Monday, December 8, 2008

Cheap Oil - An Additional Analysis

The price of crude oil over the past few years has become a hot topic, and as it hit almost $150 this summer, we all felt the pain at the pumps. Now that oil has dropped to $45, what are the issues facing us now?

Last week we discussed an article by Jim Jubak of MSN Money that pondered about the death of OPEC. Last night on 60 minutes, there was an interview discussing the price of oil, reserves, etc. in Saudi Arabia. Today, we have a good article by analyst Christopher Johnson of Reuters discussing the short and long term effects of low oil prices. Obviously, in today's economic situation, low oil prices are a welcomed sight, but what happens now?

Cheap oil: short-term good, long-term dangerous
Wednesday, Dec 3, 2008
By Christopher Johnson - Analysis

Motorists must be glad the price of fuel is one thing they do not have to worry too much about as they face the worst recession since the 1930s, but cheap fuel is not good for anyone in the long run.

Global oil prices have collapsed since July, losing two thirds of their value from a peak of almost $150 a barrel and dragging fuel costs to their lowest levels for several years.

But while low energy costs come as welcome short-term relief to consumers and companies struggling with the financial and economic crisis, longer term they can be bad for everyone.

Low energy prices squeeze investment in the oil industry, reducing future supplies. They discourage energy saving and they destabilize countries dependent on oil exports, making oil in the future more likely to be expensive and even more volatile.

Perhaps most important of all, low energy prices stifle investment in alternative energy, deepening dependence on oil and other hydrocarbons and increasing greenhouse gas emissions.

"In the very short term, because we are in a recession, we could all use a low oil price," said Mike Wittner, global head of oil research at French Bank Societe Generale. "It is like a tax break, putting money back into pockets for a short time. But in the longer term, today's oil price is too low to support much new supply and will slow the momentum toward alternative fuels, new technology and conservation."

In a rare pronouncement on oil prices, Saudi King Abdullah said on Saturday that crude at $75 a barrel was "fair." Saudi Oil Minister Ali al-Naimi later explained that oil at that level would encourage new output from marginal, higher-cost sources.


The comment drew criticism from some quarters, including a response from Japan's minister of economy, trade and industry.

"There are frequent comments by oil producers about $60-$75 per barrel," Toshihiro Nikai told reporters in Tokyo. "For us, the cheaper the oil price, the better."

But most analysts broadly agree with the Saudi view, saying they are worried about the consequences of under investment and the need to prevent a shortage in the years ahead.

They say the comments by Japan -- almost entirely dependent on energy imports and seemingly on course for its longest-ever economic contraction -- reflect a short-term strategic view.

As a key supporter of the U.N.-led Kyoto Protocol, Japan well understands the need to encourage energy efficiency, said Michael Lewis, head of commodities research at Deutsche Bank.

"In a downturn, you need any type of stimulus you can get and a lower oil price can help," he said. "But you need to find a stable 'sweet spot' which balances the need for exploration and the funding of alternative energy projects."

Stability in energy prices is essential for any sort of long-term planning, Lewis said, reinforcing comments by India's oil secretary, R.S. Pandey.

"As a major consuming nation we would like prices to remain stable and around this level," Pandey said on Tuesday. "What is more important is there has to be stability in prices. Volatility of the kind witnessed this year has been very bad."


While the desired "sweet spot" for oil prices may be lower during a recession, when extra stimulus is needed, most oil industry economists say it is probably well above where oil prices are at the moment -- around $47 a barrel.

In real terms over the last 40 years at today's prices, Deutsche Bank estimates that oil prices have averaged around $35 a barrel, a price it says is far too low for long-term comfort.

"The 'sweet spot' is between $60 and $80, probably the top of that range. That is the long-term fair value," Lewis said.

Simon Wardell, director of the energy markets group at Global Insight Ltd in London, sees broad agreement between OPEC and consuming countries that around $75 is about right for oil.

"That price gets you investment in new production, is high enough to encourage more efficient use of oil and is enough to maintain the budgets of the Middle Eastern countries," he said.

Washington-based consultancy PFC Energy estimates most Middle Eastern oil producers need oil prices this year between $40 and $60 to balance their external accounts.

"My concern is the price going too low," said Wardell. "Closer to $70-75 is a decent equilibrium price."

The International Energy Agency (IEA), which advises 28 industrialized countries on energy policy, says it wants oil prices high enough to foster sustained investment in new energy sources, including costly deep-sea drilling.

"It is very difficult to put an absolute level on what price is fair," said David Fyfe, head of the IEA's oil industry and markets division. "But there is a lot of high cost oil, be it in ultra deep-water, or Canadian oil sands or Arctic developments in northern Russia, which needs a relatively high price."

"We would see a danger if prices fall a lot lower -- that would exacerbate the chances of a medium-term supply crunch."

Source: Reuters

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