Crude oil price poised to rise to $100 and remain at elevated levels

$100/bbl oil - Get used to it!

26 November 2007 00:00  [Source: ICB]

Joseph Chang/New York

In a world of tightening supplies and unchecked demand growth, triple-digit prices loom and could be here to stay

BLACK GOLD is getting more precious. Having languished at under $10/bbl just eight years ago, crude oil recently spiked over $90/bbl. Tightening global supplies and accelerating demand from oil producing and emerging market countries could take oil well past the $100/bbl mark.

One leading economist sees crude oil prices hitting $100/bbl by the end of 2008 and staying at or above that level for some time to come.

"This is not a spike. Triple-digit prices will be here to stay for the foreseeable future," says Jeff Rubin, chief economist and chief strategist at CIBC World Markets. "Despite a doubling of the oil price in the past few years, demandis accelerating."

While global demand is growing at a modest 2%/year, growth from developing countries is rising at 4%/year, according to CIBC. "Within a decade, developing-world demand will exceed OECD demand - a startling change," says Rubin.

That would bring oil demand from these countries to over 50m bbl/day from the current 35m bbl/day.

Demand is surging from OPEC and emerging market countries, where their economies are more dependent on oil for growth. For every percentage point of GDP growth, China uses almost twice as much oil as the US.

"China has become the factory of the world and is much more oil-intensive," notes Rubin.

And OPEC economies are 15-20% more oil-intensive than China. Demand for oil in these countries is surging. From 2001-2006, consumption in Iran, Saudi Arabia and Kuwait rose by an annual rate of 4.5%, 5% and 7%, respectively. In contrast, world consumption rose by 1.5%/year and OECD demand edged up just 0.5%/year.

SUBSIDIES CREATE UNCHECKED DEMAND GROWTH

Why the huge gap? The key reason is that gasoline is highly subsidized in many oil producing countries, such as Iran and Venezuela, creating runaway demand undeterred by rising crude oil prices.

"Caracas is living on $10/bbl oil and the retail price of gasoline at 25 cents/gal reflects that," Rubin points out. "People in those countries feel they have a God-given right to consume as much as they wish, and the governments that interfere do so at their peril."

Last summer in Iran, where gasoline is imported despite the country's huge production of crude oil, the government rationed supplies. Widespread riots ensued, but the government kept the policy.

But in Nigeria, the government backed down from its attempt to drop fuel subsidies after oil workers threatened to strike and shut down production.

The oil economies of the OPEC countries, Russia and Mexico consume around 12.3m bbl/day - 250,000 bbl/day more than Western Europe, and well over China's 7.1m bbl/day, according to CIBC. The US is the world's largest consumer at 20m bbl/day.

EXPORTS TO FALL

Unchecked consumption will slash OPEC exports in the years to come, says Rubin, making the already tenuous supply-demand balance even tighter.

"OPEC's own consumption will cut into exports. Contrary to consensus expectations, OPEC will have less, not more exports over the next five years," Rubin notes. "This will also coincide with a decline in production growth elsewhere in the world."

From 2007-2012, OPEC oil production will rise by about 1.7m bbl/day, according to CIBC. However, consumption will rise by 2.2m bbl/day, resulting in a decline in oil exports of around 500,000 bbl/day.

Oil exports from Russia, the world's largest oil producer, are peaking at about 7m bbl/day and will soon decline as domestic consumption surges.

From 2007-2012, Russian oil consumption is projected to rise by an average of 4%/year, while production is expected to decline slightly, resulting in a reduction in exports of about 1m bbl/day. Russia currently produces around 9.5m bbl/day.

"By 2012, oil exports from OPEC and Russia will decline by about 1.5m bbl/day," Rubin forecasts.

But the steepest decline in production is likely to come from Mexico, where rapid depletion at the giant Cantarell field and little new supply could lead to a collapse in output.

"The official Pemex forecast has production at Cantarell declining at 2%/year, but actual production rates have fallen much faster - in line with Pemex's own worst-case scenario," says Rubin. "Mexico's exports will collapse with Cantarell's depletion."

Rubin estimates that Mexico's oil production will decline by 1m bbl/day by 2012, to less than 2m bbl/day. However, its own domestic demand will continue to increase. Mexico currently produces about 3m bbl/day and exports 1.25m bbl/day.

"By 2012, Mexico will be another Indonesia - an oil importer," he says.

And given that 80% of Mexico's oil exports go to the US, and that Mexico is the second-largest oil supplier to the US, the implications for the latter's energy supply are bleak.

"Aside from Canada, exports from the next six largest US suppliers will fall nearly 2m bbl/day by 2012," warns Rubin.

COSTLY CANADIAN CRUDE TO DEFINE GLOBAL OIL PRICE

And while Canadian oil exports will pick up to make up some of the slack, they will not be conventional crude oil. "This will be high-cost oil from the oil sands - and very high-cost when pricing in carbon emissions," says Rubin. "Rising oil sands production will make Canada a top-tier producer."

By 2012, Canada will be the largest oil supplier to the US, as its share rises from 21% today to 30%, while Mexico's 14% market share will go to zero, according to CIBC.

High prices will also be supported by the high cost of producing oil from the Canadian oil sands.

"Canadian oil sands production will be the single largest source of new supply in the world. This will define oil pricing," says Rubin. "And in the coming years, I expect the Alberta oil patch to reflect more global ownership."

The Canadian oil sands produce over 1m bbl/day today, which Rubin sees as rising to 2.5m bbl/day in 2012 and 4.5m bbl/day by 2020.

Canada has more than 50% of the world's "investable" oil reserves, meaning reserves that are not off-limits because of restrictive foreign investment policies, according to Rubin.

The economist forecasts the average price of the benchmark West Texas Intermediate crude oil to be $90/bbl in 2008, rising to $100/bbl by the end of 2008. "This will not be a spike, but what it will take to grow world oil supply," he says.

What a contrast from 2000, when technology ruled the world and the natural resource sector was in the doldrums, he notes.

"What happened was that technology got arbitraged to places like India and China. Now technology is a commodity," notes Rubin. "But natural resources are captive and cannot be arbitraged."

In the longer term, the hydrocarbon age may be coming to an end, as the rising price of crude oil amid shrinking world supplies leads to the use of alternative energy sources.

"When you're schlepping oil from sand, you're probably in the bottom of the ninth inning in the hydrocarbon economy," says Rubin. "This will incentivize new technology development in alternative energy."

 

CRUDE BEARS

Not everyone has a bullish outlook on oil. A number of analysts believe prices are artificially high, pricing in a heavy risk premium, and are poised to fall.

Lynn Westfall, chief economist at gasoline refiner Tesoro Petroleum, recently said crude oil prices should be in the $60/bbl range, based on supply/demand fundamentals. He estimates the risk premium from political uncertainty in the Middle East and other factors as accounting for about $30 of the current oil price.

Helen Helton, head of commodities research at Standard Chartered, expects crude oil prices to average $75/bbl in the fourth quarter - $15 below current levels.

Deutsche Bank global head of commodities research Michael Lewis is also bearish on oil prices, expecting them to fall in the fourth quarter on a warmer winter in the US, diminishing geopolitical and hurricane risk premiums, higher production from OPEC starting in November and a softening of demand driven by an economic slowdown in the US.

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