Reader Michael forwarded a new research piece from Oppenheimer by Fadel Gheit and Daniel Katzenberg that makes the case that oil prices will continue to decline. A core element of their thesis is that OPEC will not defend prices above $60.
Here are the main arguments (boldface theirs):
Given the bleak global economic outlook, we think world oil demand is likely to be substantially below current forecasts, as we expect steeper declines in developed countries and much smaller growth in developing countries. Despite the pullback from the $148/b record, we believe oil prices are still inflated and not supported by supply and demand, and the longer they remain high the deeper the recession is likely to be and the longer it will take for the global economy to recover. Lower oil prices could help boost consumer confidence and spending and accelerate economic recovery, which is also in the best interests of OPEC longer term.
Key points:
Hype Artists. Outrageous oil price predictions by investment banks have been self-fulfilling prophecies in recent years, since those banks are also among the largest oil traders as brokers and principals, dealers in financial derivatives, clearing houses for other traders and owners of energy assets. Tighter government regulations under a new administration are likely to curb their activities and deflate oil prices.
Government Regulation. We believe the surge in oil prices in the last five years is a result of the same bad government policies of deregulation that caused the global financial crisis. The demise of the investment banking industry, tighter regulation, and low appetite for risk should significantly curtail speculation and lower oil prices.
OPEC Dilemma. We estimate that OPEC generated more than $3.5 trillion in oil export revenues in the last 5 years, which exceeds its revenues in the previous 15 years. We believe more than $1 trillion of that amount was a direct result of excessive speculation. We don’t expect OPEC to aggressively defend oil prices above $60/b, since higher prices slow economic and demand growth, which are not in OPEC’s best interests.
Energy Policy. In addition to tighter regulation of energy trading, we expect the new administration to focus on reducing dependence on foreign oil by increasing domestic production, expanding use of alternatives and accelerating conservation. Higher oil prices undermine U.S. economic growth and national security.
Increased Supply. The oil market is not a free market, since 55% of world oil supply is controlled by OPEC and Russia. High oil prices give oil exporters less incentives to allow foreign companies access to energy resources, while lower oil prices force them to do the opposite.
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“We don’t expect OPEC to aggressively defend oil prices above $60/b, since higher prices slow economic and demand growth, which are not in OPEC’s best interests.”
Actually the break/even point for most oil producers is the $60 mark, so I must disagree. Many analysts look at the oil business only from a limited prospective, when in fact it’s a complicated business. Generally, every day the cost of pumping oil out increases – similarly the ratio of energy input vs. energy output decreases – it’s an exponential curve. This, combined with depleting oil fields should represent a set pain threshold for many producers (which will vary admittedly). I’m not saying we’re not dropping below $60 for periods of time – as you said OPEC has been raking in profits, and thus might just decide to sit things out for a while. But at the same time I doubt we’ll see the days of $30 crude again, if we do it will be a short lasting event.
An interesting perspective.
– Two days ago the OPEC President, Chekib Khelil (Algeria’s Oil Minister) said that he thought oil prices would continue to fall next year and the standard line on preserving stability in the int’l markets
– That day the Ecuadorian OPEC governor said that OPEC would analyze how the financial crisis was affecting the oil markets, and adjust as necessary (Ecuador, though tied to Venezuela, recently moderate on price).
– Yesterday that Libyan OPEC governor urged fellow members to cut production in response to crisis
– Yesterday Qatar announced they were moving ahead to actually produce at quota (not that Qatar was a big overproducer, that distinction belongs to Riyadh and Tehran)
– Yesterday Iranian OPEC governor Ali Khatibi said it was too early to tell, but that Iran was worried about the lower prices, and Iran is usually a price hawk
– Today the Iraqi oil minister said that if prices dropped further below $90/b that OPEC was ready to call an extraordinary meeting to discuss production cuts
– Last month Hugo Chavez and Ahmadinejad appeared to set $90/b as the price they would defend
– Nothing from Riyadh–and historically they are the “decider.” However, supply may well be tight enough today that another member could push up prices by cutting production, though they generally have been extremely reluctant to lose any market share.
