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What Adds Up to $80 a Barrel Oil

John Defterios / 28 October 2009

You would not know that we were in the midst of a modest economic recovery when examining the price of oil these days. At $80 a barrel, which we witnessed this past week, the price of the precious commodity is about $60 above its 20 year average.

The math adds up for the region’s producers who are part of what one seasoned energy consultant called the supply management club called OPEC.  For all the back seat analysis in the cascade down from $147 to the mid-thirty level, this price recovery to a one year high speaks wonders about controlling supplies during a recession.

Prior to the downturn, there were real capacity constraints due in large part because China and India started to mop up any extra production the market had on offer.  Global economists miscalculated the strength of that demand.  The latest growth figures from Beijing suggest that eight percent plus growth will be at our doorstep in 2010.

I had a chance to catch up with the core group of ministers, senior executives and those who consult the industry at the annual Oil and Money conference in London.  Prices are double what they were a year ago, when we did not know whether some of the world’s money centre banks would keep their doors open or not.  But this steady march back to the current level makes a lot of sense to those who track production and capacity on a daily basis.

“I don’t look at this as a price decline...,” says Vahan Zanoyan, Chief Executive Officer of First Energy Bank in Bahrain, “I look at it as a continuing trend increase in the long term.”

So the OPEC supply management club and capacity constraints are two key elements, what else is driving this market when one half of the world has recovered (the East) and the other half has a danger of being parked economically speaking in neutral (the West)? 

This requires a two part answer: one deals with getting access to the giant fields according to Jonathan Stern of the Oxford Institute for Energy Studies and the other with political uncertainty in countries such as Nigeria, Iran and Venezuela.

The market was quite excited about new finds in the Gulf of Mexico, off the coast of Brazil and the Tenqiz field in Kazakhstan.  They are promising and seemed to surprise even the most seasoned hands in the business.  The problem is that the older fields of the Middle East and the North Sea for example are dropping fast and the replacement costs are much higher today than four decades ago. First Energy’s Zanoyan summarised the thinking, “There is no question that discovering big fields is becoming much more improbable; developing the fields that you do find is more expensive and more complex.”

But there is something quite unusual about this oil price recovery beyond its current level and that is its former partner in market rallies, natural gas, has been left far beyond.  While oil is enjoying what I like to call a Goldilocks scenario, not too hot or too cold, gas is about one quarter the equivalent price of crude.

After the new promising discoveries of the past year, there is less discussion about “peak oil” where we are in a steady decline, but the $80 price may be pointing to something to a new era.  “The low hanging fruit has already been taken,” said Zanoyan, “After 40 years of this process it is not surprising that all of what is left are the tough ones.”

John Defterios presents Marketplace Middle East on CNN

(Tune in Timings: Friday 1215 & 2345 hrs, Saturday 0945 hrs and Sunday 1115 hrs    All Times UAE)

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