The “Cheap Oil Era” is Ending Soon…
[Editor's Note: This is the ninth installment of our "Outlook 2009" series, which looks at the global investing outlook for the New Year.]
By Jason Simpkins
Associate Editor
Money Morning
Oil prices have fallen 70% since hitting a record $147.27 a barrel in July, which means in just five months, crude has given up all the price gains it made in the past four years.
After such a wrenching plunge, many analysts believe the outlook for the “black gold” remains bleak - and in the short term it certainly is. In the long run, however, dwindling supplies, resurgent demand, and a lack of investment will cause crude oil to double, triple, or even quintuple in price over the next few years.
In fact, the Paris-based International Energy Agency (IEA) - energy advisor to 28 industrialized nations - says oil will rise to $100 a barrel by 2015, as a result of a major “supply crunch,” and will ultimately soar to $200 a barrel.
But before it does, prices are likely to sink even further, perhaps falling as low as $20 a barrel in the first quarter of the New Year.
Indeed, much of Wall Street expects oil prices to average about $50 a barrel in 2009. Some of the firms and their specific forecasts include:
- Deutsche Bank AG (DB), which says oil prices will average $47.50 for all of next year.
- Merrill Lynch & Co. Inc. (MER), which predicts that prices will average $50 even.
- Moody’s Investors Service (MCO) also says crude will average $50 a barrel in 2009, but says that average will increase to $55 a barrel for 2010.
- Goldman Sachs Group Inc. (GS) is slightly more bearish, predicting that prices will average $45 for all of next year - after falling as low as $30 in the 2009 first quarter. (It’s worth noting that Goldman - just five months ago - predicted oil prices would hit $200 a barrel in 2009).
But analysts also agree on something else: When the recessionary tide finally recedes, all of the factors that drove oil to its record high last summer will once again be exposed, and crude will again soar to record highs.
“We may see prices drop lower - into the twenties, even - but there’s a better-than-average chance that they’ll be back over $70 a barrel by the end of next year,” says Money Morning Investment Director Keith Fitz-Gerald. “That’s where firms like Goldman and Merrill are getting all of these ‘middle-of-the road,’ $50-a-barrel estimates. And it’s why investors who buy in through the first quarter could enjoy compelling returns at the end of the year.”
In the meantime, however, low oil prices are crimping investment in new capacity, a reality that will lead to much higher prices down the road.
Just ask the IEA.
IEA: Rising Demand + Lack of Investment = ‘Supply Crunch’
According to widely respected energy advisor, global oil demand will slide 0.2%, or 200,000 barrels per day (bpd), this year, falling to an average of 85.8 million bpd. But the IEA also says that oil demand will advance by an annual average of 1.6% between 2006 and 2030.
The bottom line: Regardless of any short-term pullback, daily demand will rise from the current level of 86 million barrels to 106 million barrels in 2030. In other words, daily demand in 2030 will be 23%.
To meet that demand, the agency estimates that the world needs $26.3 trillion in supply-side investments over the next 21 years.
China, India and other developing countries, alone, will need investments of $360 billion a year through 2030, the agency said.
About 7 million bpd of additional capacity needs to be added to the market by 2015. And right now - because of marketplace changes - the financial incentives to make that happen just don’t exist.
Exploration costs have more than quadrupled since 2000, as oil producers have been forced to take on more complex projects, and the costs of both labor and materials have skyrocketed. At the same time, the steep drop in oil prices has put even more pressure on energy companies to curtail their investments rather than increase them.
Earlier this year, for instance, ConocoPhillips (COP) and Saudi Arabia Investment Co. (ARAMCO) were forced to postpone bidding on the construction of a 400,000 bpd export refinery at the Yanbu Industrial City.
“We see and hear about energy investments being delayed … this is a major worry and could lead to a supply crunch and much higher oil prices than we’ve seen before,” said Fatih Birol, the IEA’s chief economist.
The IEA predicts that, by 2015, a lack of investment and rising demand will create a “supply crunch” - that will once again send oil prices up into the triple digits.
“There remains a real risk that under-investment will cause an oil supply crunch in that time frame,” the IEA said in an executive summary of its “2008 World Energy Outlook.” “The gap between what is currently being built and what will be needed to keep pace with demand is set to widen sharply after 2010.”
The agency predicts that crude will average more than $100 a barrel from 2008 to 2015 and rise above $200 a barrel by 2030, as demand far outpaces supply.
“While the situation facing the world is critical, it is vital we keep our eye on the medium to long-term target of a sustainable energy future,” Nobuo Tanaka, the Paris-based agency’s executive director, told reporters in London. “While market imbalances will feed instability, the era of cheap oil is over.”
