Paving the way for future price stability

OPEC Bulletin Commentary November-December 2008

The crude oil price has moved by an astonishing US $150/barrel since the start of this volatile, unpredictable year.

It began the year at $92/b for OPEC’s Reference Basket, climbed to a peak of $141/b in July and, since then, has fallen to a trough of $42/b in December.

The persistent volatility has witnessed price swings on an unprecedented scale. We have seen crude prices rise by $10/b on one day and fall by $16/b on another. In October, the monthly average Basket price fell by a record $28/b.

Furthermore, as we move into the northern hemisphere winter, the news gets no better for the global economy. This is slowing down faster than expected, and, increasingly, forecasters are suggesting that oil demand will fall next year.

The immediate outlook for oil producers is, therefore, a gloomy one.

However, the same is true for other parties in the international oil market, as we look further into the future. Low prices mean less investment. And less investment may mean that this year’s volatility will return to the market in the not-too-distant future.

Two distinct ways of assessing oil prices have emerged recently, and they must ultimately be in line with each other, if the market is to function in a stable and orderly manner.

The first relates to the present dynamics of the market, with the spiralling down of oil prices since July to half the levels of the start of the year. In this case, prices are responding to current drivers in the market and perhaps even generating their own momentum.

And the second is the realization that the plunging prices have already passed the critical levels where decision-makers have begun reassessing the viability of existing and planned investments in expanding production capacity, to meet the forecast rising levels of demand in future years.

For example, the marginal cost of producing alternative fuels, such as oil sands, is probably around $70/b. Set against this, the Basket price fell below $60/b on October 24, and below $50/b on November 21, before continuing down to $42/b.

There is a clear mismatch along the time-horizon, with many longer-term investment needs not being supported by shorter-term price movements.

Increasingly, delays, cutbacks and cancellations of projects are being announced throughout the industry, together with other responsive measures, as crude prices drop from one investment-breakeven level to the next and the realization dawns that this is no overnight phenomenon. Moreover, this trend has been reinforced by the present severe restrictions on credit and the gloomy world economic outlook.

The issue of breakeven levels for investment in both oil and other forms of energy features prominently in discussions within the industry at the present time, reflecting widespread concern among all parties. Other intergovernmental energy groups have also warned of the dangers to future supply of heavy cutbacks in investment.

There is, indeed, a strong element here of having to play-off today’s interests against those of tomorrow, in a tough, demanding and uncertain world economic climate. It is like trying to reconcile the irreconcilable. There is no perfect solution.

Therefore, when the OPEC Conference meets at times like these, it does so with its eyes wide open to the fundamental, enduring realities of the international oil market and the pivotal role of secure, stable oil supplies. OPEC is committed to this, as well as to the health of the world economy, in good times and in bad.

While OPEC’s market stabilization measures are sometimes tailored around addressing a short-term development in the market, the Organization prefers to focus on sustainable, longer-term actions, from which the world community as a whole will ultimately benefit.

And OPEC is strongly inclined to adopt the latter approach in addressing today’s pressing market challenges.

This Commentary is taken from the November-December edition of the OPEC Bulletin which can be downloaded free of charge in PDF format from the OPEC website.

OPEC Bulletin (November-December 2008)

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