In eight years, oil may be trading more or less right around where it is right now.
That’s the call energy economist Ed Morse made in a recent note to clients. The commodities research chief at Citi says he expects crude prices to stabilise around $80-90 per barrel by 2020.
Morse writes that “peak oil biases continue to blind analysts to an emerging oil cycle turning point” and that “unless the end of history has arrived, the long period of price increases that started in the last decade appears to be coming to an end.”
Why are peak oil proponents wrong, according to Morse? He points to the 1980s, when global depletion of upstream oil inventories caused many to believe that the days of abundant oil were drawing to a close, saying this is when peak oil theories “began to dominate thought leadership in the oil sector.”
This next graph explains why. Morse notes that there have only been three years since 1984 where discoveries of new oil have exceeded oil consumption:
One of those years was 2010, the latest data in the graph. Morse thinks that indicates an important turning point is in the works. He notes that historically high oil prices in recent years have spurred a wave of upstream spending in the oil industry as producers look to cash in, and capital expenditures are now higher than ever (albeit nominally), and Morse says the “upstream spending is all about inventories.”
Here is what the recent oil and gas capital expenditures boom looks like:
The bottom line on this oil boom is that all of this increased spending means increased supply. Morse explains:
It took some supply shocks to raise both deferred and prompt prices; and the price increase induced a scramble for new supplies via what turned out to be an unprecedented surge in upstream capital expenditures starting in 2003 (see Figure 1). But it took nearly a full decade to start showing results. The results are just starting to provide evidence that the cyclical trough in the petroleum sector has now passed and the global petroleum industry has just started a new phase in which supply is likely to grow robustly.
Morse uses four methods to get to a price of $80-90 per barrel in 2020. The first two he admits are “simplistic” whereas the latter two methods are perhaps more analytically rigorous:
- The first method is long term futures prices. Morse notes that five year forward contracts are currently trading at $85-90 a barrel. But the broad point is that post-2009, after a half-decade of exponential increases, there has been a new, remarkable stability and re-convergence in the $85-90 range,” he writes. “This indicates that the volatility in these prices since 2003-08 is coming to an end, and reflects other factors, including the stabilisation of costs, discussed below.”
- The second method is examining the economics of marginal fields. According to Morse, it currently costs around $90 per barrel to procure oil from the most expensive fields.
- The third method for estimating the 2020 price Morse uses deals with unit costs of production. The long term ‘4-to-1’ ratio between wellhead prices and in-ground value of oil, if it holds, “suggests target prices around $65-70/bbl.”
- The fourth and final method, relates deferred WTI crude prices with industry cost indices. Citi has a proprietary index that tracks various indicators like machinery costs to estimate a “fair value” for long term oil prices, and it’s pointing to a price around $85-90 per barrel.
But oil unchanged in 2020? Imagine that.
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