Wednesday, 18 February 2009

Keep the Dream Alive – Oasis (2005)

The following commentary is from Friday’s business section of The New York Times. It comes down to how far can industry players really push oil’s price up against the tide of today’s economic forces?

OPEC’s Pipe Dreams

OPEC is doing all it can to talk the price of oil back up to what it calls a "reasonable" $75 a barrel. Some analysts even expect oil prices to hit that level by the end of the year. But the idea that this would be a return to normality makes little sense.

Oil traded below $35 pretty consistently for decades up to 2004. Tony Hayward, chief executive of the oil company BP, said at a recent conference that he remembered when $40 felt like a "fantastic" price.

Why Mr. Hayward’s superlative? Because not long ago $40 was comfortably above the long-term equilibrium price at which supply theoretically cleared demand. In the late 1990s, oil companies traded on valuations that assumed a long-term oil price around $15 a barrel. And in the first two years of the new millennium, analysts estimated a long-term oil price around $20 a barrel. That had risen to $25 in 2004.

There are good reasons to suppose that the comparable figure is now higher — perhaps about $40, about $6 above its closing price on Thursday. First, the oil price should rise at the rate of global inflation, all other things being equal. Assume it was $15 in 1995. Then today it should be $21.

But production costs have risen too. Producers increasingly have to drill in tricky locations like deep water or tar sands. In the latter, the cost is about $38 a barrel, according to estimates by Royal Dutch Shell. Transportation and refining costs have also increased.

So for oil producers, $40 is no longer a fantastic price. OPEC members have real problems balancing their budgets at that level. The likes of Shell, meanwhile, have big capital expenditure plans predicated on higher prices.

But wishful thinking cannot underpin the oil price. On the fundamentals, there is little to justify the notion that its long-run equilibrium has risen by $50 in only five years.


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