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Page added on May 30, 2012

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Where Are Oil Prices Heading?

Business

A combination of factors has come together to depress not just the price of oil, but a wide swath of commodity prices this year. According to the FT, the benchmark Reuters-Jefferies CRB index, a basket of commodities from wheat to copper, has fallen to a 20-month low of 281.13 points.

The index is down 10% for the year to date and roughly 40% below the all-time high set in mid-2008. ICE July Brent, the global benchmark for oil prices, fell $2.76 a barrel last week to a 5-month low of $105.65 from a peak of $128 a barrel in early March, while U.S. oil prices fell through the $90 key support level, with Nymex July West Texas Intermediate falling $2.14 to $89.71 a barrel.

So what has engineered such a fall? Is it just a reflection of a depressed global economy?

 

Well, in part, of course, it’s a result of slowing demand from Asia, although buying has remained strong even as demand has softened. China in particular appears to be building stocks, probably for security reasons more than an expectation prices will rise. Europe’s woes have added to the sense that the global economy only has one way to go in the near-term. Certainly investors are having trouble seeing how a Europe with or without Greece in the single currency can achieve any significant growth in the next 18 months, with worse-case scenarios painting an even more dire picture.

Another reason is negotiations between the West and Iran over the latter’s nuclear ambitions have progressed; if slowly, at least (so far) without drama. The easing of tension as a result has taken some of the pressure off prices that had factored in a Hormuz Crisis premium.

The less well-acknowledged reason for the price fall is, well, the Saudis wanted the oil. Saudi Arabia’s influence over the oil price is not what it was back in the 70s when OPEC was the price setter and every word spoken by the Saudi oil minister was followed by the industry. But that does not mean the kingdom does not still hold significant influence.

Production was deliberately raised to counter the threat of oil loss from Iran and Aramco is currently pumping in excess of 10 million barrels per day. Indeed, the International Energy Agency estimates Riyadh pumped 10m b/d in April, the highest in 30 years, according to the FT.

Oil traders anticipate a slightly higher production figure for May and June after Saudi Arabia slashed prices by levels exceeding expectations for crude delivered to Asia, which traditionally accounts for roughly 60% of the kingdom’s oil exports. Meanwhile, in the U.S., crude stocks have surged to over 382 million barrels — the highest since August 1990 — as Saudi Arabia seeks to over-supply the market.

Is this a trough or does it have further to fall? As part of a wider fall in commodity prices, most expect prices to continue to come off. Ali Naimi, Saudi Arabia’s oil minister, has said the kingdom favors a price of around $100 per barrel, but the perceived wisdom is they would be willing to let the price under-shoot (maybe $90 per barrel) to encourage inventories to be filled and, the FT’s editorial column says, to avoid the risk of getting embroiled in the U.S. presidential campaign with gas costs becoming an issue.

Certainly, having enjoyed the benefits of oil prices around $120 for several months and with high output, Saudi Arabia can afford sub-$100 prices for much of this year.

While no predictions are made of an end to the super cycle or even price levels 2-3 years out, an oil price of sub-$100 for Brent and sub-$90 for WTI probably will prevail for the coming months.

Seeking Alpha



6 Comments on "Where Are Oil Prices Heading?"

  1. kenneth hickman on Wed, 30th May 2012 3:59 pm 

    I heard that China is buying all the oil rights in the Americas. is this true? If this is true China will own all our oil deposits and they will have control and we will be at their mercy. They will either cut us off or have the price of fuel be so high we will suffer that they will have control over us.If you can find out more on China and our oil please let me know. Thank you and God bless America.

  2. Grover Lembeck on Wed, 30th May 2012 9:56 pm 

    Notice that down to $98/barrel is now considered a huge drop? When did that happen? Are the experts finally admitting that the era of $40bbl oil is now history?

    There’s too much fracking and cookin’ down of oil sands and heavy oil for the price to go low- they stop being profitable, get taken off the market, and the price shoots up again. More likely the price will just stay up there. Barring something crazy like a Chinese collapse.

    And Mr. Hickman, please relax. What you are hearing is hyperbole, and also, look up “nationalization” in the dictionary.

  3. BillT on Thu, 31st May 2012 2:13 am 

    Up, up and away! That is where oil prices are going. Maybe the pump price on gasoline will stay under $5 but your wages will shrink until it is out of your reach.

  4. Gleb on Thu, 31st May 2012 2:42 am 

    I now make 30 percent less income than 4 years ago and feel lucky to have job. Now they might give a machinist with 25 years experience a 10 or 15 cent (thats right cents NOT percent) raise a year. What a joke.

  5. BillT on Thu, 31st May 2012 10:31 am 

    I remember when my dad came home and said he got a 10 cent raise. We celebrated with a fancy dinner. It was 1950 and that represented a 5% raise in his income. I also remember a dime for a cup of coffee and 20 cent bread and milk that was in returnable glass bottles with cardboard caps. But that was a different world.

  6. shortonoil on Thu, 31st May 2012 6:53 pm 

    Our model* (which has a 51 year historical correlation coefficient of 0.96 of actual to projected oil prices) projects a 2012 per barrel price of $71.86 (WTI). Prices have been quite high for 5 of the last 7 years, with only 2009 and 2011 falling reasonably close to the curve at $56.35/b and $71.21/b respectively. This magnitude of price elevation has historically been the result of some type of attempted price manipulation. The most pronounced episode of this occurred during the 6 years of 1980 through 1985 when OPEC attempted to elevate price by cutting their production by almost 50%. Prices surged from an average of $9.01/b to $26.34 (an increase of 292%) before OPEC discovered that you can’t beat the Laws of Thermodynamics. Once OPEC resumed normal production, prices rapidly fell back to the curve, and settled at $12.51/b in 1986.

    Although there are several possible culprits in this scenario (King Abdul a and Uncle Sam not withstanding, not to forget JPM and GS) there is another possibility. Over the the last 50 years (for which we have data) oil prices have been a function of oil’s Etp (P = f(Etp)), or total production energy; the total energy required to extract, process, and distribute the oil. Post peak, in an attempt to maintain revenue the oil industry kept production elevated by channeling energy that would have gone to the end consumer back into production; inadvertently further reducing the flow of energy to the end consumer. In the event that this happened the model projected that prices would increase beyond the statistical boundaries of the curve, the economy would slow, and crude surpluses would appear (all of which we are seeing, and quit differently from what Keynesian economics predicts).

    Regardless of intended or inadvertent actions, prices will fall back to the curve. No one cheats the Second Law; and from there they will resume their relentless climb upward.

    The Hill’s Group

    *”A depletion model of world crude oil reserves”

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