Higher Oil Prices, the New Normal

Oil prices have bounced more than 150 percent off their December 2008 lows, despite the fact that inventory levels remain at historically high levels. Does that mean the oil price is out of whack? Not necessarily.

According to Goldman Sachs, robust 2010 oil demand growth will deplete these inventories over the next 12-to-18 months and diminishing production rates in key areas around the world will create a supply/demand imbalance.

New Oil Project Peak

The top portion of the nearby chart shows the decline in production from the world’s top 230 projects. After peaking in 2009, production from these projects is set to fall for the next several years. Excluding OPEC countries (bottom portion of the chart), the decline rates will likely quadruple from 2007 to 2012.

Over that time period, non-OPEC production is expected to fall by 2.5 million barrels per day. Only Brazil, Canada and the former countries of the Soviet Union are expected to see production growth.

One of the largest contributing factors for this is chronic decline rates from some of the world’s top mature fields. Mexico’s Cantarell field, one of the largest oil fields in the world, produced 30 percent less oil in 2008 than it did in 2007 – a trend that’s expected to continue.

Norway, the world’s 11th largest oil producer in 2008, saw its oil production peak in 2001 and is down 27 percent since. Another big producer, Venezuela’s state-owned oil company PdVSA has seen annual decline rates of more than 25 percent in certain fields according to the Energy Information Administration (EIA).

Adding to the dilemma, many countries without decline-rate issues have been holding out production increases until projects become more cost effective; this is why we recently saw Russia overtake Saudi Arabia as the world’s largest oil producer.

The Saudis have been content to sit on the sidelines while awaiting the return of higher prices. The same goes for other OPEC countries; PIRA, an oil-industry consultant, says the cost of oil will have to rise above $80 per barrel in order for the cartel to increase production.

With oil prices currently hovering around that $80 level, OPEC officials have recently hinted that production increases aren’t off the table for the cartel’s upcoming December meeting.

But even if we see a production increase out of OPEC, decline rates from maturing fields and high barriers of entry to bring new fields online should keep the supply/demand balance tight for years to come.


Evan Smith and Brian Hicks
for Markets and Money

Evan Smith
Evan Smith joined U.S. Global Investors in 2004 as co-portfolio manager of the Global Resources Fund (PSPFX). Previously, he was a trader with Koch Capital Markets in Houston where he executed quantitative long-short equities strategies. Mr. Smith was also an equities research analyst with Sanders Morris Harris in Houston where he followed energy companies in the oil and gas, coal mining, and pipeline sectors. In addition, Mr. Smith was with the Valuation Services Group of Arthur Andersen LLP. Mr. Smith holds a B.S. in Mechanical Engineering from the University of Texas in Austin.
Evan Smith

Latest posts by Evan Smith (see all)

Leave a Reply

2 Comments on "Higher Oil Prices, the New Normal"

Notify of
Sort by:   newest | oldest | most voted
According to GS ? Well we can trust them can’t we? The only reason they see OIL up is because they are LONG. The only reason in 2008 they called for $200 OIL was because they gamed the OIL market. They knew SEMGROUP were massivley short… GS then got hold of SEMGROUP’s position book (C & MER also had access) and as they say that was “game set and match”. SEMGROUP went bust with about 2.5B trading losses. BARC picked up SEMGROUPS book for a song (also making a shed load of money) and the game was over for GS…… Read more »

…can we be so sure in our belief that oil has no natural purpose…?…whether the crust of the earth be an endo- or an exoskeleton(or a little or none of both) is of some consequence when oil, perhaps the lifeblood under the earth’s crust is as easy to find in arabia as slitting one’s wrists…

Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.
If you would prefer to email the editor, you can do so by sending an email to letters@marketsandmoney.com.au