Whatever happened to $200 a barrel oil?
Maybe it’s just been delayed in transit. A recession in the world’s developed economies can do that.
Remember Arjun Murti’s time in the sun when, back in May 2008, the analyst at Goldman Sachs predicted that oil would soon hit $200 a barrel? A number of other prognosticators weren’t far behind. T. Boone Pickens predicted that oil would hit $150 that year. Some guy named Jim Jubak in April 2008 called for $180 a barrel within two years in a column for MSN Money (http://articles.moneycentral.msn.com/Investing/JubaksJournal/WhyOilCouldHit180DollarsABarrel.aspx?vv=750 )
Just in case you haven’t noticed, all of us were wrong. Oil peaked at $147 a barrel in the summer of 2008 and then plunged to hit $35 a barrel by June 2009.
Let me rephrase that: We weren’t wrong; we were early. (All financial fortune tellers are told over and over again in their training at the Frogwarts School for Financial Wizards that you never, never, never forecast both a price and a date. One or the other. Never both.)
A little thing called the Great Recession killed global demand for oil. For a while
But none of the supply-side problems that lead me and others to predict $150-$200 per barrel oil have gone away. And as soon as oil demand rebounds with a global economic recovery, I think we’re going to be right back on the road to $150, $180, or $200 a barrel oil.
There are global trends that could scupper that prediction too, but I don’t think those forces are moving fast enough to change the price trend over the next ten years or so. (But I will outline those countervailing trend at the end of this post.)
The global recession wiped out roughly two years of worldwide demand for oil.
In April 2008 the International Energy Agency (IEA) was predicting that global demand would hit 87.2 million barrels a day in 2008. That would be an increase of 1.3 million barrels a day from the 85.9 million barrels a day in global demand for 2007.
By spring of 2008 the IEA already saw a slowdown in the U.S. economy but didn’t think it would be enough to significantly depress global oil demand that year.
But the slowdown turned out not to be limited to the United States and in the developed economies it hit hard enough to earn comparisons to the Great Depression.
Global oil demand fell to 85 million barrels a day in 2009, down 1.4% from 2008, and lower than in 2007. As of March 12, the IEA is forecasting that global demand will climb to 86.6 million barrels a day. That would mark a total increase in global demand of 0.8% from 2007.
Before the fall and then stagnation in global demand for oil, the International Energy Agency was worried that global investment in finding new oil, developing those finds, and increasing production from existing fields wouldn’t be enough to keep u with global demand and that would send oil prices surging. The three examples that I cited in my April 22 column were Russia, where the oil ministry was predicting a decline in production for 2008; Nigeria where massive corruption left the country’s plans to double oil production laughably underfunded; and Mexico, where underinvestment in the huge Cantarell oil field in the Gulf of Mexico and other oil fields had already resulted in an 18% decline in production in 2007.
Fast forward to 2010 and the IEA is worried about, you guessed it, under-investment in capital spending on finding oil and developing reserves. Global capital spending on those activities—including capital spending on maintaining or increasing production from existing fields—fell by $90 billion, or 19%, in 2009. That the first decline, the IEA reports in a decade.
Three trends make this decline particularly troubling to the IEA.
First, the world’s most deep-pocketed oil companies, the Western oil majors, are increasingly excluded from the most promising areas for exploration and development. National oil companies control access to those geologies but often don’t have the capital to exploit them fully or completely because national governments siphon off oil revenues to fund government budgets.
Second the cost of finding new oil continues to rise. Western oil majors have recently reported a rise in the drilling failure rate. Chevron (CVX), for example, reported that 35% of the wells it drilled in 2009 came up dry. In 2008 the rate was just 10%. More dry holes mean spending more money to find less oil. (For more on the dry hole surge see my post http://jubakpicks.com/2010/03/09/oil-drilling-failure-rate-plunges-at-the-western-majors/ ) And more of the wells that actually find oil are in extremely challenging geologies. On March 11, for example, BP (BP) paid Devon Energy (DVN) $7 billion for assets that included Devon’s stake in the promising Campos deep-ocean region off Brazil. The oil and gas in this region is under more than a mile of water and a thick layer of salt. Drilling a single well can easily cost $100 million. Energy analysts estimate that BP needs a price of $70 a barrel or more to break even on the assets it purchased from Devon. If breakeven on new oil is $70, that would suggest that oil prices aren’t about to drop under $70 a barrel in the future, right?
