The world oil market has undergone dramatic developments over the last 12 months. On January 3, 2008, the price of a barrel of oil passed the $100 mark for the first time. The price continued to rise in the following months and by July 2008 it had risen another 45 percent, briefly reaching more than $145. Soon after, a drastic price correction set in. In the last four months, the price of oil has fallen more than 60 percent and reached levels below $50 — a price last seen in 2005.
Part of this price correction is surely the result of the liquidation of speculative long positions and the reduction of risk positions by key market participants in connection with the financial crisis. However, the main culprit is a change in the balance of supply and demand. For example, demand for oil in developed economies has dropped off sharply in recent months as a result of the economic downturn and the high prices seen in the first half of 2008. At the same time, oil production has risen significantly, especially in OPEC countries, with many oil- producing countries working at full capacity over the summer months. This combination of rising supply and weak demand has led prices to decline, a process that has been accelerated by the financial crisis.
Can’t help but rise again
In view of the size and speed of the price decline, the question now is whether this represents an end to the structural price increase of the last few years. However, this is probably not the case. Again, this is mainly because of the long-term balance between supply and demand. Worldwide consumption of oil is currently slightly more than 85 million barrels per day (mb/d). This represents an increase of 13 percent over 2000, and if emerging markets — particularly India and China — continue their industrial rise over the next few years, global oil consumption will climb even further. The International Energy Agency (IEA) expects oil consumption to increase to more than 106 mb/d by 2030. In order to meet this rise in consumption, considerable investments will be necessary, primarily in countries in the Middle East. The region is home to more than 60 percent of the world’s oil reserves, but it is only responsible for 30 percent of global oil production. Because oil fields in Europe, the US, and to some extent Russia are in the advanced stages of production, output in these areas is declining. Production at oil fields in the US and the North Sea in particular have been waning for some years, so production will increasingly have to be shifted to the Middle East just to maintain current levels. Significant investments will be required to increase production to more than 100 mb/d by 2030. The IEA estimates that $11.7 trillion in investments will be necessary by 2030. The costs to shift production and tap new oil fields will likely impact the price of oil.
The current price of less than $50 per barrel is already below the marginal cost of production and is therefore likely to be unsustainable. The marginal cost to produce 85 mb/d at present is about $60 to $70 per barrel, a figure that is more likely to rise than fall in coming years as a result of the necessary shift in production. While weak oil prices and increased volatility will continue in the short term as a result of the economic slowdown and the credit crisis, prices should gradually stabilize in the first half of 2009. In all likelihood, oil prices will resume their structural upward trend in the longer term.
FADY EID is chairman and general manager of
Credit Suisse (Lebanon Finance) S.A.L.