While it’s probably true that the “era of cheap oil” is in our rearview mirror, a new question has arisen: Just how high do oil prices go?
According to some analysts, the IEA’s target price of $200 a barrel is far too conservative.
$500 Oil?
The lack of exploration and development is certainly a problem. But a much bigger issue is the fact that output from the world’s existing oil fields has sharply declined.
“The future rate of decline in output from producing oilfields as they mature is the single most important determinant of the amount of new capacity that will need to be built globally to meet demand,” the IEA says.
And output from the world’s oilfields is declining faster than previously thought.
In its “2007 World Energy Outlook,” the IEA estimated that output from the world’s existing oilfields was declining by 3.7% a year. But in its latest report, published in November, the IEA revised that estimate to an annual decline of 6.7%. (The November report was based on the first major study of the world’s 800 largest oil fields.)
Unfortunately, the IEA is behind the curve.
For nearly a decade, Matthew R. Simmons has said that the world’s oil production was nearing - or already at - an “inflection point.” While his book “Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy,” was scoffed at when it was originally published back in 2005, Simmons is now viewed as perhaps the preeminent expert on the so-called “peak oil” movement.
“Like most people who ignore conventional wisdom, he was scoffed at, ridiculed, and denied,” commodities guru Jim Rogers told Fortune magazine. “And now, of course, people are starting to say, ‘Oh, well, I thought of that.’”
Simmons, chairman of the Houston-based investment bank Simmons & Co. International, poured through hundreds of technical documents submitted by Saudi oil geologists to the Society of Petroleum Engineers over the past 50 years.
“I finished reading the last paper on a Sunday afternoon,” Simmons told Fortune, “and I sat back and thought, ‘Holy crap, this is unbelievable. I’ve just discovered the biggest energy illusion ever in the world. We’re in big trouble. I’m going to write a book.’ “
Much of the alleged Saudi Arabia subterfuge has to do with a complete lack of transparency with respect to the Organization of Petroleum Exporting Countries. After OPEC decided to base its production quotas on reserve figures in the 1980s, several of the cartel’s producers suddenly raised their levels of “proven reserves” by 40% or more.
Back in 1988, for instance, Saudi Arabia raised its proven-reserve figure from 170 billion barrels to about 260 billion barrels. That figure has remained more or less constant since then, despite the fact that billions of barrels of oil have been pumped out of the ground.
“Saudi Arabia has announced for 20 years in a row that they have 260 billion barrels of oil in reserve,” Rogers told Money Morning during an exclusive interview in Singapore recently. “It’s astonishing. The figure never goes up and it never goes down. They have produced dozens of millions - billions - of dollars of oil in that period of time.
“Every oil country in the world has declining reserves except Saudi Arabia,” Rogers said. ”And I know that every oil company has declining reserves. So unless somebody discovers a lot of oil very quickly in very accessible areas, the surprise is going to be how high the price stays, and how high it goes.”
Simmons thinks oil prices could hit $300 a barrel - and could possibly even surge as high as $500 a barrel - during the next several years.
“Black Gold” Profit Plays
When it comes to investing, the oil sector poses some very clear risks, especially given the murky near-term outlook. However, there are a number of large-cap integrated oil companies that may offer some truly compelling values at current prices.
Exxon Mobil Corp. (XOM) and Chevron Corp. (CVX) are currently trading at multi-year lows, making them exceptionally cheap in both relative and absolute terms. These companies also have strong balance sheets (Exxon is “AAA”- rated and has more cash on its balance sheet than debt), generate strong cash flows, and have traditionally increased their dividends on a regular basis.
Chevron was actually recommended as a “Buy” by Money Morning Contributing Editor Horacio Marquez in his “Buy, Sell or Hold” column earlier this year.
“Chevron is the kind of company that is capable of continuing to post large profits - propelling its share higher from current levels - even if oil-and-gas prices were to drop from current levels over the next three years,” Marquez said. “That’s because Chevron’s business is well cushioned, since refining, marketing and chemicals margins would expand dramatically if market ’spot’ prices were to decline. Also, the company’s production is poised to expand strongly and Chevron uses some selective hedging that works very well in downside oil markets.”
Offshore drillers, particularly those capable of drilling in the deepest waters, also offer value at current levels. Petroleo Brasileiro (PBR), also known as Petrobras, is particularly appealing, as it recently discovered one of the largest offshore oil fields on earth off the coast of Rio de Janeiro. Known as Carioca, the field could hold 33 billion barrels of oil and gas, making the world’s largest discovery in at least 32 years.
