best guess--oil price will continue to be volatile
- letter in London Financial Times 4-20-2012
from Mr. John A. Bolitho.
Sir, I was surprised to read Nick Butler's article on oil prices, which appears to ignore a number of key issues on oil demand, supply and pricing ("Away with the jerry cans!Oil's bubble is bursting", April 18).
On the question of supply, current world conventional oilfields have a depletion rate of about 4.0 per cent a year and "post-peak" fields 6.5 per cent. Thus the world must bring on stream between 4m and 5m barrels a day of new sources to maintain current production. Professor James Hamilton at the University of California, San Diego has shown that, despite rising oil prices, world oil production has been more or less constant since 2005. Rises in Chinese and emerging market demand have been offset by reductions in consumption by developed countries, with no net increase in supply.
Balanced against this, new oil supplies such as tight oil may make a significant difference in the medium term to world production, but must compensate for falls in production from existing suppliers. Major discoveries such as Brazil offshore remain a long way from full production. While the scale of other resources such as Canadian oil sands is potentially vast, so are the environmental, economic and technical challenges of their extraction--the Canadian Petroleum Association predicts only 3m b/d by 2020.
On demand, the Japanese power industry is drawing off approximately 600,000 b/d and this will in time reduce. However, even a cooling Chinese economy is likely to show rising petroleum consumption as China remains the world's largest new vehicle market.
On pricing, the most perplexing part of Prof Butler's article is the constant use of the analogy with the fall in North American natural gas prices due to shale gas discoveries. Oil and natural gas are seldom used as substitute fuels--more than 75 per cent of liquid oil is used for transportation fuels. Oil is only used in home heating and power generation in countries where piped natural gas is not available. North American gas prices have fallen because that gas is physically trapped--there are as yet no ways of exporting it to more lucrative world markets. An equally inappropriate analogy would be to argue that oil prices should fall because steam coal prices are falling--they are simply different forms of energy.The spot price of oil may be too high, handing a windfall to current oil producers. History says because supply and demand of oil as a commodity is inelastic in the short run there are large swings in oil prices on relatively small swings in either factor.That is a long way from suggesting, as Prof Butler appears to do, that we are entering another protracted period of very low oil prices. The best guess is that the oil price will continue to remain volatile, and that while it may drop down to the cost of new high marginal cost sources such as deep offshore and Canadian tar sands oil (say $80 per barrel) it is unlikely in the long term to sustain a price much below that, simply because the easy and cheap to access oil in the world is running out.Such a view would be consistent with the most commonly used economic model of an exhaustible resource, the Hotelling model, which predicts a rising time path for the price of a resource as it is exhausted. New extraction technology alters the timing of that path but does not change its general direction.John A. BolithoLondon N2, UK