![]() Date: 2025-02-11 Page is: DBtxt003.php txt00011284 | |||||||||
Energy | |||||||||
Burgess COMMENTARY | |||||||||
Opinion: Why $50 is the new ceiling for crude oil prices Petroleum prices are now being set by the marginal producer, not by monopolists Getty Images LONDON (Project Syndicate) — For the first time since last October, the price of a barrel of oil CLN6, +0.14% has broken through $50. So it seems a good time to update the analysis I presented in January 2015. Back then, I argued that $50 or thereabouts would turn out to be a long-term ceiling for the oil price. At the time, with crude prices still above $60, almost everyone believed that $50 would be the rock-bottom floor. After all, futures markets predicted prices of $75 or higher; the Saudi and Russian governments needed $100 to balance their budgets; and any price much below $50 was considered unsustainable, because it would put the U.S. shale-oil industry out of business. As it happened, the price of Brent crude LCOQ6, +0.22% did fluctuate between $50 and $70 in the first half of last year, before plunging decisively below $50 in early August, when it became obvious that the lifting of sanctions against Iran would unleash a massive increase in global supply. Since then, $50 has indeed proved to be a ceiling for the oil price. But now that this level has been exceeded, will it again become a floor? That seems to be what many investors are expecting. Hedge funds and other “noncommercial” speculators have increased their long positions to an all-time high of 555,000 of the main oil contracts traded on the New York futures market, compared to the previous record of 548,000 contracts, set just before the oil price peaked at $120 in June 2014. The return of speculative enthusiasm is usually a reliable sign that the next big price move will probably be down. More important, the fundamental arguments are more compelling than ever that $50 or thereabouts will continue to be a price ceiling, rather than a floor. The case begins, as it did in January 2015, by observing that the oil market is no longer controlled by the monopoly power of the Organization of the Petroleum Exporting Countries (or the Saudi government and OPEC). Because of new sources of supply, advances in energy technology, and environmental constraints, oil is now operating under a regime of competitive pricing, like other commodities do. This is what happened for two decades from 1985 to 2004, and, as the chart below shows, trading in the spot market during the past 18 months has been consistent with this idea. So has trading in the futures market: oil for delivery in 2020 has fallen to $56, from $75 a year ago. Oil prices are now being set competitively.
If this competitive regime continues, the price of oil will no longer be determined by the needs and desires of oil-producing governments. Saudi Arabia or Russia may want, or even “need,” an oil price of $70 or $80 to balance their budgets. But oil producers’ need for a certain price does not mean that they can achieve it, any more than iron-ore or copper producers can achieve whatever price they “need” to keep paying the dividends their shareholders expect or want. Similarly, the fact that many debt-burdened shale producers will go bankrupt if the oil price stays below $50 is no reason to expect a rebound. These companies will simply lose their oil properties to banks or competitors with stronger finances. The new owners will then start to pump oil again from the same acreage, provided prices are above the marginal cost of production, which will now exclude any interest payments on loans that are written off. A clear illustration of the “regime change” that has taken place in the oil market is the current rebound in prices to around the $50 level (the likely ceiling of the new trading range). The steepest part of this increase occurred after April 17, when OPEC failed to agree on a new price target and persuade the Saudi, Russian, and Iranian governments to coordinate the output cuts that would be required to achieve any such target. Now that all of the main oil producers are unequivocally committed to maximizing production, regardless of the impact on prices, oil will continue to trade just like any other commodity (for example, iron ore) that is in oversupply in a competitive market. Prices will be determined as described in any standard economics textbook: by the marginal costs of the last supplier whose production is needed to meet global demand. When oil demand is fairly strong, as it is now and tends to be in early summer, the price will be set by the marginal production costs in U.S. shale basins and Canadian tar sands. When demand is weak, as it often is in autumn and winter, the market-clearing price will be set by marginal producers of cheap but less accessible oil in Asia and Africa, such as Kazakhstan, eastern Siberia, and Nigeria. From now on, the costs faced by these marginal producers will set the top and bottom of oil’s trading range. Low-cost producers in Saudi Arabia, Iraq, Iran, and Russia will continue to pump as much as their physical infrastructure can transport as long as the price is higher than $25 or so. The price needed to elicit