Crude Oil Price to Continue to Rise – Despite Threat of U.S. Recession

RelevanceRecent data shows that 1Q08 U.S. oil consumption was 475mbd lower than the same quarter last year. The Energy Information Administration (a U.S. government agency) suggests that oil demand in January dropped 2.2%, the lowest demand in any month since April 2005. Data such as this, however, is unlikely to move the oil markets much in the short term. The U.S. has seen declining oil consumption for some time now, but this has been overwhelmed by worldwide supply-demand factors. Add in a great deal of speculative trading activity around oil and the recipe is set for higher dollar oil prices still.

AnalysisLooking at the supply and demand sides of the equation, we see that there is plenty of upward support for oil prices:

Demand Side

  • Population Growth: Population growth, along with its close relative economic growth, is the main driver for oil demand. While not a factor in short term oil prices, the world’s population is nevertheless expected to continue its robust growth, providing plenty of support to oil prices in the medium to long term.
  • Economic Growth: Despite the slowdown in the U.S., other regions are still growing well, adding to oil demand. China (10%) and other emerging economies have posted strong growth rates, and even continental Europe is holding its own.
  • Weakening Dollar (1): increases demand in non-dollar countries by reducing oil price in the local currency.
  • Weakening Dollar (2): speculators buy oil as a hedge against further weakening of the dollar. Some speculators currently see oil as a one way bet, and some believe that in the short term oil prices are influenced by such activity and that increases become almost a self fulfilling prophecy.
  • Weakening Dollar (3): Some believe that a weakening dollar causes OPEC to attempt to increase oil price through setting reduced quotas.
  • Substitution and conservation efforts: inter and intra governmental efforts to conserve energy, reduce reliance on oil and invest in other forms of energy is one of the few areas to put downward pressure on oil demand and price.
  • Environmental concerns: initiatives to reduce pollution further reduce demand for oil. However, many of the world’s high oil demand growth regions are placing a lower priority on pollution reduction.

Supply Side

In the short-term, and absent significant spare capacity within OPEC, there is little flexibility to increase supplies. Even in the medium to longer term, increased supplies are becoming more, and not less, difficult to achieve:

  • Leveling/decline in non-OPEC production: as evidenced by the ultra low growth rates in production of the majors, and to a certain extent by their declining reserves replacement rates, the world is currently finding it difficult to increase non-OPEC supplies. Rex Tillerson, ExxonMobil’s CEO, recently commented that non-OPEC production has probably peaked. The recent news from Russia, confirmed by a senior executive within Rosneft, is that the country will, most likely, find it very difficult to maintain current production levels.
  • Significant challenges to future non-OPEC production: much of the future non-OPEC production is difficult to access, both technically and politically. The industry is deploying greater capital expenditures, and these are predicted to increase still further, but this expenditure is being soaked up by non-conventional oils (e.g. heavy oils, tar sands, Arctic oil, shales and others) and other projects that pose severe technical challenges.
  • Ability/willingness of OPEC to increase production: there are now serious questions surrounding the current level of capacity within OPEC. OPEC, also, has increased capital expenditures, but there remains the issue of its appetite for further increases that may be necessary. OPEC still recalls its lesson of the late 1970s, where it increased capacity only to see consuming nations implement energy conservation measures, diversify energy sources (gas and nuclear) and open up new oil regions (Alaska and North Sea). The result was a collapse in oil price in the 1980s. The recent report commissioned by the Nigerian government, which indicated that the country will find it extremely difficult to grow production, does not make good reading for those seeking increased supplies.
  • Weakening Dollar: A weakening dollar increases supply costs for regions of the world that are dollar based (many of the oil producing countries of the Middle East, for example, have their currencies pegged to the dollar). Non-dollar based costs are more expensive for these regions, leading to downward pressure on supply.
  • Technological advances: this provides the one area of hope for those seeking upward pressure on supplies in the medium term. The current period of high oil prices has led to increased investment in technology that could result in reduced costs and/or increased supplies of non-conventional oil.

 

23 April 2008

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