Third, IEA estimates that output from existing fields will drop by almost two-thirds by 2030. The world is counting on oil from BP’s deep-water wells, from Canada’s oil sands, from Venezuela’s tough-to-refine heavy oil deposits, and from new finds and increased production from fields in high-cost environments such as Siberia and the off-shore Arctic.
On March 9, the U.S. Department of Energy raised its oil price forecast (for West Texas Intermediate) to $85 a barrel by the end of 2011. With oil trading near $82 a barrel now that forecast price for almost 21 months from now appears very low—unless you’re counting on a double-dip recession for the U.S. and global economies.
That possibility—and the fate of my April 2008 forecast—should be a reminder that extending any trend line into the future is a tricky business. So what could go wrong and stop oil prices from rising at the rate that I now expect?
- A double-dip recession in the global economy. A recession in the developed world won’t do the job, mind you. The IEA forecast for 2010 already calls for a drop in demand in the world’s developed economies of 0.3% –a drop of 120,000 barrels a day–in 2010. Global oil demand is being driven by China, and the rest of the developing world. Developing Asia, for example, will account for half of total growth in demand in 2010. By 2025, the International Energy Agency forecasts, China will pass the United States to become the world’s biggest spender on imported oil and natural gas.
- A global glut—or at least expanding supplies and falling prices—in natural gas. The IEA predicts a glut of natural gas of 200 billion cubic meters by 2015 thanks to expanding supply from unconventional sources in the United States and increasing exploitation of conventional gas reserves in the Middle East and other OPEC (Organization of Petroleum Exporting Countries) producers, such as Angola. Unfortunately, natural gas can’t currently be easily used to replace oil for transportation. In the United States transportation accounts for about two-thirds of oil demand. The rest of the world uses more oil (as a percentage of demand) for heating and power generation than the U.S. does—and in those areas cheap natural gas will indeed replace expensive oil holding down oil price increases. But most of the oil demand growth in the developing world is coming from the transportation sector as these countries start to look more and more like the United States. In 2005 vehicle use accounted for just one-third of China’s total oil consumption. But by 2030-2041a study by Argonne National Laboratory projects, oil demand for road transportation in China will equal that in the United States. The annual growth rate in oil demand from road transportation in China will be between 3.9% and 5.1% from 2005 to 2050, the study concludes. That growth in transportation demand for oil decreases the likelihood that lower natural gas prices will significantly restrain rising oil prices.
- A transition in transportation uses from oil to bio-fuels and increases in auto fuel efficiencies. I think this is the One Big Thing that could significantly cut into oil demand growth and make predictions of $200 a barrel oil wrong again. Brazil already produces ethanol from sugar cane at a cost of $36 to $43 a barrel, according to estimates from Brazil’s Bank for Economic and Social Development. If you’ve spent decades fostering a flex-fuel auto industry—the 10 millionth flex-fuel car rolled down Brazil’s auto assembly line on March 4—that makes ethanol a hugely attractive substitute for gasoline when oil is selling for $80 a barrel. No wonder that Brazil’s ethanol industry is in the midst of a mergers and acquisition boom as players scramble to grab share. (For more on that and why you want to own Brazil in your portfolio see my post http://jubakpicks.com/2010/02/05/how-to-build-a-global-portfolio-what-countries-do-you-want-to-own/ ) Short of building a flex-fuel auto industry (and no reason other than a lack of political will that other countries can’t), the best way to reduce oil demand in the transportation sector is by increasing auto miles per gallon. The higher oil prices are the more attractive hybrids and all electric cars become.
I think a number of investing ideas fall out of this forecast for rising oil prices. You can, of course, by oil producers. I’d favor the shares of the few national oil companies that will let you buy in—Norway’s Statoil (STO) and Brazil’s Petrobras (PBR) as well as companies such as Apache (APA) that specialize in getting more oil out of old fields. (Apache has been in Jim’s Watch List http://jubakpicks.com/watch-list/ since December.) The pick and shovel (or drill bit and drill ship) companies are also good bets if oil prices are headed up over the long term. I’d favor Jubak’s Picks Transocean (RIG) and, after the merger-dust has settled, Schlumberger (SLB). I’d also take a look at some of the big Brazilian agricultural companies such as Cosan (CZZ), Bunge (BG) and Vale (VALE), the big iron or producer that has recently moved into fertilizer production. (More sugar cane for ethanol means equals more need for fertilizer.)
Full disclosure: I own shares in the following companies mentioned in this column in my personal portfolio: Apache, Statoil, Transocean, and Vale.