HAS CRUDE OIL VALUE TAKEN A STEP DOWN

The year ends with a provocative question: Has the value of crude oil taken a structural step down?

Dec. 27, 1993

3 min read

The year ends with a provocative question: Has the value of crude oil taken a structural step down?

A strong case can be made that it has. Technology is slashing the costs of finding and developing reserves and of producing crude and natural gas from them. It also is helping producers find hydrocarbons in places previously considered unprospective. With access opening to prospects previously closed to outsiders in the former Soviet Union, Yemen, Latin America, and elsewhere, opportunities are growing for technically astute producers to take advantage of their new efficiencies and skills. All this, the argument goes, keeps crude supply high relative to demand and suppresses prices.

The argument is strong but has a weakness: It assumes that current conditions will endure. The assumption is one over which price forecasts have a way of stumbling.

REASONS FOR DECLINE

There are reasons for prices to have declined late in 1993 that have nothing to do with reduced finding and development costs. One of them is demand, which has not lived up to expectations. Too little attention has been paid to the consequent drop in product prices and narrowing of refining margins that preceded the crude price slump in many areas, including the U.S. In such a fundamentally weak market, little can be done to shore up crude prices that is not self-sacrificial. This means real jeopardy for production with lifting costs close to current crude prices.

Another factor in the recent price drop is. the ability of the former Soviet Union to maintain exports despite plunging crude production--an ability that results from moribund economic performance. The region's future crude exports will be some function of economic recovery, which will revive internal demand, and stabilization of production.

Absent a political upheaval, both demand and production will rebound, but no one can say when or how they will interact to affect exports in the meantime.

A third and crucial reason for prices to have dropped recently is politics in the Middle East. At some point, under some conditions, Iraq will again export oil. That inevitability intimidates traders; to some degree the market is discounting Iraqi production. And the prospect of an eventual Iraqi return certainly gives the Organization of Petroleum Exporting Countries reason to support production now rather than price.

Those currently strong price influences--low demand, exports from the former Soviet Union, and the Iraqi question--will not last forever. Eventually, worldwide economic recovery will revive demand, the former Soviet states will absorb rising volumes of their own production, and OPEC's heavy producers will reduce flow to make room for resurgent Iraqi exports.

A LID ON PRICE

A crucial question is how much of the current price slump results from transitory factors and how much results from costs permanently lowered by technology. And the answer must be that no one knows. What is certain is that the market has one more nail--perhaps an especially strong one-holding an economic lid on the prices of crude and the fuels with which its derivatives compete.

If nothing else, 1993 demonstrated yet again what the special report on p. 37 shows: There's a lot of oil in the world. There are probably more reasons for prices to fall than there are for them to rise. The implications are enormous for producers, consumers, and policy makers hawking nonpetroleum agendas. Current conditions seldom last forever. Tomorrow will differ in many ways from today. If the recent past accurately instructs, there will be more oil.