Rebutting the Rebounding Oil

Predictions of oil price normalization

February 2015 Feature, News Jeffrey V. Shirts Web Exclusive

Recently, Business Insider printed an article about a potential oil boom of $200/bbl (a barrel) to occur in the near future. I am generally very surprised when I read articles like this, because it goes against why the price of oil dropped, and seems to think that they were only temporary reasons. But that isn't the case; the oil market bubble has burst.

There are some interesting points in the feature, but overall I found the premise to be off—I believe that the price of oil won’t rebound too much higher than $55/bbl (note: that amount is an estimate).

Right now, the oil market is totally focused on finding a bottom for oil prices. However, according to OPEC's Secretary-General Abdulla al-Badri, we've already hit bottom.

Not only that, but he sees a real possibility that oil prices could explode higher to upwards of $200 per barrel in the future. He's far from the only one that sees a return of triple-digit oil prices.

While I agree with the first paragraph, the second paragraph appears off to me. Following the link to their prediction, an observant reader will note that T. Boone Pickens predicts only $100/bbl, and that the second half of the document is about why oil won’t rebound to $100/bbl.

OPEC's secretary-general is calling the bottom in oil prices. While he's not the first to call a bottom, he does lead the organization that currently controls the oil market so his comments do have a lot of weight. Further, he's also suggesting that the cuts that oil companies are making could have a dramatic impact on future oil prices as the under investment has the potential to cause oil prices to rocket higher if demand grows faster than future supplies. That, however, would all be part of OPEC's plan as it purposely pushed for lower oil prices now so it could control market share once oil prices surged in the future. It's willing to endure short-term pain for the potential of a big long-term gain. 

This is exactly the reason why oil prices have bottomed out, and most likely have just shot past normalizing. I predict that oil prices will rise again, but only to the point where oil production becomes most profitable to all parties involved.

With skyrocketing oil prices, fracking and other forms of oil extraction—such as the Canadian tar sands—became immensely profitable. The hurdle of start-up cost, which is always the biggest obstacle after environmental regulations, is followed by trying to predict a profitable turnaround, which is easier when oil prices are trending at $100/bbl. 

With oil trading at $70+/bbl it was much easier to sell short-term investors into fracking and tar sands. Thus the high prices of the oil market bubble kicked off the North American Oil Boom.

Fracking in Texas and North Dakota brought in new sources of oil, and a much needed economic boom during the 2007 recession. Canada started exporting their tar sand oil, as did the US with our fracking oil, and last year we accounted for roughly 40% of all exported oil. OPEC and within them, Saudi Arabia, saw a dip in their profit margins and decided to respond in a very unusual manner: to flood the market and lower the cost of oil.

Middle Eastern oil cost something like $5/bbl to produce, but in the US and Canada its closer to $15/bbl. At $70+/bbl the cost to produce North American oil is easy to justify. Once oil drops to 40~$50/bbl, though, the profitability of North American oil is lost. So, it would appear as if OPEC's longterm plans are to push North America out of the market by raising the cost to produce oil.

There might be case that there is uncertainity in the oil market with the death of King Abdullah of Saudi Arabia. However, his successor has already gone on record stating to continue his father's oil production pollicies for now. Thus, I don't see it as a potential threat to the volatility of the market. 

Here's where simple economics takes over: whatever arbitrary cost of oil to profit ratios will eventually push the US BACK into production once it becomes profitable—in my example I postulate that the magical number is about $55/bbl. The only way OPEC keeps us out of the market is to keep prices low. Once the market becomes profitable again, demand will soar and the US will start producing again, albeit at a protracted rate, until, inevitably, the price of oil finds that sweet spot of most profitable to all oil producers.

$200/bbl would create too much competition opportunity increasing supply and lowering demand. Currently, oil has just passed about the most profitable cost per barrel for all oil producers and we should see oil rise to about $2.15/gallon of gasoline and roughly $3.00/gallon for diesel, which is roughly $55/bbl, and then remain there.



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