Christopher Swann: Oil bulls may have to pull in their horns

Recent years have been humbling for oil bulls. In 2008 Goldman Sachs was arguing that crude would have risen to between $150 and $200 a barrel by now. Since then the notion of peak oil on which many such forecasts were based has taken a battering. Rather than bumping up against the limits of available oil — as peak theorists expected — drillers have uncovered an embarrassment of mineral riches. And this happened to occur just as hunger for oil slackened amid a deepening global recession.

Despite this setback, oil optimists, like Goldman’s analysts, have recovered something of their former swagger. Surging demand from growing Asian economies, they argue, will outpace even the ingenuity of oil producers, forcing crude prices inexorably higher. Again there are reasons to be skeptical of such prognostications.

For a start, the unused pumping power of the OPEC cartel still stands at 5.4 million barrels a day — against less than 1 million when oil hit its $147 apex in July 2008. So it would take several years of punchy demand growth to chip away at the cartel’s spare capacity. And that’s without counting an impressive range of oil industry investments that are coming on stream.
A steady upswing in oil prices since 2004 rekindled exploration spending and advances of drilling technology have also helped. Shrugging aside BP’s deepwater disaster in the Gulf of Mexico, oil majors are stepping up production in once-inaccessible deposits off the coasts of Ghana and Brazil.

And improving recovery techniques are also prolonging the life of aging oil wells. This is particularly evident in the United States where a seemingly inexorable slide in production, stemming back to the 1970s, appears to have been arrested. Some of the same techniques that have been rejuvenating geriatric wells — including hydraulic fracturing and horizontal drilling — have brought a bountiful supply of oil within reach in the Bakken shale of North Dakota.

Meanwhile bumper gas finds have spewed out precious fluids. Output of these light natural gas liquids could climb by 700,000 barrels a day next year, according to Credit Suisse, up from a rise of 200,000 in 2009. Even OPEC members can pump these freely since they are not counted as part of their quotas. This unexpected treasure trove of easily refined oil is helping relieve pressure on traditional crude.

Penny-pinching motorists across the globe can also look to Iraq for relief. Assuming the political situation continues to improve, output should rise strongly from 2011. And non-OPEC crude supply is expected to climb by 800,000 barrels a day. Tot all these extra sources up and global oil output could rise by around 1.6 million barrels a year, according to Credit Suisse.

Bulls will counter that even these new sources will not match demand. But here too their arguments look premature. True, demand rose by a monumental 2.3 million barrels a day in 2010. A repeat of this would indeed eat into OPEC spare capacity. This, however, looks unlikely. The International Energy Agency is braced for a more manageable increment of 1.2 million barrels a day in 2011. Rich countries even look likely to trim 300,000 barrels a day from their energy diet.

This will offset three-quarters of the increase in demand from China — which though growing fast, still only burns 11 percent of the world’s oil. And the IEA’s cautious demand estimates could fall if the brewing financial crisis on Europe’s periphery eats into economic growth.

Of course, predicting the price of oil requires the kind of omniscience that even mighty Goldman hasn’t mustered. It involves accurately predicting global growth and output in dozens of countries, not to mention changes in efficiency technology, tax and regulatory policy as well as fickle market sentiment. Still, there are few signs of the bottlenecks that pushed oil through the roof in the summer of 2008. Consumers appear generously well supplied as the world’s oilmen look to be keeping up with the rising appetite for crude.

Reuters Blog