Fitz-Gerald, the Money Morning investment director, suggests investors look at China National Offshore Oil Corporation, or CNOOC Ltd. (ADR: CEO). The Hong Kong-based company recently got approval for a $29 billion exploration project in the South China Sea. The company expects to produce 50 million tons of oil equivalent per year from that region during the next 10-20 years. That would equal the production of China’s biggest project, the Daqing Oil Field.
Petrobras and CNOOC are also attractive because, as foreign companies, they will also get a boost from any devaluation in the U.S. dollar.
All of these companies have been hit hard by the combination of commodity-price weakness and credit market turmoil. But these operators do not require peak-cycle commodity prices to generate stellar results and have little or no credit-market exposure.
For a more direct play on oil prices, you might also try an exchange-traded fund (ETF), such as the United States Oil Fund LP (USO), the iPath S&P GSCI Crude Oil Total Return Fund (OIL), or the United States Gasoline Fund LP (UGA).
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Comment by Clifford J. Wirth, Ph.D. on 10 January 2009:
Jason Simkins article is supported by my scientific research.
The top story of the year is that global crude oil production peaked in 2008.
The media, governments, world leaders, and public should focus on this issue.
Global crude oil production had been rising briskly until 2004, then plateaued for four years. Because oil producers were extracting at maximum effort to profit from high oil prices, this plateau is a clear indication of Peak Oil.
Then in August and September of 2008 while oil prices were still very high, global crude oil production fell nearly one million barrels per day, clear evidence of Peak Oil (See Rembrandt Koppelaar, Editor of “Oil Watch Monthly,”
Peak Oil is now.
Credit for accurate Peak Oil predictions (within a few years) goes to the following (projected year for peak given in parentheses):
* Association for the Study of Peak Oil (2007)
* Rembrandt Koppelaar, Editor of “Oil Watch Monthly” (2008)
* Tony Eriksen, Oil stock analyst; Samuel Foucher, oil analyst; and Stuart Staniford, Physicist [Wikipedia Oil Megaprojects] (2008)
* Matthew Simmons, Energy investment banker, (2007)
* T. Boone Pickens, Oil and gas investor (2007)
* U.S. Army Corps of Engineers (2005)
* Kenneth S. Deffeyes, Princeton professor and retired shell geologist (2005)
* Sam Sam Bakhtiari, Retired Iranian National Oil Company geologist (2005)
* Chris Skrebowski, Editor of “Petroleum Review” (2010)
* Sadad Al Husseini, former head of production and exploration, Saudi Aramco (2008)
* Energy Watch Group in Germany (2006)
* Fredrik Robelius, Oil analyst and author of “Giant Oil Fields” (2008 to 2018)
Oil production will now begin to decline terminally.
Within a year or two, it is likely that oil prices will skyrocket as supply falls below demand. OPEC cuts could exacerbate the gap between supply and demand and drive prices even higher.
Independent studies indicate that global crude oil production will now decline from 74 million barrels per day to 60 million barrels per day by 2015. During the same time, demand will increase. Oil supplies will be even tighter for the U.S. As oil producing nations consume more and more oil domestically they will export less and less. Because demand is high in China, India, the Middle East, and other oil producing nations, once global oil production begins to decline, demand will always be higher than supply. And since the U.S. represents one fourth of global oil demand, whatever oil we conserve will be consumed elsewhere. Thus, conservation in the U.S. will not slow oil depletion rates significantly.
Alternatives will not even begin to fill the gap. There is no plan nor capital for a so-called electric economy. And most alternatives yield electric power, but we need liquid fuels for tractors/combines, 18 wheel trucks, trains, ships, and mining equipment. The independent scientists of the Energy Watch Group conclude in a 2007 report titled: “Peak Oil Could Trigger Meltdown of Society:”
“By 2020, and even more by 2030, global oil supply will be dramatically lower. This will create a supply gap which can hardly be closed by growing contributions from other fossil, nuclear or alternative energy sources in this time frame.”
With increasing costs for gasoline and diesel, along with declining taxes and declining gasoline tax revenues, states and local governments will eventually have to cut staff and curtail highway maintenance. Eventually, gasoline stations will close, and state and local highway workers won’t be able to get to work. We are facing the collapse of the highways that depend on diesel and gasoline powered trucks for bridge maintenance, culvert cleaning to avoid road washouts, snow plowing, and roadbed and surface repair. When the highways fail, so will the power grid, as highways carry the parts, large transformers, steel for pylons, and high tension cables from great distances. With the highways out, there will be no food coming from far away, and without the power grid virtually nothing modern works, including home heating, pumping of gasoline and diesel, airports, communications, and automated building systems.
