Energetic Disagreements on Oil
With crude-oil prices hovering near $60 a barrel since June 17 and around $50 a barrel off and on since February, oil and energy have been the favorite sons of many a stock-picker. But the question that keeps those successful investors awake at night is: How much longer can it last?
Conventional wisdom holds that oil prices, like anything else, are controlled by supply and demand, and international economic growth is fueling better-than-expected demand (see BW, 7/11/05, "Is There Plenty of Oil?").
Yet oil industry insiders seem to disagree on whether imbalances exist and availability projections. The picture is clouded since reliable data on supply and demand, especially in certain foreign markets, can be difficult to come by.
BusinessWeek Online's June Kim spoke with several experts to see if they can define current market conditions and what may happen in the months and years ahead. Following are edited excerpts of their answers to key questions about oil.
Q: Is enough oil out there? Beth Ann Bovino, Standard & Poor's economist:
Q: Is enough oil out there?
Beth Ann Bovino, Standard & Poor's economist:Our concern is that oil companies aren't really looking for oil right now. We've seen a bit of a pickup in exploration, but in the last few months, oil companies have been expecting prices to drop and haven't put expenditures in.
They don't want to be burned like they were in the '80s, so they've been reluctant to spend on exploration. There will certainly be a need to increase exploration and build refineries to increase capacity, which are at very tight levels.
Michael Lynch, president of Strategic Energy & Economic Research: I don't think there's a supply problem. Inventories are quite adequate and rising by about half a million barrels a day above the five-year average.
Stephen Leeb, editor of Complete Investor newsletter: No. Basically, demand and supply are roughly balanced at this moment. But there's not nearly enough ability to increase supply to match the increase in demand. There's not any meaningful excess capacity. Given that the world will continue to grow, that says there's a protracted supply deficit ahead of us.
John Kingston, global director of oil at Platts: If the question is simply whether supplies are adequate to meet demand, yes, they are, in that we're now consuming 100% of supply. There's still some spare capacity in the world, estimated to be as much as 1.5 million barrels per day and maybe as little as 500,000 barrels per day.
What's different this time is that there's so little spare capacity relative to demand. Secondly, the capacity that's unused and the capacity that has been brought on recently is mostly capacity to produce heavy sour crude, which is the least desirable crude on the market because of its lower yield of light ends such as gasoline and diesel.
Q: Are demand growth forecasts from India and China accurate? Bovino:
Q: Are demand growth forecasts from India and China accurate?
Bovino:India's demand isn't as extreme as China's. We'll see that change in the next 10 years.
Demand for oil is driven by economic growth. Economic growth in China has been very large, and demand for oil has really been driven by China and the U.S.
China is expected to grow at a 8.7% rate in 2005, decelerating from the heady year-over-year 9.5% rate in 2004, but still very strong. Growth should come in between 7% and 8% through 2008. Everyone expected China to overheat, but it seems that it's still showing strength.
Lynch: They were certainly important last year when both saw booming demand, but that level of growth is unlikely to represent a long-term norm. They'll certainly grow, but not at the high end of the forecast that some people are saying. China is growing more rapidly, but it's overstated. The thought that they're going to drive us over a cliff is an exaggeration.
Leeb: There's nothing to suggest demand growth for oil is understated for China or India. Bear in mind that China and India together represent 2.3 billion people, and their combined economies in terms of per-capita use of energy is roughly one-half that of the world and one-seventh that of high-income countries.
Given that they want to put themselves on a trajectory to become high-income, you have to expect torrid demand for oil from these countries. China basically plans to double its car population, and cars need oil.
Going a step further, if you look at projections for China's oil demand that were made two years ago by the U.S. Energy Dept. and the International Energy Agency, they predicted 6.5 million barrels per day by 2010. China is likely to consume that amount in 2005, five years earlier than these agencies thought two years ago.
[Editor's note: Kingston did not get an opportunity to respond to this question before publication deadline.]
