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Shahla
Money Managing Guru
Joined: 13 Nov 2004
Posts: 3324
Cash Points ££ 126163.28
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 Posted: Tue Feb 13, 2007 6:41 am Post subject: Crude Oil - Will it go down to $40 or up to $100 |
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If you knew the answer to this one, you could make a lot of money and beat the market . So let's take a look at the issues and see what can be determined. First, demand is going to increase over time as an energy-hungry developing world needs more and more energy. Take a look at this chart from the Bank Credit Analyst showing the percentage of global oil consumption that comes from China and India. It is going from the lower left to the upper right, and only slowed during the slowdown in global growth around 2001.
Crude prices are trading near $59 as of 2/9/07, down considerably from the high of $77 it hit in 2006. Prices were down 10% over the last month. Inventories are high and parts of the northern hemisphere were having an unusually warm winter, though it is getting cold now.
OPEC has claimed they have cut their production and will likely try to cut again, as they would like to maintain prices closer to $60. The problem is that OPEC members cheat. It is one of the few reliable factors in the oil business. As a result much of the actual burden of production cuts falls on the shoulders of Saudi Arabia. They have done the work so far, but will it be enough? There is reason to think they might let oil prices drop even further in the near term. And here, I want to highlight some fascinating research by Ben Dell and his team at Bernstein Research.
Today, there are about 2.5 million barrels of spare production capacity (excluding Iraq, Nigeria, and Venezuela), with almost all of it controlled by OPEC. If OPEC actually cut production as they say they will, they could work through the high inventories and take the price back up to over $65. By the way, excess capacity is on target to rise to 4 million barrels a day in 2008, even with solid growth of 1.8% in world demand. There is a lot of new production coming online.
The problem for OPEC, however, is that most members cheat. So far Saudi Arabia has been willing to cut enough to make up for their cheating partners. But it looks like they will have to make further deep cuts in production, to 8 million barrels a day, which is below levels not seen since 1991 or the aftermath of 9/11 in 2001.
But the Saudis have said they intend to increase their production capacity to 12.5 million barrels per day by the end of the decade from 10 million barrels presently. They are spending the money to increase their capacity, and significant new capacity will come online this year and next.
Bernstein concludes: "The dilemma facing Saudi continues to grow. While cutting back incremental heavy barrels when crude prices were $75/bbl was relatively painless, the country is now facing the prospect of having to drop below 8Mbpd to keep the market balanced. At the same time, Saudi Aramco is undertaking one of the biggest investment programs over the last 20 years, as evidenced by the soaring rig count and multiple field reactivations. Of these, the AFK field is the first to come online in 3Q/4Q 2007 for 500kbpd and 1Bcfd.
"Should Saudi decide to hold back volumes to maintain prices, their proven capacity utilization would probably need to drop to 75-77%, which has historically been a threshold level. While this may sustain pricing for others it would of course lower Saudi's market share, given that few other OPEC members seem inclined to assist. Furthermore, it would continue to stimulate the oversupply in the market, hence prolonging the problem. Evidence of any countries 'cheating' on their production cuts may emerge soon with the IEA and OPEC January reports, which will be published later this month, or through February when the new quota system comes in, and will highlight the extent of the compliance within the OPEC group. |
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