Friday, April 25, 2008

Oil prices will fall substantially over the next 18 months

I have emphasised before that the effects of increased fuel prices will eventually come to reduce fuel demands and create incentives for new sources of supply - these reflect supply elasticity effects and cross price elasticity effects. In the US - which purchases one third of the world's petroleum - this seems to have already occurred with the first annual reduction in gasoline demand since 1991. Part of the decrease might be recession-related and part to changing demographics but most of it seems to be a direct effect of higher prices on demand.

Moreover, with higher food prices now a global reality one would expect these price effects to be relatively most intense in developing countries such as China and India which provide the bulk of the extra demands putting pressure on oil prices globally.

I'll stick my neck out with a bold forecast. Fuel prices will decline considerably over the next 12-18 months. Crude prices at present are having problems breeching the $120US per barrel level so how far do I think they will fall. Medium term prices of around $75US per barrel make investment in the provision of additional oil supplies attractive. That's where I expect them to settle. They might go lower than this - break even prices for tar sands are around $33 per barrel while oil from the Gulf states has a break even price of around $38.

The laws of gravity will eventually apply to oil markets - all cartels fail eventually but they die quicker when demands are falling and competitive fuel products look like they will gain significant market share.

9 comments:

Simon said...

I have difficulty with those figures for break even prices. How is it that the break even price for Canadian tar sands is $33 while the Gulf States are $38 (and Saudi is $30) ?

hc said...

My intuition is with you Simon. the Middle East figures seem too high and the tar sands figures a bit low - I had read in other places about $40.

The figures came from the Central Bank of Kuwait (here.

If the Middle East figures are lower than quoted then my forecasts should, if anything, understate the extent of price falls.

conrad said...

I'm not sure if 12-18 months is a good guess -- I imagine (perhaps incorrectly) that it takes many years to get approval and build new extraction and processing plants for things like tar sands. So presumably new supply is miles away.

hc said...

Conrad,

The demand effects have already begun and the supply shifts began some time ago.

Short run price elasticities of demand for fuels are caround half long-term elasticities.

Canada supplies of oil from tar sands are already a significant source of oil exports to the US. Biofuels also now provide a significant source of alternative fuels.

The processes I allude to in the post have been in train for several years now.

Anonymous said...

Unfortunately every prediction of lower oil prices since about 10 years ago when The Economist predicted $5 oil (it was then priced at about $10 a barrel) has been, to put it mildly, rather wrong.
CERA, who have access to considerable data and expertise, famously predicted that oil would fall to about $20 in 2005, when it never actually went below $65. Then they predicted low 60s for 2007, when it actually started at ~$72 and ended, as we know, over $100.
I imagine they used much the same arguments you have here, so while you're logic might be sensible enough, you'll excuse me if I remain skeptical.
There are certainly scenarios in which oil prices could fall in the next 12 months, perhaps even as low as the mid 80's, but I would truly surprised if they ever hit $75/barrel again.
China and India are growing more than fast enough to absorb any extra supply that comes on to the market in the next 18 months.

Anonymous said...

I totatlly disagree with your analysis. Oil prices will continue to reach an all time until well after the November Election. Further, gasoline with go to $5 a gallon on the short term and $8 a gallon on the long term.

Anonymous said...

I agree most for several reasons. Everything in life is tied to a cycle. You are born and you age. You can't stop it. Wars are started and ended. How many times have you been told the earth will end? You are a certain age now. You will age and you will think exactly what another person thought at that age. We all think we know everything and we are certain of it. One thing is for certain. The price of oil will fall because if it gets too expensive, it fuels new technology. To block "entries" oil will attempt to fall, but it will be too late as the consumer will know not to trust oil. Oil will fall even further to the end when it will be demised. Take VHS vs DVD. In closing, everything is tied to cycles. You really should listen to the author of this website and take an economics class. It will improve your life and you will have a greater understanding of how business works. Thanks for your time.

pcsolotto said...

I agree with you about these. Well someday Ill create a blog to compete you! lolz.

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