Thursday, October 29, 2009

Barrel of Oil Cost to Increase by End of 2009

With uncertainty in the air about the future cost of a barrel of oil, CARE contacted our good friend Michael J. Economides, a nationally energy analyst, to provide us with some foresight. As a regular contributor to national TV and radio programs and PhD petroleum engineer that has performed technical and managerial work in more than 70 countries; Dr. Economides has both the credibility and expertise to predict how much a barrel of oil will cost in months ahead. With both international political calculations and oil-producing nation's economic policies guiding the future price for a barrel of oil, things can get confusing sometimes and it takes an expert to provide clarity. Below is Dr. Economies's case that the cost of a barrel of oil will soon increase from $80 per barrel to $100 per barrel.

$80 oil on the way to $100 by the end of 2009
Oil has been flirting with $80 per barrel and from the start of this year I have been predicting $100 oil before the end of the year. Almost all other analysts were predicting $40 to $60 oil. I am not quite ready to declare that I was exactly right and they were wrong but it looks like increasingly so.

There are obvious and real underlying reasons for the escalating oil prices which we will expound upon below but news headlines have ruled the price of oil since at least 2004. There was no real rational economic reason for almost $150 oil (which for people with short memories may seem to have happened last century – it happened a year ago, July) nor was there any reason for below $40 oil, which happened right after the late last year "crises" such as the economic crisis, the credit crunch crisis etc. In fact had it not been for those events delegating oil announcements to the seventeenth page of newspapers, a report by the International Energy Agency in Paris last November, which showed that world oil production from operating wells has been declining by 9.1 percent per year, the largest ever, would have shot the oil price to over $200. In fact, even now, there is a lingering possibility that a strike by Israel on Iran may close the Straits of Hormuz and will shoot the price overnight to the stratosphere.

The headlines started in 2004 and included the Abu Ghraib photographs, which increased enormously the fear factor in the Middle East, the re-Sovietization of Russia’s oil industry following the assault on Yukos by then President Vladimir Putin and the re-nationalization of Venezuela’s oil industry by the Hugo Chavez government. That perfect storm of headlines created one of the most telling and repeatable events from 2004 to last year’s economic collapse. With escalating energy and energy product prices, every quarter ExxonMobil, the largest multinational oil company, would announce the biggest profits of any company in the history of the world and "Big Oil" would be in the mouth of many politicians in many countries as the devil-incarnate himself. And yet that very same day, mystifying to many people, their stock would plunge because in smaller letters they would announce that their oil production and reserves were declining. Shut out of reserves in some of the most prolific oil provinces of the world, such as Russia and Venezuela, international Big Oil was, and is, in trouble.

Recent hints of economic recovery and the price of the dollar are offered now as the reason for the oil price escalation. They are real reasons but they hide others. There should be no mistake: oil producing countries love $100 oil and they have little incentive to shoot themselves in the foot by increasing production. Neither the price escalation of the previous four years nor the oncoming one have anything to do with "peak oil". This will eventually happen but not for decades. Physically but not necessarily politically, the world can produce 130 million barrels of oil per day, compared to the current 85 million, but with proper investment and management and will.

Many of the oil producing and exporting nations are run by regimes that want the oil revenue not for technological and even business re-investment and long-term resource management but to affect other internal political and geopolitical aims.

Let’s look first at Russia. From 1998 and the admittedly imperfect privatizations that involved Yukos and Sibneft when the country produced 6 million barrels per day to 2005 when production escalated to more than 9.5 million barrels per day (almost 10% increase per year) Russia was the brightest spot in the international oil business. There was talk of increasing production to 12 million barrels per day which some Yukos executives touted as very realistic. Since then Russia has vegetated to about the same production and the tax regime and government control of the oil business can mean only one thing: imminent declining production and no incentive to do any of the spectacular things that Yukos and Sibneft became legendary for.

Venezuela is an even bigger factor, considering its oil dominance in the Western hemisphere. Before Hugo Chavez took office in 1999 Venezuela was producing 3.4 million barrels per day and there were concrete plans to increase that production by now to 6 million. Instead, after the massive firing of practically all petroleum professionals and the re-nationalization and expulsion of international oil companies, Venezuela is producing 2.6 million barrels per day, the lowest volume since the first nationalization in the 1970’s.

And of course Iraq, with a demonstrable ability to escalate its oil production to 6 million barrels per day has been languishing at 2 million. It may have been quieted down a bit but the sectarian violence is barely beneath the surface and the risks are still great. In a recent auction for oil blocks the interest by international oil companies was abjectly disappointing.

Saudi Arabia is the only country with excess production capacity, estimated at 2.5 million barrels per day, and this is a role that the country found itself once more, in the 1980s, when at the prompting of then US President Reagan it overproduced. The ensuing oil price collapse contributed greatly to the demise of the Soviet Union which depended on oil for almost all its foreign revenues. Russia today depends pretty much at the same level on oil and gas and Saudi Arabia has the capability, if it chooses, to bring enormous hardship on that and other oil producing countries. There is no evidence they will do so, considering it will bring huge hardship on them as well.

Finally, the signs of imminent Chinese exploding oil demand are already here. After phenomenal economic growth in the first seven years of this decade, oil demand was growing by annual double digits. A short-lived slowdown lasted for a few months after the dire headlines of last year’s economic crisis. But Chinese economic growth has bounced back to more than 8 percent. So did oil demand which just came in with vengeance. Last January and February, Chinese oil imports stood at 3.1 million barrels per day, compared to an average of 3.87 million barrels per day in 2008. But from March to June oil imports averaged over 4 million barrels per day and in July they jumped to an unprecedented 4.6 million barrels per day, close to a 20% increase over the average of 2008. (Source: China Customs, August 2009.) This level of imports inch towards the two-thirds of total demand that the United States has been experiencing.

All signs point that oil is on its way to $100 very soon and it will not stop there.

Prof. Michael J. Economides, University of Houston and also Editor-in-Chief Energy Tribune Houston, TX.

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