– Wild card: Russia, which is sending a high level delegation to the December meeting, stated, via high level Gazprom executive, that they expected OPEC to defend price going forward
I agree that it’s not in OPEC’s interest to bleed the working economies just now and that stimulating economies by production increases would make more sense. Still, many OPEC budgets are fragile just now and domestic (and member state) politics will sometimes trump common sense.
How is it that Oppenheimer has become an opponent of “speculation”? Must be they’ve never gone long on oil except to hedge … *cough*
The analysis is overly simplistic and probably wrong. How much of the current drop in oil is due to wind-up of spec positions? How does the market combat the declining production from Mexico, the North Sea, and – gasp – Russia? Go over to the Oil Drum and read up a little….
This is too facile an argument, following on the CW – gee, how about that: an analyst following the trend line out the window?
Oil may go under $80, it may even touch $60, but I’m willing to bet dollars to donuts that by 12/2009 the price is back near $100.
What about the impact when the US$ declines due to the bloated federal debt?
I’m in the “above $60” camp I think, because domestic demand in China and India seems to pick up as soon as you get near $75 or so, which implies that you can’t rely on a US/EU recession to kill demand completely.
i.e. It’s not just about OPEC decisions.
The question shouldn’t be if the price for oil is above or below 60$ but rather how much 60$ can buy in the future.
Go over to the Oil Drum and read up a little….
Production declines from Mexico, etc, have been known for years. Despite all of this, oil production has not suffered a precipitous decline yet.
As for “The Oil Drum”: that is a den of bat-poop crazy people; they are the hard-core of the hard-core doomer disaster pornographers, and likely a key meeting area of the speculative pump that created $150/bbl.
but I’m willing to bet dollars to donuts that by 12/2009 the price is back near $100.
I find most oil analysis more self-serving than honest, so it’s nice to see an open declaration of a position…
because domestic demand in China and India seems to pick up as soon as you get near $75 or so
US+EU consumption is something like 35 Mbpd, while India+China is about 25% of that. This means that a relative demand drop of X% in US+EU would have to be “made up” by about 4X% in India+China. Right now it looks like India and China consumption is modulating in step with the US/EU, but even if their demand kept growing at 15% per year, this would be about balanced by the 3-5% reductions being observed in Western countries.
How long the current situation can can persist is anyone’s guess. Full disclosure: my only direct exposure to the oil market is a gasoline pump.
to above:
Your observations are interesting as far as ratios of demand but your criticism of The Oil Drum is childish.
Peak oil is a fact. It’s now if they are right, it’s when. All the super giant fields were discovered decades ago and they ALL have a production life cycle. The best we are able to do at the moment is keep production flat thanks to enormous investments in oil field recovery.
Yes, TOD sometimes starts to see the future a little too clearly but to ignore them is to be in the child-like “tomorrow will be like today because that’s all I know” camp.
IF we don’t prepare for the end of easy fossil fuels (which will happen in this lifetime) we will be rather savagely kicked back in terms of our quality of life.
“We don’t expect OPEC to aggressively defend oil prices above $60/b, since higher prices slow economic and demand growth, which are not in OPEC’s best interests.”
This arguments been made for years and has never made a lot of sense. There is limited elasticity in demand. So OPEC would really rather have oil at $60 a gallon than $120 because otherwise demand might drop 10%?
“As for “The Oil Drum”: that is a den of bat-poop crazy people; they are the hard-core of the hard-core doomer disaster pornographers, and likely a key meeting area of the speculative pump that created $150/bbl.”
With name calling like that, you must know what you’re talking about.
Peak oil is a fact.
Peak oil what? Supply or demand? I see no evidence yet of a peak in supply, though there is lots of hand-waving and gnashing of teeth by people who are long in oil (e.g., the denizens of TOD).
I do see plenty of peak demand though.
IF we don’t prepare for the end of easy fossil fuels (which will happen in this lifetime) we will be rather savagely kicked back in terms of our quality of life.
This is straight from the inner sanctum sanctorum of TOD. And it is absolute nonsense. Not that oil will not peak (good grief, eventually, at some point in the remote future, production will be zero), but that the peak, when it arrives, will “savagely kick” us. People will adapt, as they did in the past.