Q: What role has speculation played in the recent price spike? Bovino:
Q: What role has speculation played in the recent price spike?
Bovino:It's hard to determine what's speculative and what's demand-driven, but certainly both are factors. Companies are hedging and creating contracts to lock in prices, a boost to oil prices right now. That demand is going to put upward pressure on prices.
Lynch: The fundamentals really don't justify current prices, and you could argue there's a $20 speculative premium on the price right now. Last year, there was more of a security premium and a tight market, but that's not true anymore.
Leeb: Virtually none. Oil is basically rising on underlying economic fundamentals. Oil prices have remained on an uptrend since the end of 1998, rising pretty steadily from $10 to over $55 per barrel. There's nothing to suggest that it's hedge funds or speculation or anything else since. During that period of time, hedge funds have been long and short oil.
The biggest players are the commercial oil companies, not hedge funds, and the undeniable fact [is] that there's no excess capacity in the world today.
Kingston: This remains a huge question that analysts will debate endlessly. One can argue it's still a combination of tight refining capacity, tight production surplus, and strong demand that's driving this market. Recent reports by the Commodities Futures Trading Commission and the New York Mercantile Exchange downplayed the impact of speculation. However, recent activity in the markets don't back that up.
Q: How much influence does OPEC have? Bovino:
Q: How much influence does OPEC have?
Bovino:OPEC has tried to bring down prices in recent months. In mid-May prices rose to $50, and there was actually concern that OPEC capacity was going to shrink. They then came out and raised production levels, and that had no impact on prices.
On June 30, oil prices jumped over $1 on comments from the Algerian OPEC minister, who said there was no OPEC consensus to raise output by 500,000 barrels.
It could be part speculative, but on the downside they might not have so much of an impact. They drive markets more to the upside than the downside.
Lynch: OPEC right now has become mostly irrelevant. Until the market weakens they really don't have much ability to drive prices. It used to be that they had the ability to raise production and moderate prices, but they can't right now because they're at full production. They don't want to make prices go higher, and they can't make it go lower, so both of those have to change.
Leeb: Prices are beyond OPEC's control. Blunt facts: Saudi Arabia came out recently and said over the next four years, they plan to add over a million-and-half barrels of capacity. Saudi Arabia has more ability than any other country to add capacity.
But that won't come close to reaching the increased growth in the world. That'll be one year, never mind four or five. OPEC today is maxed out, and their plans for adding capacity don't come close to matching projected increases in demand.
Kingston: At this juncture, OPEC has little influence. But remember: OPEC was created to deal with glut. The taps are open, and the world needs the oil. So what is its role? Maybe it doesn't need a role now and can sit back until the next glut, which looks a long way away.
Q: At what price do you see West Texas Intermediate crude oil by the end of 2005? Bovino:
Q: At what price do you see West Texas Intermediate crude oil by the end of 2005?
Bovino:We're expecting by yearend $52 per barrel. We think it's going to edge down slowly over the next three years, but not to $25 or $30 levels. We see maybe to $48 in 2006, and [then] going down, hitting $46 by 2007 and $45 by 2008.
On the flip side, although it's unlikely, we can't rule out $100 per barrel. It all depends on speculative activity, risk in the Middle East, and a burgeoning demand that isn't in the equation. The U.S. economy can hold up $50 per barrel and survived close to $60, and the economy can hold at $60 and even $70 per barrel, but any higher than that and we see the real risk of a slowdown.
Lynch: $40. The fundamentals are weakening so much now and over the next few months that a lot of the investors -- potentially hedge funds, but more the pension funds and mutual funds -- are going to start to pull out and look for some kind of potentially higher-return investment.
Leeb: Between $65 and $70. Oil over the past five or six years has been rising at a 35% annualized rate. If anything, the rate will become stronger, and projecting 35% gains is basically the norm right now.
Kingston: Nope...we at Platts don't do that.
Edited by Beth Belton