Oil industry executives and bankers are assuming oil prices will stay above $100 a barrel in the year ahead, despite mounting economic worries, as any fall below that level would trigger a cut in Saudi Arabia’s output and force closures at high-cost projects around the world.
A straw poll by Reuters of oil executives, traders, bankers and fund managers showed seven respondents predicting Brent crude trading at $100-$120 a barrel in the next 12 months. Four respondents saw prices at $120-$140 and only four at $80-$100.
At a previous summit last June, most respondents also saw prices above $100.
Then worries centred around supplies following a full outage of Libyan output and OPEC’s failure to boost production to compensate for the loss.
By contrast, the current mood is dominated by demand concerns as euro zone collapse worries, poor US economic data and signs of slower demand in China overshadow jitters about a potential loss of Iranian oil supplies.
But although Brent prices are almost $20 down from their 2012 peaks at $110 a barrel, few expect a repeat of the 2008 crash which saw them collapsing to $34 per barrel from an all time high of $147 in a space of six months.
“The marginal cost of production is the ultimate floor in the oil market. In the North Sea it can be $80 to $100 dollars,” said Andrew Moorfield from Scotiabank.
“But the real marginal cost of production also includes social costs that some big oil producers need to pay. When you add social costs in Russia and Saudi Arabia, it means that the effective floor on Brent is around $100 a barrel,” he said.
Saudi Arabia has ramped up output to ten million barrels per day – the highest in decades – to calm market fears over a potential outage of Iranian oil flows amid Tehran’s stand-off with the West over its nuclear programme.
Riyadh has said it wants oil to fall to around $100 a barrel as higher levels damage the global economic recovery.
Saudi’s current desired oil price level is only a third higher than $75 per barrel it sought back in 2008. But its oil price budget needs are estimated to have doubled from $50 to $100 as it had to splash money to calm discontent at home and unrest among neighbours.
“I believe there is a floor at $100. Ultimately the Saudis are the ones that have the single biggest positive influence in the oil price, other than anyone starting a war – which would have a negative but upward impression on oil price,” said Philip Wolfe, head of energy EMEA for UBS.
“There is no point for the Saudis having production of ten million barrels per day at $50 or even at $75 per barrel if you can adjust the barrels and keep the oil price up at $100 or more… I think the Saudis can do a lot without having to announce anything,” he added.
Global inflation might have already pushed the costs of exploring and producing oil from new most expensive projects – known in the industry jargon as the marginal cost of production – above $100 per barrel, according to JBC energy consultancy.
That compares to $50-$75 prior to the 2008 financial crisis while a decade ago, oil companies such as BP, were saying they would start a project if oil traded above $17-$20.
“The United States is producing an awful amount of oil from tight shale and tight sands reservoirs… If oil prices send a signal and drop below the $90-$80 level it is going to be uneconomic to drill those well. So drilling will stop immediately,” said Michel Hulme, fund manager at Lombard Odier.
US tight oil production already amounts to 0.5 million bpd and is expected to rise steeply in the years to come.
Global inflation is not only endangering developments of the most difficult fields but is also testing profitability levels of existing projects or greenfield projects in areas generally seen as low-cost.
“It seems the gap between the cash cost per barrel of existing production and the cost to bring on incremental production is narrower than it has been for a long time,” said Bob Maguire, partner at Perella Weinberg, previously with Morgan Stanley and adviser on some of the world biggest oil mergers.
Even the International Energy Agency, which represents consuming nations, says production costs have gone up sharply.
“There is not a single drop of oil in the world that cannot be produced at a price of oil of $85-$90,” IEA’s chief economist Fatih Birol told the summit.
Scarce equipment availability is one of the reasons behind it, according to shipping tycoon John Fredriksen.
“It looks like oil companies will all have to stall part of their drilling programmes because there is limited drilling capacity. There are just not enough rigs around,” he told Reuters ahead of the summit.
For Mercuria, one of the world’s top oil traders, the dangers are still as much on the upside as on the downside for the oil price.
“The danger is that if for some reason the geopolitical tensions in the Middle East start rising again, prices could very quickly go back up to where they were one-and-a-half-months ago,” said Mercuria’s co-owner Marco Dunand.