Do Oil Prices Have to Go Higher?

Wednesday, October 14, 2009

Brendan's comment on the inevitability of higher oil prices offers several good reasons for his conclusion.

While we also believe that the long term trend will be for higher prices, however we would like to offer the following qualifications:

Growth in Emerging Economies --> Rising Oil Consumption - The rate of development of emerging economies is the primary reason for the increase in demand. However, these economies are highly dependent on oil to meet their energy needs. Higher prices hurt their economies and those of their trading partners. So these emerging economies are more likely to be hurt by higher prices. This will, in turn, lead to lower demand and put pressure on prices.

OPEC --> Governments depend on oil income --> Cartel restricts supply - In the past few yeras OPEC has generally done a fair job at controlling prices. However, they had to abandon their market basket triggering process several years ago. So overall, OPEC would probably not get good grades as a cartel. We believe that international events (wars) have contributed more to oil price movements than specific OPEC actions. OPEC actions tend to be in agreement when prices are rising, but disunity occurs in a falling price environment.

Geopolitical Issues --> Cause disruption / thread of oil production --> Lower global spare capacity - We certainly agree with this comment as our analysis of world oil markets has shown.

Peak Oil Theory --> Declining Oil production --> Less Supply - Oil is a scarce resource and as it is produced the resources will decline. The real question is how much oil is remaining to be discovered. Scientists can only make educated guesses in this area. The utilization of oil sands and heavy oil reserves is increasing. The current oil reserve lifetime is 40 years and has increased from 29 years in 1980. Over the past ten years the lifetime has been around 40 years.

Our view of oil prices is that they will continue to increase in line with inflation and oil demand. However, we don't believe that today's prices are indicative of oil's true value.


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