Crude Reality: Why Oil Prices Won't Plunge
Wednesday April 21, 3:19 pm ET
By Christopher Edmonds, Special to RealMoney.com
With crude oil changing hands at around $36 a barrel and gasoline approaching $2 per gallon at the pump, it's hard to imagine prices going much higher. After all, OPEC knows prices can't remain too high for too long. Non-OPEC producers, such as Russia, Norway and Mexico, also must be willing to push more oil to market with prices at such profitable levels.
Right? Well, not exactly.
I'm not convinced that oil can move much above its recent $37-plus highs, absent a major war or embargo. However, I also don't think crude will push back into the mid-$20 range anytime soon. Those who are waiting for more crude to flood the market may be waiting a long time.
I'll dissect some of the most common arguments in favor of plummeting oil prices, and explain why I think they're wrong.
On the Supply Side
OPEC has an abundance of oil just waiting to be tapped.
Some people seem to believe that somehow, OPEC nations are keeping crude off the market just to see Americans suffer every time we fill up our SUVs. That might have motivated OPEC in the past, but today's reality is different: Like every other hydrocarbon producer, OPEC is finding it much more difficult -- and costly -- to bring additional production to global markets.
The table below indicates there's no glut of oil waiting to come from OPEC nations. In fact, only Saudi Arabia has meaningful additional capacity. The United Arab Emirates, Kuwait, Qatar, Nigeria, Libya, Algeria and Indonesia have little, if any, additional production capacity.
OPEC Production Pushes the Limits
All figures in millions of barrels per day
March 2004 Quota February 2004 Production Production vs. Quota Output Capacity Potential Additions
Saudi Arabia 7.963 8.45 106.1% 10.2 1.75
Iran 3.597 3.95 109.8 4.05 0.1
UAE 2.138 2.29 107.1 2.35 0.06
Kuwait 1.966 2.25 114.4 2.31 0.06
Qatar 0.635 0.76 119.7 0.76 0
Nigeria 2.018 2.33 115.5 2.35 0.02
Libya 1.312 1.48 112.8 1.48 0
Algeria 0.782 1.15 147.1 1.15 0
Venezuela 2.819 2.558 90.7 2.65 0.092
Indonesia 1.27 0.97 76.4 1.05 0.08
Totals 24.5 26.188 106.9% 28.35 2.162
Source: International Energy Agency, OPEC, Merrill Lynch
Iraq has lots of potential.
Some say that Iraq still has plenty of capacity, and that may ultimately prove true, but time is the wild card. Estimates now suggest that Iraq is producing 2.4 million barrels per day and could add up to another 2 million barrels daily as stability returns and the oil infrastructure improves. However, nothing in Iraq is as easy as it seems, and it could be months, if not years, before its potential is close to being realized.
Non-OPEC production could flood the market.
Recent analysis by the energy research team at Merrill Lynch suggests that also isn't likely.
"Our model indicates that based on recently released 2003 finding and development (F&D) results, the core integrated oils can achieve a growth rate of only 0.2% per year based on three-year average F&D costs and budgeted capital spending levels," wrote Merrill Lynch analyst Steven Pfeifer in a recent report. "With the largest core integrated oil companies likely to significantly miss their aggregate 3.3% production growth target, we believe it is likely that non-OPEC supply growth will also be less than expected."
On the Demand Side
If the economic recovery fails, demand will fall.
Generally, as the global economy accelerates, so should energy demand. However, many claim the economic recovery may not be sustainable, though Fed action and business development will have an impact on that.
Others argue that high energy prices could derail any recovery. But the winter months saw decent economic growth and surging hydrocarbon prices, making that argument appear less than compelling.
Emerging economies -- and their demand -- could slow down.
Growth in countries such as China and India will most likely slow from its breakneck pace, but it certainly won't stop altogether. In fact, these countries will need even more energy, not only for infrastructure development but also for personal transportation use.
Consider this: In 1980, China consumed about half as much coal as the U.S. Today, China consumes twice as much as the U.S. The same pattern could emerge for oil and, over time, even natural gas.
What's Next?
Crude prices are likely to remain strong, but the second quarter is typically a period of seasonally weak demand. Demand from heating dissipates, and the demand for gasoline from summer travel hasn't yet arrived. As a result, crude prices typically moderate in the April-through-June period.
The question is by how much. Given the challenges to supply and an incrementally improving economy, crude prices will most likely remain near or above the $30 level.
That creates a positive outlook for some energy equities. Although pressure on crude and natural gas prices could temporarily pressure energy stocks as well, $30 for oil and $5 for natural gas creates a robust cash-flow environment for most energy companies. If those prices hold, integrated oil companies such as ExxonMobil (NYSE:XOM - News) and ConocoPhillips (NYSE:COP - News) and independents such as Pioneer Natural (NYSE:PXD - News), XTO Energy (NYSE:XTO - News) and EnCana (NYSE:ECA - News) should post robust results.
Pay attention to first-quarter results, and you should be able to follow the cash flow.
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At time of publication, Edmonds was long ExxonMobil and ConocoPhillips, although holdings can change at any time. Christopher S. Edmonds is vice president and director of research at Pritchard Capital Partners, a New Orleans energy investment firm. He is based in Atlanta. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send it to cedmonds@thestreet.com. |
