The oil price is not a concern anymore, so why regard the lower oil price as a risk and not an opportunity? Right now some in the equity markets believe in a soon end of the global crisis. If this is the case, then oil demand should jump sending the price much higher, that again contracts global growth before growth got started. Intuition says that the oil market isn’t balanced leading to a risk for new big swings in the oil price, growth and stock prices.

Another reason to check oil is the yearly annual report from IEA later this month.  A draft version is apparently circulating among some journalists. It contains information that should worry oil consumers and global growth hopers.

Until the world stopped booming ½ year ago, the market had a serious oil supply/demand discussion where focus was on increasing demand. Due to different articles, the World Energy outlook report says that output from the North Sea, Mexico and Alaska dropped unexpected late last year and early this year. The reason is that old oil fields mature. I don’t believe that supply didn’t matched demand at that time, but we didn’t understand why the supply surplus wasn’t bigger creating a natural concern about future price increases (many oil producing countries actually keeps their declines secret).

IEA apparently talks about a production decline of 9,1% per annum from existing oil fields. The yearly decline rate can be reduced to 6,4% by optimizing the production techniques.

This sounds alarming, but the goods news are that IEA sees no supply difficulties just the investments in new oil fields are kept at USD 360 billions per year the next 20 years. Big money, but the oil industry is about big money. All readers of my comments know that investments need to include a return for investors otherwise the money will go elsewhere.      

If we accept the assumption that the global oil reserves can meet even higher demand from China and India, then it’s a matter of attracting investments in the oil industry, keeping the purchasing power for oil producing countries and understanding the public budget needs in oil producing countries.

The OPEC countries are more linked up to the oil production than non-OPEC members. For the OPEC members it’s therefore easier to link the oil price and their respective public budgets (public spending needs). Due to calculations done by PFC Energy (a Washington based industry consultant) OPEC members needs an oil price from anywhere between $10 and $100 per barrel to keep their trade balance around zero. Qatar needs $10, Iran needs $100, Venezuela is in the upper end as well, where the very important OPEC member Saudi Arabia is around $50. This might partly explain the hawkish price rhetoric from some countries, where Saudi Arabia can allow themselves to search for a compromise all the time. I would expect these numbers to refer to crude, meaning Brent/WTI is higher. Crude has a clear low at $50 with a mid price like level at $70 – 75, indicating Brent/WTI higher.

Where oil should trade to keep the international purchasing power for oil producing countries is always a good question, as not everything is traded in Dollar. If you look at WTI in EUR, the price was in a narrow EUR 50 – EUR 60 band between June 2004 and November 2007. We are now back trading just above EUR 50 per barrel. If you regard EUR 60 more fair than EUR 50 (due to inflation etc.) then it means $77 per barrel WTI (or oil trades unchanged but EUR/USD drops to 1,0500).

The last but extremely important estimate is where oil needs to trade to attract investments. IEA suggest that Saudi Arabia can increase their production, deep water production like outside Angola will increase and very important is more production from oil sand in Canada.

Current new oil field project seems to be finalized, but the global credit crunch and the relative low oil price most likely cause a halt to planned projects. This is where my concern is growing, because with the current oil price new investments are not attractive.

Mr. Christophe de Margerie, CEO of the French oil company Total, says that it’s Canadian oil sand projects need an oil price around $90 to make it interesting. Their deep water developments of the Angola coast require $70 per barrel. He also mentions that new projects will be postponed at the current oil price. He is of course not speaking for the whole industry, but due to different media reports other executives confirm this picture. The global credit crunch doesn’t seem to worry as much as the actual oil price, which makes sense.

Adding all the above together, it indicates that at $85 per barrel Brent/WTI the oil world can and will satisfy the demand. It means a price increase of 30% compared to the current price. It will have a contractive impact on growth or maybe just delay a turnaround, and it will hurt the stock market again.

If the oil price stays around the current level for a longer period, then the price will jump above $100 per barrel very fast when the world start moving again. Market participants will suddenly remember the IEA report from this month about declining production.

If we don’t get a part of the pain now, then I fear that stocks will crash again if oil jumps. Both scenarios are negative for the stock market though the $85 per barrel should be manageable. Most negative for Europe and Japan, less for USA and the least for India and many Far Eastern countries (partly due to the state subsidiary of energy).

Peter

3^rd November 2008

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