Comfortable with high oil prices

June 13, 2011
Neither consumers nor governments are unhappy about high oil prices—as long as they are not too high, said Fereidun Fesharaki, chairman of FACTS Global Energy group.

by Sam Fletcher, Senior Writer

Neither consumers nor governments are unhappy about high oil prices—as long as they are not too high, said Fereidun Fesharaki, chairman of FACTS Global Energy group.

"Current market sentiment is $125/bbl Brent is too high," Fesharaki said in the group's June online publication. "As soon as prices reach this level, they will retract. At least for now, this is the market view," he said. The July North Sea Brent crude contract closed at $115.84/bbl on June 3.

"The producers obviously like the high prices," Fesharaki said. "Renewable energy supporters like the high prices; so do environmentalists who find the rising price is more than any carbon tax they could wish for."

Moreover, he said, "The LNG producers really like high oil prices in a gas market indexed to oil prices. The huge investments in Australia, both for conventional and nonconventional LNG or offshore liquefaction, all need oil prices in excess of $70-80/bbl. At high oil prices, all or almost all alternatives work. The limitation to the number of developments that might proceed is overwhelmingly operational, not economic."

Fesharaki claims the price of oil is determined by "God, Saudi Arabia, and the market, in that order." Other analysts, however, would rate Saudi Arabia's influence higher. The kingdom's role in determining oil prices "is stronger than ever before," Fesharaki acknowledged. The Organization of Petroleum Exporting Countries also is stronger because of Saudi Arabia, he said.

Saudis in control

"With diminishing non-OPEC supply growth and with two thirds of OPEC's spare capacity in Saudi Arabia, what the Saudis target for in oil prices, they can get—until they exhaust their spare capacity," he said. "The paper [futures] markets today do not lead the physicals; they follow the physical markets. They follow what the Saudis want."

Fesharaki said, "For the Saudis, 2009 was a difficult year. They moved decisively to raise oil prices to the $70-80/bbl range and to everyone's surprise, they got it for most of 2010. But as prices jumped, they have chosen not to announce a range but [to] observe the market. They might intervene if they have to, but so far, there is no compelling reason for them to change their mode of operation."

Last year most OPEC countries based their budgets on an average oil price of $45-55/bbl, "with Iran budgeting $60/bbl," Fesharaki said. "For 2011, expectations have increased. Most countries are now budgeting in the $70-80/bbl range with Saudi Arabia at $70/bbl and Iran at $80/bbl. Given the additional Saudi Arabian payouts this year, the budget may need $80-85/bbl. This gives us a credible floor of the price of oil at $70-80/bbl.

As of June 3, the 2011 price of OPEC's basket of 12 benchmark crudes averaged $106.36/bbl. The price of oil has risen some $20/bbl since earlier this year on political crises in the Middle East. "While there are no serious supply issues, it is clear that OPEC (especially Saudi Arabia) must raise oil production; otherwise, the price of oil may head higher and remain volatile," Fesharaki predicted.

So far, he sees little evidence of demand destruction in Asia, Europe, or Latin America. "Despite continued economic fragility in several countries, rising oil prices have not materially impacted demand; although at least part of the reason for this is that the weak US dollar has 'softened the blow.' There is some evidence of demand destruction in March and April in the US, but it is likely to be minor," said Fesharaki. "The prices are not high enough to impact the global economic growth and substantially cut US demand."

He said, "In this environment, there is little reason for intervention in a big way, especially when leaders of the industrialized world have been so quiet. Unlike the past, formal and informal lobbying for lower prices has not been a priority despite earlier concerns in the US about rising gasoline prices, which have become muted after the pump prices have fallen back."

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