Commentary, 1/2 2008

Published Feb 11, 2008
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1/2 2008
1/2 2008

Reality Check?
As we begin this new year, one thing we can be certain about – or at least as certain about as possible: the time of inexpensive oil is over.

We haven’t seen truly cheap oil since almost a decade ago, a time when prices dipped below USD 10 per barrel. For the industry, such prices meant stagnation, that exploration costs were prohibitive and that older and marginal fields would not be a priority.

What felt right was when prices moved between above USD 30, ranging in the 30s and 40s, and the cost for extraction was calculated to be around USD 30. Then, the industry moved steadily forward, with cash for exploration and innovation. And as prices continued to rise to current levels, we’ve seen more and more corresponding activity.

In the present, since the new year began, we’ve seen the price flirt with 100 and drop below 90. As prices approached these levels, we’ve also seen that the price of extraction is rising. The cost of doing business, from the oil companies to the suppliers, has risen, which can account for at least a fraction of the overall increase in price per barrel.

Some say that as much as 20 percent of the price of oil is the result of traders themselves, so, in part, January’s price swings can be attributed as much to market psychology as to the actual force of supply and demand.

The most common reason given for the recent price dip is the fear of US recession, which many believe will mean lower demand. Troubled US markets have meant troubled markets around the world. Daily, following the sun, as markets open and close, the news has been worrying, and each drop has stimulated the next market in line.

In a nutshell, the US has seen a housing bubble burst, which has created credit problems for Wall Street, and the resulting market downturn is making itself felt around the globe. Attempting to stem the losses in an attempt to create a brighter outlook, the US Federal Reserve has lowered the interest rate by first 0.5 percent and then by an additional 0.75 percent, bringing it down to 3 percent. In addition to this, a stimulus package passed by the US Government is hoped to buoy domestic confidence, possibly averting recession.

Although these actions may succeed in helping Americans and even the markets to be a bit more positive, one immediate result has been that the value of a dollar has dropped further. The dollar, which has been weakening for a number of years, has been troubling to many outside the US, especially those who make their living in petrol-dollars.

So even if oil is at USD 100, a price based on a weakening dollar means dwindling profits (and rising exploration and extraction costs). It’s little wonder that we’ve heard a number of proposals to peg fossil fuel prices to other currencies. So what will happen if the US demand for oil actually does drop? Little in the long run. Emerging markets are poised to make up for any real shortfall in US demand. Across the globe, the demand for energy continues to rise, and the faster a market creates value, the faster its demand grows.

So it’s looking less and less likely that oil will ever be cheap again. Fortunately, we have done much to increase the efficiency of use – oil as fuel goes much further per litre than it did 30 years ago. But even efficient use will not fully compensate for future demands – expensive fossil fuels will also herald an era of active exploration for and development of alternative energy sources.

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