Facing $100/bbl oil

Nov. 5, 2007
The December contract for benchmark US light, sweet crudes climbed as high as $92.22/bbl during the regular trading session Oct. 26 on the New York Mercantile Exchange before closing at $91.86, up $1.40 for the day.

The December contract for benchmark US light, sweet crudes climbed as high as $92.22/bbl during the regular trading session Oct. 26 on the New York Mercantile Exchange before closing at $91.86, up $1.40 for the day.

It was the second time in as many sessions that contract hit new highs above $90/bbl after crossing that mark for the first time on Oct. 18. Moreover, the contract’s price continued to climb pass $93/bbl in after-hours electronic trading over the weekend and appeared set to scale new heights before expiring.

“The oil market may be only one or two events away from $100-plus oil, and there is much momentum in that direction,” said Daniel Yergin, chairman of Cambridge Energy Research Associates, at an Oct. 29 energy symposium at Georgetown University in Washington, DC. “With prices over $90/bbl and strong anticipation of $100, the oil market is showing signs of high fever, stoked by fears of clashes in the Middle East and resulting disruptions of supply.”

Analysts in the Houston office of Raymond James & Associates Inc. cited several factors pushing crude prices higher, including:

  • Storms in the Gulf of Mexico forced Petroloeos Mexicanos, Mexico’s state-run oil company, to shut in 600,000 b/d of offshore production, one-fifth of Mexico’s total oil output.
  • The US dollar hit record lows against the euro, as investors anticipated that the US Federal Reserve will cut interest rates at its next meeting.
  • Ministers of the Organization of Petroleum Exporting Countries have disregarded calls from various sources to increase production. Instead, OPEC blames geopolitical issues for driving up prices.
  • Increased military tensions between Turkey and Kurdish rebels in Iraq.

Turkey and Iraq

Turkey’s threat to invade northern Iraq and attack bases of the Kurdistan Workers’ Party (PKK) , “has sent prices spiraling upwards, primarily because the words ‘conflict’ and ‘Middle East’ always cause traders to respond with alarm,” said Michael C. Lynch, president of Strategic Energy & Economic Research Inc., Amherst, Mass. However, Lynch said, “The Turks are unlikely to do much more than cross into border regions and attack the mountain bases near there, which are well away from any oil producing areas (located mostly near Kirkuk, over 200 km from the border).” He said, “Some military action can be expected, but it is unlikely to be major and should be dismissed by the market fairly quickly.”

Meanwhile, Yergin said, “Oil prices are becoming increasingly decoupled from the fundamentals of supply and demand.” He said, “What we’re seeing in the oil market today is rooted more in the cauldrons of geopolitics and the impact of financial markets, expectations, and psychology than in supply and demand, but these are real factors.” He cited the impact on the energy market over the previous 2 weeks of tougher rhetoric over Iran’s nuclear program and heightened tension between Turkey and Iraq.

Yergin emphasized the importance of Russia in global energy markets in this decade. “While there has been so much attention around the world to the rapid increase in Chinese oil consumption, the growth in Russian oil production between 2000 and 2006-2.9 million b/d-exceeded the 2.5 million b/d increase in Chinese oil demand over the same period,” he said. “But while Chinese consumption continues to go up, Russia’s increase in output is flattening out rapidly owing to swiftly rising costs and very high government taxes on oil production.”

He told the Georgetown University conference, “Although publics and governments around the world are focused on prices, one of the most important factors in the world oil industry is the rapid rise in costs owing to shortages of people, equipment, and skills.”

Natural gas

Natural gas has become “arguably the most contentious issue” between Europe and Russia, which is the world’s largest producer of natural gas and the major exporter to Europe, Yergin said. A new CERA study of the gas interdependence between Europe and Russia shows “structural reasons” for that tension, because of major changes in Russia, Europe, and the international gas market itself over the last decades.

The US National Petroleum Council estimates world energy consumption is likely to increase by 50-60% over the next quarter century, Yergin said. “Meeting that demand in an environmentally-sound way will be a very major challenge for all energy-producing countries, including both Russia and the US,”he said. “And the results will have a decisive impact on how nations define their energy security and what they do about it.”

(Online Oct. 29, 2007; author’s e-mail: [email protected])