By Bjorn Fehrm
January 16, 2017, ©. Leeham Co: Oil has now doubled in price since the lowest point a year ago, with a present level of $50-$60/barrel. What is the trend going forward?
We are at the Growth Frontiers 2017 conference in Dublin, where Paul Horsnell, Head of Commodities research at Standard Chartered and Mike Corley, Mercatus Energy Adviser, gave their view on the future of oil prices.
The air transport market has seen a worldwide passenger and profitability growth over the last 12 months. The driving factors are increased appetite for air travel, especially in Asia, and cheap fuel.
The world market price for crude oil (and by it the price of jet fuel) is decided by supply and demand. The demand-side of that equation is predictable and stable. The need for energy, for industry or private use, is not changing fast.
This is not the case for the supply. The past slump of oil prices from over $100/barrel to under $30/barrel was driven by the oil producers in OPEC (essentially the Middle East producers), wanting to weed out new competition that had come into the market.
The OPEC producers had the strategic advantage of low production costs, below $10/barrel. The new competition by, predominantly US shale oil producers, had a production cost north of $60/barrel. By forcing the world market price to dip well below $60, OPEC would make the US shale oil production unprofitable.
With it, several other producers would be forced to sell oil below production costs. Examples would be North Sea Oil (production cost around $60/barrel), Russian oil ($70/barrel) and oil from South America.
Since price hit bottom at $26, it has now gradually climbed up to $60/barrel, Figure 1.
The big question is now, what happens next?
Horsnell/Corley said the low oil price had a profound impact on the market. Producers stopped investing. The capital behind the expansion of shale oil in the US disappeared as fast as it appeared. Longer term investors in other forms oil exploration decided that this was not an attractive market anymore.
Those that had no choice but to slug it out (North Sea, Russian, South American producers) stopped investing. They continued production but planned capacity increases were stopped.
For many producers the oil at $60 is just at the break even, where they get their production costs covered. As the investors are no longer there, they will avoid making continued losses but their capability to follow an expanding market is hurt.
The result is the strategy of OPEC, to stop alternate source competition, has succeeded. The experts see it as in OPEC’s best interest to keep a steady oil price going forward with a steady, slow increase from the present level.
They don’t see what constellation should argue this with OPEC. The risk willing capital that came into the market to exploit alternative sources for oil has backed out. There are easier ways to earn return on invested capital than to pick a fight with behemoths like OPEC.