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Daily Telegraph: Gushing demand will barrel oil past $100

Last Updated: Saturday 12:01am GMT 10/03/2007
Energy expert Tim Guinness looks at the future for the black stuff

What is the outlook for oil? In the 1960s, oil mostly traded between $10 and $15, adjusting for inflation since then. During the 1970s, two Middle East oil crises created a 13-year period where the oil price averaged $57 in today’s money and spiked at more than $100 in 1980.

The early 1980s saw the development of the North Sea, Gulf of Mexico and Alaska and a subsequent collapse in the oil price to under $20. For the next 17 years the oil price traded mainly between $20 and $30 a barrel in today’s money.

Beginning in 2003, we have seen a very strong upward move in the oil price with a peak in July 2006 at around $78, followed by a sharp correction to $50 by early January this year and more recently a recovery to just under $60.

Are we going to see the oil price now retreat back to the $25 level of between 1986 and 2002? Are we at the start of a long period when the oil price trades in a new trading range of $50 to $70, or is the oil price just pausing before an inexorable move up above $100 a barrel?

It is sometimes said that anyone who claims to know where the oil price is heading is a liar and likely a thief, too: that small amounts of over or under-supply can send the market price soaring or plummeting.

There is much truth in this but, over time, several different industry structural arrangements such as Standard Oil’s monopoly in the 1890s have evolved to smooth price fluctuations. Most recently this has taken the form of the Organisation of the Petroleum Exporting Countries (Opec), which seeks to stabilise the oil price through production quotas for each member country.

Opec’s current policy of seeking to put a floor under the oil price at around $50 a barrel means we can be more confident about the outlook for oil than might at first seem likely.

So what of demand in this $50 or more a barrel world we are now experiencing? My view here is that the rise in the oil price by 24 times, seen since 2003, has not been enough to dent world oil demand growth materially. It has taken oil from cheap to good value; it is not remotely expensive yet.

In the US the average motorist who drives 15,000 miles a year at 20 miles per US gallon uses 2,840 litres, for which he pays a price that has doubled from just 16p a litre to about 32p a litre, costing him an extra £420 a year (note how little that is compared with the poor Briton, who is faced with 88p a litre at the pumps).

The chief executive of Chevron recently commented in my hearing that many people simply did not understand that the current 24 times rise in the price of oil did not yet bear comparison with the “10 times” event in the 1970s.

Not only is demand not being dented by this sort of price rise, but we have moved into a renewed period of high oil demand growth, as between 500m and 1bn consumers in developing economies, principally in Asia, pass through the energy intensive stage of economic growth.

Alternative energy cannot offer a complete solution. The sad truth of the matter is that, even if we aggressively develop biofuels, it will be hard for them to replace even 5pc of the total oil market over the next 10 years. That would require 1.5bn barrels a year, requiring around 250m acres of maize for ethanol or 500m acres of rape for biodiesel (or some combination of the two).

What of supply? We have consumed 1 trillion barrels of oil since the dawn of civilisation but mostly in the past 60 years. There are another 1 trillion barrels in proven conventional reserves, possibly another trillion barrels in resource and let us say, for example, another trillion barrels that we have yet to find at all. If this picture is right, we have consumed a quarter of the 4 trillion barrels of accessible oil and we are only 25 years away from reaching the point we will have consumed half of it.

Signs that there is quite a lot of truth in this way of looking at oil supply are increasingly evident. A number of traditional oil basins are now mature and have already peaked. Moreover, Exxon, Shell, BP and others are having difficulty increasing their own production.

Some argue that this is less a manifestation of a peak oil problem and more a reflection of the fact that 80pc of the world’s oil is now in the hands of national oil companies such as Aramco, Adnoc, Gazprom, Pemex or Pedevesa. This only highlights another supply problem: that these national oil companies are not as motivated as the independent oil companies and are not responding to the current high oil price by increasing supply.

The case seems to be that non-Opec supply is not responding sufficiently, despite the current oil price, to meet world demand growth. This year is projected to be one of the best years this decade for new supply, yet net supply is held back by declines and is projected by the International Energy Agency to grow only by some 1.2m barrels a day. This is still behind its current projected 1.4m barrels a day growth in global demand.

Where does all of this take us? In my opinion we are facing a new paradigm. Notwithstanding current price levels, demand growth from Asia is going to remain strong for 10 to 15 years and supply growth is going to be difficult, while Opec will vigorously defend a $50 oil price floor.

The most likely scenario seems to me to be one in which the oil price settles down for a period in a new $50-$70 trading range. If by 2009 it becomes apparent that the worst fears about the difficulty in growing non-Opec supply turn out correct, then a further significant upward move in the oil price to more than $100 in the early part of the next decade seems, to me, inevitable.

Tim Guinness is the manager of Investec’s Global Energy Fund

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