Why Oil Prices May Shoot Back Up
Price forecasts from the Organization of Petroleum Exporting Countries have never been particularly reliable, so it's easy do dismiss the latest one -- a "constant nominal price" of $110 per barrel of crude oil until the end of this decade, and $177 by 2040. It is, however, worth listening to OPEC secretary general Abdalla El-Badri when he says speculators played a major role in oil's recent spectacular slump, and prices may rise again next year.
OPEC has been publishing its World Oil Outlook since 2007. That first report assumed $50-$60 per barrel of OPEC oil until 2030. Then prices rocketed to $141 and dropped to $33 in 2008, as the global financial crisis developed. In 2010, OPEC predicted a price level of $70-$80 until 2020, but that forecast has been blown out of the water. In the last four years, the average price has been above $100.
As Vagit Alekperov, the founder of the Russian oil giant Lukoil, once remarked, "The price is from God." Too many factors affect supply and demand for the most ambitious analyst to build a reliable model. OPEC tries, though, and according to its reference scenario, world oil demand will keep rising by at least 1 million barrels per day throughout 2019. Next year, demand outside the world's most developed countries -- members of the Organization for Economic Cooperation and Development -- should for the first time outstrip that in the OECD.
The assumption underlying this scenario is that even though the developed world is using more sustainable energy and cars that guzzle less gas, emerging economies' thirst for oil will grow faster than the developed ones' will abate. While OPEC expects average oil use per car or truck to decline by 2.2 percent per year, the increase in vehicle fleets in China, India and other emerging markets -- more than 1 billion additional cars by 2040 -- should more than compensate.
To meet the increased demand, oil companies need to maintain a high level of investment. The organization predicts that its members will invest $40 billion a year until the end of the decade, while non-members will plow $300 billion a year in maintaining and expanding production.
"The situation of low prices cannot continue because if it continues, most of the investments will be stopped," El-Badri said today. At first glance, that statement suggests the OPEC secretary general is confusing cause with effect. After all, the oil price is supposed to be falling because of slower economic growth and shrinking investment. The World Oil Outlook stresses that "economic growth is not only a key driver of oil demand, but it is also a major source of uncertainty of the required volumes to be invested."
I wouldn't dismiss El-Badri's argument as misguided, however. Oil demand is rather stable. OPEC's base scenario is based on average global economic growth of 3.5 percent a year between 2014 and 2040. Revising it down to 3.1 percent a year only reduces 2015 demand by 300,000 barrels of crude per day, and 2020 demand by 2 million barrels per day, to 95 million barrels.
Supply, by contrast, is more volatile, and not just because it's more subject to geopolitical shocks. It's easy to imagine how underinvestment might cause a disproportionally steep drop in supply. Much of the predicted output growth depends on the success of capital-intensive projects: tight oil, deep-sea drilling, extraction from oil sands. If these are shelved, even with low economic growth, oil will become scarce and prices will rise.
The problem with investment decisions is that they are made by humans, who tend to live in the present. An executive's gut feeling in reaction to another news story predicting a long-term oil slump may not be entirely rational, but it will affect supply. And, as El-Badri points out, oil prices move because of speculation, as well as supply and demand factors. The OPEC secretary general says supply outstripping demand by 600,000 barrels per day, as it does now, does not justify a 28 percent price drop since mid-June.
El-Badri refuses to conjecture why speculators might want to drive the oil price down. That takes someone less careful, such as Russian President Vladimir Putin, who complained today that the disconnect between the physical oil market and futures trading "creates the conditions for speculative activity and, as a consequence, for price manipulation in somebody's interests." According to Putin, "at certain critical moments one gets the impression that politics prevails in forming the prices of energy resources."
Putin, whose political support is threatened by a rapid ruble devaluation set off by lower oil prices, sees Western plots against him everywhere. One doesn't, however, need to subscribe to his conspiracy theories to realize that, in financial markets, the power of narratives is great. Now that it's conventional wisdom, for one reason or another, to be pessimistic on oil, unnecessary investment cuts become more likely, laying the foundation for future price growth.
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