Thursday, October 15, 2009

Oil Market Break Out

(click chart to enlarge)
Crude oil hit a new high for the year 2009 today, crossing above US$78 per barrel.  We have finally broken out of the summer doldrums as we head into what is seasonally the highest demand period of the year for oil. 

OPEC members' publicly stated price target is US$70-$80 per barrel.  However, once OPEC members increase production prices tend to fall rather than move sideways.  So US$85-$95 per barrel is likely the level which has enough of a price buffer to be the range at which OPEC will increase production.  OPEC meet next in December and this may coincide with prices reaching the US$85-$95 price level at which point they will increase production.

One of the questions asked in feedback was where do I think the oil market is going longer term (3-5 years).  Over such a long time frame it is really only possible to estimate boundaries.  It appears unlikely that oil will price above US$150 per barrel in real inflation adjusted terms (2009 dollars) over any 12 month rolling average even if there is a supply shock or long term decline in supply.  On the downside, given that the marginal cost of non-OPEC production and the required oil price to balance OPEC government budgets are at least US$60 per barrel it is unlikely prices can persist beneath this level.

The next 5 years is also likely to be an era of extreme divergence within the hydrocarbon business.  Some areas are heading for distressful times.  Other areas are primed to do very well.  We are witnessing a replay of some of the same themes from the early 1980s (see Oil 101).  However, this time there will be the twist of a supply crunch and periods of little if any spare capacity.
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