Friday, March 05, 2004

Cheap Oil?
A friend forwarded a recent article in Business Week that suggests the era of cheap oil is over, due to a combination of increased demand and greater OPEC cohesion. The industry has a rich history of seeing the future as a continuation of the present: when prices crashed in the late 1990s, due largely to the Asian economic crisis, it was hard for even seasoned oil executives to imagine a return to prices over $20/barrel any time soon. I believe the technical term for this is "availability bias."

We are clearly in an alignment that favors the producers at the moment. The US economy is recovering--whatever the politicians may say--and China is booming. At the same time, exports from Iraq have been sporadic and well below expectations for this stage of the occupation. Venezuelan production is probably less than officially stated, due to lingering aftereffects of last year's strike and production shut-in.

So in the short term, prices look very firm and have some upside. And in the long term, as I've discussed several times in this blog, there is the prospect of supply being unable to keep up with demand, due to the combination of depletion of mature basins and problems in bringing on new fields rapidly enough. But that leaves the all-important medium term, from a year to five years out. And the lesson of the 90s is that a swing of less than 5% from short to long can drop the market by multiple dollars.

In less than five years Iraq could start to have a real impact in the market, with existing production and infrastructure rehabilitated and new fields starting to come on. There are a number of other projects around the world that will be reaching the market in that period, including major projects in West Africa, the Caspian, and possibly Iran. And that ignores any demand-side impact a new US Administration might have. Combine these factors, and a couple of years from now we could just as easily be looking at $18-20 oil and wondering if OPEC can hold it together. And a few years after that, we could be back to scarcity.

The real lesson here is understanding the difference between true structural changes and temporary market conditions. And the kind of structural changes I'm talking about would be at the level of economical alternatives, new regulations, geological or capital constraints, or major new discoveries. However tempting it is to proclaim that things have changed for good and we are now looking at permanently high/low prices (take your pick), the incredible complexity of the factors involved has a way of overtaking such predictions in a remarkably short time.

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