Energy is the ultimate fungible, the money of physical reality. No fractional reserves either!
With name calling like that, you must know what you’re talking about.
What more do I need to know about TOD? Are there any moderates within the realm? Any dissenters tolerated? Consider this:
http://peakoildebunked.blogspot.com/2008/10/377-why-robert-hirsch-is-dead-wrong.html
Note carefully the “postscript”. As I said, “bat-poop crazy”, etc, etc.
I cant see any enlightment in this report. Frankly i dont see the point.All I know is that OPEC fiscal budgets are spending taking oil at 100,oil at 60 is a total depresion scenary. For the sake of developed countries , OPEC will resign 0,4 trillion annnually, does it make sense?
It is good to see the window, which some speculated might be 80 to 120 for a while, has been lowered now that the price hit 80.
Might not wish for things to get too good on this front, given the amount of whiplash there has been everywhere else (and in energy). What we really want is steady, not depressed. But I’d like to see 60 and stabilize around that.
“The question shouldn’t be if the price for oil is above or below 60$ but rather how much 60$ can buy in the future.”
That is actually an EXCELLENT point and I was referring to the ‘current’ buying power of the U.S. Dollar. Since our currency is being deflated by about 12%+ each year now (according to shadowstats.com) that break/even point should actually INCREASE not decrease going forward.
I think lower oil prices are simply wishful thinking. All the evidence re: this finite resource points to much higher future prices.
So, why are oil prices recently trending lower you might ask? In a short period everything is possible, is the correct answer, including the illusion of lower priced oil.
I’m an editor of theoildrum.com and I assure you I am not ‘bat-poop crazy’. (though I suppose if I were, I would assure you just the same).
Tonight we have a Presidential Energy Debate Fact Check:
http://www.theoildrum.com/node/4621
on the veracity of the claims on offshore drillings impact on oil prices and energy independence. (The sources are all the bat-poop crazy people at the Energy Information Administration.)
I have oft written about the magnitude of financial assets dwarfing the energy markets. The hedge funds leaving the industry now, both from lack of returns, liquidations and fear of further rule changes are causing mother of all forced sells.
Two comments directed at the Oppenheimer report:
1)From a trading perspective, markets usually don’t reverse until sentiment of Wall St firms economists has shifted 180 degrees. The more reports we hear about $60 oil, the sooner oil is going back up (and the sooner we get a better long term price signal for renewable infrastructure)
2)Oppenheimer report focused on demand. Not only is global depletion rate 4.5%. Not only is net energy declining (i.e. energy companies using more oil, natural gas and electricity to procure the same amount of energy as before). Not only are the commodity prices well below the cost of the marginal unit (and approaching that of the average unit),:
http://www.theoildrum.com/node/4562
which is resulting in delays and cancellations of projects. But we now have a credit crisis that is causing firms to reduce capex, postpone new capacity, delay substitution of renewables, and pose serious business risk for any company that can’t fund their business through operations.
So, when economy was strong, we were in a race between technology and depletion. Now we are in a race between depletion and credit contraction. We’re currently in the liminal space where demand IS lower than supply – but many factors suggest that won’t last for long.
But I ramble – I need to go take my medications before I lose sanity again..
I was exposed to Martenson, courtesy of one of Yves’ bloggers. I am returning the favor:
http://www.chrismartenson.com/peak_oil
re: molecool: “Actually the break/even point for most oil producers is the $60 mark, so I must disagree”
That’s categorically incorrect according to the EIA. The ME can pump the stuff for $5.26…average production costs for non-us countries is less than $30.
Molecool…if you’re gonna throw numbers out there, please cite something, because, as of now, you’ve jumped the shark.
And btw, Gheit is far from a “trend follower,” he’s testified, on multiple occasions, for over a year now (see here, here, and here), about the vagaries of excessive speculation and how fundamentals only justify $60.
I think everyone agrees (including Gheit) that specs are absolutely necessary, but only when used in moderation (just like credit). And for anybody wondering, the past year has not been a portrait speculation in moderation.
