Crude oil prices: New supply discoveries and the future of oil prices (Part III)

In the last review of oil prices, I tried to give a historical framework as well as a review of more recent evolution of oil prices. This capricious evolution of prices has put pressure on the Philippine economy to adjust to higher and higher prices.

“The market for oil today.” Internationally traded oil today is mainly based on the pricing of Brent crude, which is North Sea offshore oil and delivered off terminals in the Shetland islands of Scotland. Whether oil is sourced from the Middle East or elsewhere, the pricing basis is with reference to Brent crude.

A less widely used oil price is based on WTI (“West Texas Intermediate”) which is oil delivered off Cushing, Oklahoma terminal. WTI is mainly most relevant today for the US market which is the world’s most significant oil user. More recently, the US market has used Brent crude for its sourcing of traded oil when importing from international sources than on WTI.

Short run market prices are very volatile and are affected by worldwide macroeconomic conditions and political events affecting the oil supplying and oil-using nations. The price of oil reached a peak of $145 per barrel in July 2008.

In December, 2008, WTI crude oil spot price fell to $30.28 per barrel. This was the lowest since the financial crisis between 2007 and 2010. In 2009, oil traded at $35 a barrel and $82 a barrel. In end January 2011, Brent price of oil hit $100 per barrel for the first time since October 2008.

Recently (last week), Brent crude was at $112.05 a barrel and WTI at $96.13 a barrel, with Brent selling at a 16-percent premium over WTI.

Such high prices and their wide fluctuations have come about because of the uncertainties in the oil supplying regions: mainly the Middle East. A further threat of war in the region over the nuclear ambitions attributed to Iran has brought high speculation on crude prices.

A different factor that tends to dampen demand for oil, however, is the euro zone crisis. The recent election results in France and in Greece seem to point out that the Greek bailout program faces an uncertain future. This could threaten a longer European recession.

“Level of prices on a high plateau.” New realities on costs and the entry of new areas of oil discoveries into the world supply of oil mean that the cost of oil extraction will be at a higher level than in the Middle East. A long term price plateau could start in the range of $60 to $100 per barrel. Brent crude is offshore oil and certainly is extracted at much higher costs than oil mined in the Middle East.

New oil and carbon fuel discoveries have been found in more hostile natural terrains: in deeper offshore areas (in different continents), in more challenging climatic conditions (Arctic and Antarctic regions), and through the use of challenging drilling and conversion to oil technologies (horizontal drilling, and environmentally challenging issues concerning these new approaches). The addition of higher cost of pipeline and transport investments to the port destinations further add to these costs.

Also, the decline of the US dollar in the post 2007 world recession period has made cost of drilling rise in dollar costs. This is another cause of the inflation in oil prices, because world prices of traded oil were denominated in US dollars per barrel of crude.

“Factors accounting for long-term future of oil supply.” Three major factors account for the continued long-term future of oil.

First, the oil reserves of the traditional Middle East oil exporting nations are not dwindling but are likely still to rise.

Second, in view of the high price of oil due to the efforts of oil exporting nations to restrict supply (OPEC) and due to oil price uncertainties in the main trading routes (still the Middle East), enormous new discoveries of oil have been found around many parts of the world. Such discoveries were prompted by the need for oil security of the oil consuming nations.

Third, in the future, the sources of oil will be more diverse and competition in supply will put a downward impact on long term supply price. This is due to the geographic spread and diversity of the new discoveries.

“Oil reserves in the Middle East.” Crude oil reserves in the Middle East are not dwindling despite the exports of the past. The nationalized oil companies of the Middle East dwarf the oil reserves controlled by the world’s big multinational oil companies. For instance, of the world’s biggest oil firms in terms of reserves of oil and gas, 16 of the largest are nationalized oil companies.

Saudi Aramco, the biggest of these national companies, has more than 10 times the reserves controlled by Exxon, the largest privately owned oil company. Saudi Aramco’s proven reserves are believed to last for decades to come. At its present pumping rate, it could supply another 70 years of crude.

Yet Aramco and other oil exporters of the Middle East have not yet really thoroughly exploited their oil reserves. Only around 2,000 “wildcat” wells have been dug in the countries around the Arab Gulf compared to more than one million such wells in the United States!

“New oil discoveries.” The popular press has highlighted recent discoveries of oil in Africa, in North and South America, and in Russia, not to mention the more hostile Arctic and Antarctic oil explorations that are currently going on. New explorations continue in other areas.

New suppliers of oil are widely spread in geography. Along with Nigeria and Angola in Africa, recent discoveries have been found in Ghana, Chad, Sierra Leone. In Latin America, the Venezuela and Colombia are enlarging their fields. Brazil has found substantial oil that will make her into a major exporter. Recent finds were discovered in Argentina. Russia is an oil power.

Big oil exploration companies and also big consumers of oil looking for supplies for their future needs outside of the Middle East have made possible many of these discoveries. In Asia, the tensions in the offshore areas of the South China seas are generated by the search for oil.

Moreover, technological developments in oil exploration and processing of other products related to oil have dominated new oil production activities in the United States and Canada.

Vast rock formations in Texas and in North Dakota have become beehives of new activity in oil production. Such rock formations were thought to be worthless until the method of oil extraction involving horizontal drilling and hydraulic fracturing became possible. Such technology involves the blasting of water, chemicals and sand through rock to free the oil inside. Hence the new term, “fracking.”

My email is: [email protected]. Visit this site for more information, feedback and commentary: http://econ.upd.edu.ph/gpsicat/