Pingback by The resource Intensity of Stupidity « Keeping Ahead of the Oil Curve on 10 January 2009:
[...] The “Cheap Oil Era” is Ending Soon… Money Morning - 3 hours ago The IEA predicts that, by 2015, a lack of investment and rising demand will create a “supply crunch” - that will once again send oil prices up into the triple digits. “There remains a real risk that under-investment will cause an oil supply crunch in … The problem with cheap oil Salon Oil set for rebound in 2009, analysts expect Calgary Herald Bloomberg - Boston Globe - Wall Street Journal Blogs - Wall Street Journal all 1,399 news articles » [...]
Pingback by DrumBeat: January 10, 2009 | EcoSilly on 10 January 2009:
[...] The “Cheap Oil Era” is Ending Soon… Oil prices have fallen 70% since hitting a record $147.27 a barrel in July, which means in just five months, crude has given up all the price gains it made in the past four years. After such a wrenching plunge, many analysts believe the outlook for the “black gold” remains bleak - and in the short term it certainly is. In the long run, however, dwindling supplies, resurgent demand, and a lack of investment will cause crude oil to double, triple, or even quintuple in price over the next few years. [...]
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[...] The “Cheap Oil Era” is Ending Soon… Oil prices have fallen 70% since hitting a record $147.27 a barrel in July, which means in just five months, crude has given up all the price gains it made in the past four years. After such a wrenching plunge, many analysts believe the outlook for the “black gold” remains bleak - and in the short term it certainly is. In the long run, however, dwindling supplies, resurgent demand, and a lack of investment will cause crude oil to double, triple, or even quintuple in price over the next few years. [...]
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Pingback by DrumBeat: January 10, 2009 | Bear Market Investments on 13 January 2009:
[...] The “Cheap Oil Era” is Ending Soon… Oil prices have fallen 70% since hitting a record $147.27 a barrel in July, which means in just five months, crude has given up all the price gains it made in the past four years. [...]
Comment by inwere cyril on 24 January 2009:
funny how we beleive so much in our scientific methods and forget the most unpredictable factor : “human irrationality”
Comment by inwere cyril on 24 January 2009:
funny how we beleive so much in our scientific methods and forget the most unpredictable factors : “human irrationality” and the limitations of our scientific methods in the light of todays knowledge.
Comment by dhewitt on 31 January 2009:
Wow. And we believe this stuff? Here is my prediction. The fall off from existing fields will escalate far beyond any “GURU’s” predictions. They cannot get themselves to make a consolidated analysis of the obvious - meaning reported facts they can read. Have they taken into consideration unprecidented production losses and the underlying financial/banking confidence in the oil and gas industry? Has no one considered that THE PRODUCTION LIFTING COSTS PRICE POINT IS CRITICAL FOR ONGOING FINANCING OF EXPLOITATION of known resource. My estimate is based on reading what is being reported by by IEA etc. Bottom line? The world will loose approximately 6 million barrels of production delivery capability in the next 8 months, if oil remains below $80 per barrel. Don’t believe it? Even with 100+ dollar oil, production from North Sea was off 9%, Mexico 9%, US to drop off 33% in the next 15 months, Russia continuing to drop off by another 7% this last year, Canadian and Venezuela Tar Sand Heavy oil to loose approxmately 1.6 million barrels per day due to lack of net income margins and NO INVESTMENT! If you were a bank would you lend to an oil company if a price collapse in a few months would decimate your borrower from news of the slightest building inventory report? The only answer is to establish and set a WW price base for crude oil so companies and banks can clearly understand what the lending parameters are and appropriately respond in determining risks. Engineers and bankers establishing lending parameters does not exist in the current environment. Unfortunitely we need a system of governments setting a WW base price for crude so investment is worst case predictable and the worlds energy demands can be given an honest shot at investment and demand accomodation. It is not a convenience but a issue of national security. If we dont see this happen, we will always be in a feast and famine cycle in an ongoing deteriorization of what used to be a quasi-predictable industry. The North American oil industry is completely decimated and that is a good thing? For who? Enemies who may one day shut off our ports and bomb a few installations and reduce our nation to bent knees trying to find oil because we didn’t set a energy policy of self reliance? And the Americans wonder why they are spending trillions of dollars keeping “peace” in the middle east for a sure flow of oil? seems like we can spend $100 per barrel and could get it for 1/3rd the price as compared with the cost of financing wars. Not only that, we are sending trillions of dollars in national wealth to nut jobs that have an average population of 16 whose only objective is to spread their form of “Peace” We are in very deep trouble folks. It is time to be real and quit listening to day job analysts.
