The best measure of oil price is what you paid today

Tom Ashby

• Last Updated: February 23. 2009 8:14PM UAE / February 23. 2009 4:14PM GMT

When the slump in the global economy brought oil demand growth grinding to a halt last September, price forecasters who had been predicting a rise from $150 to $200 a barrel were understandably shaken.

How does a self-respecting financial analyst respond to a precipitous $100 a barrel slide in four months, leaving predictions of a two-year “superspike”, such as that posited by Goldman Sachs, in tatters?

There would appear to be two options.

The first might be to throw oneself off the nearest balcony. This would be a particularly likely choice for anyone so convinced by their own erroneous forecasts that they also bet the family silver on them.

The safe option, of course, is to write increasingly lengthy reports insisting that one’s original analysis was fundamentally sound, but some temporary distractions have just got in the way.

Needless to say, many oil market analysts have chosen the latter.

In some cases it serves their interest to talk up the risks of price spikes.

Market watchers at the International Energy Agency, for example, have continued to refer to a structural tightness in the oil market and the risk of oil shocks even as the world market is absorbing so much surplus crude that traders are buying the stuff just to store it on the high seas in tankers.

As soon as prices collapsed, researchers wasted no time in predicting the next spike. Some even said it could come within a year.

Those with egg on their face include the head of Total, Christophe de Margerie, who embraced the theory of peak oil and insisted that prices had entered a new paradigm.

Even Saudi Arabia, the world’s oil superpower, got carried away with the decade-long boom that took prices from $10 to $150. Just as prices were in free-fall in December, King Abdullah stated that $75 a barrel was a “fair price”.

Just two months later, prices have dipped below $40 and one American trading house has even chartered a two-million-barrel tanker to lie at anchor off Fujairah as if to send a signal to the world’s largest exporters.

Meanwhile, the cost of developing oil reserves is coming down. Not only is the price of raw materials, from steel to concrete, dropping fast, but also more specialised equipment such as deep-sea drilling rigs are coming to market, opening up unexplored acreage that is sure to yield billions of barrels of new reserves. Global oil demand, which is falling for the first time in quarter of a century, may never grow again at historical rates.

In this context it is comforting to see that some commentators are finally coming to terms with a more moderate oil price outlook.

Ed Morse, formerly Lehman’s oil analyst, now expects oil prices in a range of $40-$75 a barrel.

Only five years ago, this would have looked high.

One man who has consistently avoided naming a price is Ali al Naimi, Saudi Arabia’s oil minister. His stock response to such questions is that if he knew what the oil price would be or should be, he would be in Las Vegas.

King Abdullah may have an idea of his “fair price”, but the kingdom’s over-riding policy has always been firmly based on maintaining a healthy supply to world markets, working with OPEC to match supply to demand and letting the free markets decide the rest.

The balance of power in OPEC is increasingly flowing to the Gulf, as other members including Iraq, Iran, Venezuela and Nigeria have all failed to make the investments needed to make capacity expansions.

Venezuela spends more on fuel subsidies than investment in new capacity and prices now are half the level assumed in this year’s budget. Nigeria is seeking to borrow US$3 billion (Dh11.01bn) from Shell just to sustain output. Iran has failed to attract any meaningful investments due to UN sanctions over its nuclear programme. Iraq, now emerging from decades of sanctions and war, is struggling to agree on a framework for foreign investment.

None of these nations has built up financial strength during the boom to sustain investment through the downturn, and they will inevitably surrender market share to those nations, such as Saudi Arabia and the UAE, which have saved and invested in their economic mainstay.

The fact is that no-one knows what the price of oil will be in the future, which is why the best brains are consistently wrong. The best estimate of the future price is quite simply the price today. All you can do as an exporter is to manage global supplies to avoid creating a self-destructive glut and ensure that you are producing at the lowest cost with the highest efficiency possible.

tashby@thenational.ae