foreign oil companies. Most of the Kashagan oil output delay is due to technical problems. Difficult to determine future loss from government forced renegotiation of contracts, but may result in chill on investment levels for new resources.
US: Opening the Arctic National Wildlife Refuge (ANWR) to development has an estimated 10.4 billion bbl of crude reserves—was the major part of President George W. Bush's energy policy when he took office in 2000. Bush policies came into direct conflict with environmental law and his low popularity and poor leadership created problems across the board. Legislation that would allow drilling in Arctic National Wildlife Refuge (ANWR) has been unpopular. Attempts at new offshore exploration have seen similar fates. In August 2007, US courts revoked Shell's right to drill three exploration wells in the Beaufort Sea near ANWR. Depending on when ANWR leasing would have occurred, loss in domestic production could be substantial, the exact amount is unknowable as the prospect has not been drilled, but it could be as much as 1 million b/d had leasing occurred 10 years ago. Oil and gas production with new technology is seen as a positive. Also some leaders in the US oil industry has been interested in the Wind Industry, and have encouraged combining oil, gas, with Wind, to create new efficiencies. Note Boone Pickens and also: http://www.wind-inc.com
Canada (Alberta): Canada has the second largest crude oil reserves in the world, 179.2 billion bbl, behind only Saudi Arabia. It is estimated that about 95% of those reserves are located in Alberta's oil sands deposits. In 2007 the Alberta government introduced new royalty rates, which will increase the government's take by an additional 15%. Alberta has already seen a loss of investment that will hinder future production in the region. In 2007, oil and gas land sales were down over 50%. Several companies, including Canada Natural Resources, Nexen, and Imperial Oil have announced reduced investment in the area. Loss of output is unknown, but rising royalty rates likely will curtail future output growth.
Bolivia: In 1999-2006 natural gas production, a major part of Bolivia's economy, grew by nearly 400% to 466 bcf. Nationalization of state energy resources in 2006 by President Eva Morales and the subsequent loss of U.S. Investment but there has been increased investment interest by Russia and China. Some believe that poor management caused production growth to diminish. The government announced that it will be unable to meet contractual export requirements to Argentina and Brazil in 2008. Lost
Ecuador: Had huge abuses by Texaco and Shell, causing deep environmental concerns by the government. Other disputes and abuses by foreign investors created a political environment and the nationalization of oil properties took place. This has been a positive thing for Ecuador, in that many environmental clean up programs have started, and the industry has stabilized. Ecuador has also agreed to work with other nations such as Venezuela, and the potential net profits for the nation look good. Long term production increases are possible in Ecuador. Ecuador is also encouraging new Wind projects.
Mexico: During 1995-2004 Mexican production increased to 3.85 million b/d from 3.08 million b/d. In September 2004, the EIA predicted production of 4 million b/d in 2005. Mexico's production has been in decline since 2004. The 4 million b/d predicted for 2005 never materialized. Instead output dropped to 3.78 million b/d. Only 3.53 million b/d were produced in 2007, and 3.39 million b/d are expected to be produced in 2008. Some analysts believe Mexico's oil output has peaked, but the more serious problem is that Pemex, Mexico's state-owned oil monopoly, does not have the funds needed for exploration and development of new fields. Much of Mexico's lost production comes from lack of funding for Pemex. Pemex's budget is subject to approval by the Mexican Congress. Pemex operates on a very tight budget, large debt service, and no legal authority to bring in outside investors. We estimate lost of Mexican supply to the world market in 2005-10 to be at 500,000 b/d and possibly more. *Estimated loss of supplies to the world market, 2005-10, would be 2.5-4.5 million b/d. In the end, the estimate of lost production is just that, an imprecise estimate. In many respects, the lost opportunities from these unfortunate events may be more significant as producers lose opportunities to evaluate and extend new technology and gain information that could enhance future exploration in the region in question.
Sources: Energy Information Administration, USGS, Upstream Online, Oil and Gas Journal, Institute for Energy Policy (Moscow), EPRINC Information and data edited by Global Perspectives