I GAVE up forecasting oil prices a few years ago. From the economic perspective, the equilibrium price – with demand and supply in balance – was then about $15 per barrel. It fell to about $10, which caused serious problems for many producers, not least in the North Sea, but has never been near that level since.
Brent crude is currently trading at around $90 and got close to $100 during January. I have just finished an analysis of price changes since January, 2004, when Brent crude began the year at $30. There was then a steady upward trend, with inevitable fluctuations, to $75 in the summer of 2006. The next six months saw falls to around $55, but since January, 2007, the trend has been upwards again.
The demand-supply balance is little different from what it was in 2004, so that does not explain why world oil prices have tripled. I am strongly of the opinion that the single most important reason has been financial speculation, particularly by the hedge funds.
It is easy for those of us who work in the oil&gas industry to ignore what happens in other sectors, but as I write this, the price of gold has risen above $900 per ounce and the prices of many other metals are at, or close to, record highs. Thus there are external factors to take into account.
The world demand for oil has been increasing at an annual average of about 2.5%, which is relatively modest. The growth has been much higher in China and India, but consumption has actually fallen in some European countries.
The industry has had little difficulty in supplying oil to meet the growing demand, contrary to many claims. That oil is becoming more difficult and expensive to find and produce, however, which has undoubtedly added $10-15 per barrel to prices.
The recent track records of the multinationals have been very disappointing, and more and more supplies are being concentrated in the hands of the national oil companies such as Saudi Aramco.
My company has a joint venture in Saudi Arabia and our main client is Aramco. I believe that my Saudi partners have a very good understanding of thinking there and we frequently discuss these issues.
Most companies in the industry use a range of price scenarios for their planning and Aramco’s base case for investment appraisal is currently $70. They and the Saudi Government are doing extremely well from the high prices and there is little or no internal pressure in the country to force prices down by increasing production.
Aramco currently has about 1.3million barrels per day of spare capacity, mainly heavy crudes, which it is increasingly reluctant to sell at hefty discounts. In my opinion, it has the ability to knock up to $20 off oil prices.
Work is under way to add another 1.5million bpd, although the net increase will be less because of declining production from existing fields. Progress with the new developments is slow because of rig and skilled labour shortages, as in many other countries.
My understanding of the recent meetings between King Abdullah and President Bush is that the king is very disappointed with the US efforts to broker peace in the Middle East, notably in Palestine, and wants to see real and sustained progress there before he will respond to requests to help bring down oil prices.
Bush is in a weak position, of course, because his term expires soon. His recent visit to the Middle East was probably only window-dressing, although I sincerely hope not.
The angry rhetoric about Iran only misleads people because that country is not the critical threat. The real problem is the continuing Israeli-Palestinian conflict.
The financial problems in the US do not help him. The Federal Reserve Bank’s two big cuts in interest rates may help the domestic economy, but must, inevitably, further reduce the external value of the dollar.
In other currencies such as sterling and the euro, the oil price rises have not been as dramatic.
Prices may drift slowly down, but there is a threshold – probably around $75 – at which the Saudis and other Gulf countries will take action to prevent a sustained deterioration.
As an economist, I prefer to concentrate on the economic variables which determine oil prices, but my Saudi partners are strongly of the opinion that prices will continue to be very high until there is a genuine peace settlement in Palestine.
Tony Mackay is MD of economists Mackay Consultants