My prediction on price? 60 - 80 by year end; provided we have the first signs of coming out of a recession by December 30th. Price in 2010? About $200 per barrel. Hard to imagine? Go do your own homework and just watch. The first indications of a recovery and the price will move $20 dollars in the first 5 days. That doesnt take into consideration the issue of a flare-up in the middle east. It won’t be fair but other nations are prepared to live with this price and we wont because we will still be driving cars and not scooters in Asia and rail systems in Europe.
Comment by jerry kozel on 26 February 2009:
I think that these analysts think is ok if you leave out the prospect of alternative fuels .Our cars don’t need to run on petroleum based product.Also believe that is about to happen faster with oil prices rising.You will see more so called hybrid cars being fueled by other means.Slowly leaving the era of oil behind.I would only consider a short term investment in oil.
Comment by Jacques Moore on 30 March 2009:
I spent over 55 years of my life in the Oil Ind, & retired @ 50
years old from Chevron Oil Co, only to stay in the IND. I have read your piece on Cheep Oil , & I disagree with this assumption 100% , We have more OIL & Natural Gas still left in
the USA than we have taken out . I am 68 years old now & I still live & work in the oil fields of SE NM & West Texas .
Back in 2005 when OIL started to the $150.00 a bbl, we started to DRILL in the Permian Basin again & right where I drilled over 50 years ago & in less than one year we had drilled over 500 wells & that put the US back on top & @ the same time we put in over 200 very big wind Generators along the rim of what we call the CAP ROCK & that will help to relieve the Pressure on our two old Electric Plants that supply
this part of the Nation .
We have plenty of Energy to take care of the United States ,but we must learn how to use what we have like using the wind along with the Oil & Gas . Putting higher prices on Gasoline is not the way to help the Nation ,but only to make the American People very made, WE can keep the price down & the American worker busey ,but we must work @ this
& we must start now & not look back or it will sneak up on us
& we will be right back where we were …
Comment by chuck stone on 8 May 2009:
A NEW ENGINE THAT USES TAP WATER FOR FUEL IS BEING DEVELOPED. THE INVENTOR WILL INTRODUCE THAT ENGINE TO THE PUBLIC IN 2010.
ENERGY FROM THE ENGINE WASTE HEAT IS USED TO “CRACK” THE WATER INTO HYDROGEN AND OXYGEN TO FUEL THE ENGINE ON-DEMAND. WHILE MANY ACADEMICS SAY SUCH AN ENGINE CANNOT WORK, THE INVENTOR IS BUSY PLANNING PRODUCTION FOR 2011.
THE PROTOTYPES HAVE BEEN RUNNING FOR 3 YEARS TO TEST THE DESIGN FEATURES. ONLY ONE FILM CREW HAS BEEN ALLOWED TO FILM AT THE LABORATORY WHERE THE WORK IS BEING DONE. SELF FINANCING BY THE WEALTHY INVENTOR MEANS THERE ARE NO OUTSIDERS TO DERAIL THE PROJECT.
SUCCESSFUL RESULTS WITH FUEL TANK DESIGNS, CYLINDER HEADS, BLOCKS AND OTHER ESSENTIALS FOR AN OTTO CYCLE ENGINE SPELL AN END TO HIGH OIL PRICES. WHO WILL WANT CARBON FUELS WHEN PENNY A GALLON TAP WATER WILL DO?
EMISSIONS ARE SO CLEAN THEY ARE HARD TO FIND IN A TEST. IS IT TIME FOR PEOPLE TO SELL THEIR OIL STOCKS?
Comment by Clifford M Skinner Jr on 12 May 2009:
Book Writer’s Corporation
Middletown, CT 06457
Dearest Concerned Individual,
A joke to think oil has any value. It is all political and the use of oil is not needed or necessary. There was technology to use water for fuel in 1938 and before. Even the use of oxygen pure oxygen is possible. The oil companies buy out the right of way of producing other forms of use of energy sources. A John Deere tractor in 1938 the one tank of fuel for kerosene another tank of fuel for water. Many years ago it was possible to use water for fuel. Also it is possible to use oxygen for fuel.
This article Cheap Oil Era is ending soon is a joke. It is all political and the use of policy to increase prices. It is a joke to make money. The whole economy is the bases for use of oil or gas— WE NEED NO Gas or OIL>
Sincerely,
Clifford M. Skinner Jr.