I think it’s clear to everyone by now that the oil run-up was in part generated by speculation (i.e. was a bubble). That, plus the long term elasticity of demand, is why prices are dropping now, but I don’t expect the peddlers of gloom to admit that they were wrong on this count. This is just another case of how politics always informs economic discussions, even on the more grounded left (ie Krugman’s reasoning about high oil prices which ignored the ways in which investors are sometimes irrational)
anon @ 10:19: “I’m an editor of theoildrum.com”
You’re a hard-core blogger posting under “anonymous?” Do you mind identifying yourself?
Not to mention you provided a hack-job of an http web address instead of a nice, neat html hyperlink to your (supposed) own website?
I’ve seen stranger things, but I call BS. You’ve jumped the shark as well.
You’re a hard-core blogger posting under “anonymous?” Do you mind identifying yourself?
My name is Nate Hagens. I’m a phd student at University of Vermonts Gund Institute for Ecological Economics – after working at Salomon Brothers, Lehman Brothers and running my own fixed income hedge fund since MBA school.
I am hardly a ‘hard-core blogger’. This was my first comment on this website, which I have just started to read.
The 2 posts I referenced, (now with hyperlinks) are:
Presidential Energy Debate Fact Check
and
The Marginal BTU – Return of the Red Queen
Of relevance to Yves’ current post are:
Hedge Funds, Hurricanes, and Energy Markets
and
At $100 Oil What the Scientist Can Say to the Investor
and
Peak Oil and Reflexivity and Peak Oil
For those with a spare hour or two, here are two bigger picture essays:
I’m Human, I’m American, and I’m Addicted to Oil (on evolutionary origins of habituation to stimuli and competition for resources)
and
Peak Oil – Believe it Or Not (on cognitive biases underpinning our belief systems)
Nate, are you claiming that energy companies’ EROEI is a primary cause for “delays and cancellations of projects.”? If so, a very narrow view.
And hey, while you’re here, could you please set straight those above who seem to believe production has not been on a rise.
It’s important, valid, pertinent to highlight and consider Merrill Lynch and Morgan Stanley’s role as oil brokers. I don’t have the figures to hand, and I’m not going to spend all day doing a spreadsheet, so treat it as gossip if you like. With the brokers broken and banks frozen, no one is trading except the Seven Sisters which are now Four Orphans and a Halfwit, thanks to merger mania to consolidate nonexistent reserves.
I don’t think it matters what spot price is from day to day. It could be $50 or $100 or $200. Much more important is light sweet production (not sour, not nat gas, not condensate, not heavy) and delivery to US ports. Price means nothing. Inventory is everything.
The analysis is simply admitting the obvious. The supply and demand explanation for a price that rose from $60 to $147 in a year is only slightly less flaky than one which applies the same explanation for a price that has dropped from $147 to $87 in slightly over three months.
Combine that with the other commodities that have risen and fallen in sync.
Now pity commodity producers, including American farmers, auto companies and airlines who made investment decisions on the assurance of a new and higher base price.
Which is not to say that a low oil price is the planet’s friend. Just that the commodities bubble appears on charts. I suppose if it were in the shape of a mushroom cloud it could be more obvious, but I’m not certain even then that the obvious would be admitted.
The fact is this this was a bubble caused by chasing a rising asset price, not by some new and unforeseen explosion of demand or constriction of supply. Likely the inflation and the collapse were also aided by speculators. (One wishes he could visit the trading floor at Goldman Sachs and interview a couple of the ex-Enron traders there.) I still recommend shorting oil companies.
I don’t think the EIA is a good source for oil predictions. Their blue skies scenario is simply not supported by the evidence on the ground.
As a previous poster noted, the price of oil at any moment is not the story. Supply, demand, and *production cost* are the stories.
We’ll never run out of oil.. it will just take more energy and expense to extract than it is worth.
From TOD:
9/17 OIL FIRMS PRODUCING AT A LOSS DUE TO LOW CRUDE PRICES
“For the first time in the history of the Russian oil industry, a remarkable threshold has been achieved — Russian oil producers are transferring everything they get from customers for crude oil exports to the budget,“ (Moscow Times –UBS Analyst)