Budget caution averts panic over oil price slide

Bob Tippee

The price of crude oil has fallen by more than $7/bbl in 3 weeks. Shouldn't oil companies be canceling projects, laying off workers, and shedding physical assets? Is a $7/bbl slide no longer sufficient to shove industry managers into scorched-earth mode?

Apparently not. There's no sense of panic. Companies are going about their business.

Part of the reason for the calm response to a bona fide price slump is simple arithmetic. A $7 decline from $56/bbl, in the case of West Texas Intermediate spot crude, isn't the same as a $7 swoon from $20/bbl.

Furthermore, few decision-makers in the industry expected $56/bbl oil to last.

Sure, the price might have lurched even higher if oil-field strikes had curtailed exports from Nigeria or political unrest had again idled Venezuela. Either calamity can still happen.

But $56/bbl and up forever? With no supply emergency? No way.

For the moment, the market has plenty of oil. Members of the Organization of Petroleum Exporting Countries have increased production. Output in the Gulf of Mexico is rising back toward its level before Hurricane Ivan forced shut-in of as much as 30%. Oil is moving into inventory.

For the first time in a long time, prompt prices have slipped below those of forward prices several months into the future. The pattern, called contango, encourages storage.

The market thus is trying to repair its eroded buffers. It's still vulnerable to a sudden loss of supply, of course. Idle production capacity remains less than the deficit that would result from any one of several easily imaginable disruptions. For that reason, continuation of the inventory build is especially important.

Without such a disruption, how low will oil prices go? One high-profile guess comes from Total CEO Thierry Desmarest recently, who recently told Le Figaro of France they might approach $30/bbl next year.

So a $7/bbl dip would become a $25/bbl slump. What would oil companies do then?

Not much, probably. Most companies still base budgets on $20-25/bbl oil. A few weeks ago, price thresholds that low, according to many observers, were too cautious. They're beginning to look wise.

(Author's e-mail: bobt@ogjonline.com)

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