Future Direction of Oil Prices May See a Major Shift

Steady Climb

Since I first started writing about energy in 2005, I have said many times that my view on oil prices is long-term, and that if I projected five years into the future, I foresaw oil prices being higher than they were in the present.

The chart below — using spot prices from the Energy Information Administration (EIA) for both Brent and West Texas Intermediate (WTI) crudes — shows that this has held true since 2001.

The annual average price of crude (source is again EIA) rose every year from 2001 ($25.98 for WTI) through 2008 ($99.67), fell back to $61.95 in 2009 (which was still above the price of five years earlier), and then climbed again in 2010 and 2011.

Starting from 2001, the average annual five-year increment on price through 2011 was $38.66. In other words, that’s how much WTI in this case had appreciated in price five years into the future. Over that same time period, the lowest five-year increase was $20.44 (2004 to 2009) and the highest was $68.59 (2003 to 2008).

However, I believe that trend may break in 2013.

Why We May See a Break in the Recent Trend

A number of developments point to this possibility. The most important driver is that oil companies have made record investments into finding and producing new oil in the face of rising prices. As a result, oil production both globally and domestically in the U.S. has been on the rise. BP will release their 2012 Statistical Review of World Energy on June 13th, and I believe that it will confirm that this trend of rising production continued through 2011. (The Statistical Review will be the topic of next Monday’s post).

Future oil production is likely to continue to rise somewhat in my opinion, as the fracking revolution that has increased tight oil production in the U.S. has yet to spread across the rest of the world. There are other tight oil formations like the Bakken in North Dakota, and some of them are enormous. As those formations are fracked, oil supplies will grow. (My prediction for global oil production has been that it would peak in the vicinity of 90 million bpd).

Economic weakness in many countries (partially brought on by higher oil prices) is another major factor. Countries are broke, and will be increasingly forced to implement austerity measures. This favors a lower oil price. The Western world has responded to higher oil prices, lowering their consumption over the past several years. This is true for North America, the EU, Japan (although their oil consumption is currently on the rise due to the shutting down of their nuclear reactors), and many other developed countries.

There are a number of factors working in the opposite direction to raise oil prices. The most important factor there is near insatiable demand for oil by developing countries — even in the face of $100 oil. However, those developing countries consume a lot of oil to supply goods to developed countries, and the belt-tightening going on will reduce demand for those goods. Recent reports indicate that China’s growth is slowing. On the other hand, China is still growing, so unless they rapidly improve their GDP efficiency, their oil consumption will continue to rise, albeit more slowly than in recent years.

The other major factor that will work to keep oil prices propped up is OPEC’s desire for high oil prices. Regardless of the growth in oil production outside of OPEC, they can cut production to compensate. A number of OPEC members have indicated that they are happy with oil at $100/bbl, and they have gotten accustomed to the revenues provided by high oil prices.

Put all of those factors together, and I believe that oil prices will remain high, but that 2013 could see a lower average price than we saw in 2008. The price for 2012 will almost certainly be above the $72.34 from 2007, but 2013 may not average the $99.48 seen in 2008. Further, I think it is unlikely that we will see prices spike as high in 2013 as we saw in 2008 when WTI spiked to nearly $150/bbl (barring of course major events like war with Iran or widespread unrest in Saudi Arabia).

Excess Energy?

There have been numerous stories in the media recently about how we now have an excess of energy (see here, here, or here). The following graphic has gotten a lot of attention recently:

It expresses graphically what I have stated above: Higher oil production and lower demand have led to the first oil production surplus since 2005. I have consistently stated that I believe the rise in oil prices over the past decade was precisely due to the erosion of spare production capacity, and it looks like for 2012 we are back into (slight) surplus territory. So do those trends continue, or does the surplus look like it did in 2005, when it vanished quickly?

However, we must not allow complacency to creep in. Even if prices are beginning to moderate and the outlook is for oil to stabilize at $80 to $90 a barrel (as forecast in one of those stories), that still stresses the economy. A decade ago we could not have imagined oil at those prices, and yet now $80 oil is a relief. But $80 oil is still a strain on developed countries, it enriches many countries that are hostile to U.S. interests, and it is still dependent upon the whims of OPEC.

One of the major points I try to drive home when writing and speaking about energy is the risk factors involved in our energy policy. As long as global oil prices are dictated by OPEC’s decisions, and as long as high oil prices threaten the U.S. economy, we must not become complacent about our oil consumption (or more appropriately, our oil imports).

We must continue to work hard to reduce oil’s stranglehold on our economy, while simultaneously working to ensure that to the greatest extent possible our oil needs are supplied domestically or by friendly countries. But the good news (for most people) is that oil’s stranglehold is at least temporarily easing up.