enough production from U.S. shale and Canadian tar sands to meet strong demand may be $50, $55, or even $60, but it is unlikely to be much higher than that. Unpredictable shifts in supply and demand will, of course, cause fluctuations within this trading range, which past experience suggests could be quite large. In the 20-year period of competitive pricing from 1985 to 2004, the oil price frequently doubled or halved in the course of a few months. So the near-doubling of oil prices since mid-January’s $28 low is not surprising. But now that the $50 ceiling is being tested, we can expect the next major move in the trading range to be downward. Anatole Kaletsky is chief economist and co-chairman of Gavekal Dragonomics and the author of “Capitalism 4.0, The Birth of a New Economy.” This article has been published with permission of Project Syndicate — The Limits of Oil’s Rebound. COMMENTS Daryl Montgomery 15 hours ago The analysis of the oil market in this article is specious, superficial and incomplete. As is usually the case with most articles on oil, there is no significant discussion of demand. Global oil demand rises inexorably and since the Credit Crisis has been up on average 1.6 billion barrels per day (bpd) each and every year. There have in fact been only THREE years since 1859 (the last 157 years) when oil demand declined. Rising demand for oil can easily wipe out supply increases in a few years unless there are massive amounts of new supply of CHEAP oil available to market. This was the case in the 1980's, when the giant oil fields in the North Sea, Prudhoe Bay, and the Gulf of Mexico came online and flooded the market with cheap oil. Production in all three fields is now in rapid decline. Currently, there are no equivalent replacements. New oil nowadays is expensive oil and it's true that the market will have to pay the price on the margin to increase production. This price, though, will have to include reasonable profit rates for the producing companies, not the exact cost of production, and that is the cheapest possible price, not the ceiling as the author claims. Also not mentioned in this article is that it is indeed fairly easy to increase oil production in the short term, but this is not sustainable. This is what we are seeing now with the Gulf States. Extra production today, usually leads to depressed production a few years down the line. The oil market is actually setting up it's next big price spike later this decade. FlagShareLikeReply Matthew Schilling 16 hours ago We need a tariff to set the minimum price of domestic oil to $50. Then HAMMER the international price. How? Besides letting the glorious frackers do what they do (by protecting them from economic warfare waged against them), the government should 1) Order plants to make a million barrels of oil per day worth of pristine clean diesel and jet fuel from coal. (Two guys won a Nobel prize in Chemistry a decade ago for greatly improving the process). The U.S. military gobbles up more diesel and jet fuel than any other entity on the planet. Order enough to fully satisfy that need. 2) The Fed government should push to reduce the amount of oil used for heating in the winter. Lunatic Luddites are trying to upend the market and prevent cheaper cleaner natural gas from displacing that oil. The Feds should put an end to the foolishness. 3) Break ground on a new nuclear power plant each month (China has been building huge coal-based plants at the rate of roughly one per WEEK). A nuclear power plant is 90% cement and rolled steel. Talk about shovel ready jobs! Keep up the pace until we've doubled our inventory. Then keep building - replacing the older dinosaurs with new plants that are better in every way. The U.S still imports way too much oil. Drop that by another couple million barrels a day and we will see $40 Brent for the foreseeable future. That stifles Russia and Iran and robs Islamofacsists of funds. It also makes for $30 million a day in tariff revenue to a government running massive deficits, along with a bigger, healthier domestic energy industry. FlagShare1LikeReply Dmitry Glago 1 day ago Someone expects oil on $30, optimists see oil on $57 - 60, but oil could be locked between $47 - 53 during a long time and this situation can make stress for all. FlagShareLikeReply Bill H Illify 2 days ago Oil equities are acting like they are topping out to me... FlagShare1LikeReply James Thompson 2 days ago @Bill H Illify XLE still under its Nov high. Yielding just under 3% FlagShareLikeReply D. L. 2 days ago $65 per barrel by years end. FlagShare1LikeReply Dean Wormer 2 days ago The Cannon pump! Back to green man! Saints be praised! FlagShareLikeReply Jack Benny 2 days ago 'Now that all of the main oil producers are unequivocally committed to maximizing production' What makes you think that is etched in stone? All it takes to move the price above $50 a barrel is cooperation between the top producers. What makes you think they are predictable now? FlagShareLikeReply Dean Wormer 2 days ago How soon to $70 man? A week? A Day? A Weekday? FlagShareLikeReply James Thompson 2 days ago Because it's not next week yet? (Just kidding. Who knows? Maybe $50 is the new normal.) |