Oil Prices Fall As Saudis Boost Supply ... But Not For Long
I know some OEI readers raise their eyebrows when oil prices fall in back-to-back trading sessions as they did yesterday and today. Thats why I wanted to send a special issue today to talk about what happened. As you probably know, Brent crude, the market benchmark price for oil, fell nearly 4% to $108.43 a barrel today at the London exchange. And Western Intermediate crude, traded on the New York Mercantile Exchange, fell nearly 4% to $91.99 a barrel earlier this afternoon. The decline on oil prices over the past two days has hit the oil community by surprise here in London. But the view from across the pond is that this is likely a temporary downturn.
Earlier this afternoon, I met with members of Saudi Petroleum (the trading arm of Saudi Aramco). The Saudis have pledged to maintain flows of 10 million barrels a day, an expansion of their current output. The move is seen by many as a means to help boost global economic growth.
But theres just one problem. This expansion moves them to about 2 to 2.5 million barrels a day from their capacity. That becomes a serious issue, as we are starting to see the return of global demand (not North American or Western European). Fueled by emerged markets and expanding economies, growing demand will begin pushing the Saudi production threshold. So, while this expansion of production will alleviate some pressure, it creates entirely new supply concerns on the other side.
Three important views are emerging from the people with whom I spoke this week:
- First, the current pull back in prices will be short-lived. Simply put, there are no essential fundamentals justifying a downturn;
- Second, and critical, international demand this year will still come in at more than 88 million barrels per day, and exceed 89 million by June of 2013; and
- Third, the rising joint efforts of central banks on quantitative easing the latest addition being the Bank of Japan overnight -- are causing renewed inflationary concerns. Actions by the central banks will raise the price of commodities in general and oil in particular.
What This Means Going Forward
I recognize that some people on television or in the news might be saying that the price of oil is now going to start falling because of "oversupply." They might point to the Saudi production expansion now instead of all the shale gas we have in the United States. But as I said on Monday, the fundamentals are what really matter over the long term.
A strong price consensus among major players has formed in advance of my critical meetings tomorrow: The view is that Brent will push back to $130 and Western Intermediate will hover between $105 and $110 by the end of the year. And it's very clear why.
First, as I said on Monday, production costs matter. Last week, Bernstein Research noted that marginal costs for oil are continuing to rise, making production outside of Saudi Arabia more expensive as we turn to unconventional sources of crude. With global marginal costs at $92, we're seeing a long-term floor emerge, as producers aren't going to sell oil for less than what it costs to pull it out of the ground.
Second, and more important given the nature of my meetings, international geopolitics continue to emerge as the true wild card in international pricing. With the floor starting to emerge, so too will premiums as geopolitics take center stage in the markets.
The briefings I will be giving here tomorrow (Thursday, September 20) on the Iranian oil sanctions are getting expanding publicity. While tensions on Iran's nuclear program continue, potential conflict in the China South Sea too could affect commodity prices.
The view from London shows an upside of Brent toward $150 and WTI prices up to $130 by end of 2013. Naturally, increasing tensions in the Mid-East (especially from Iran) would encourage spikes in price much before that.
My dinner tomorrow evening with the Persian Gulf ambassadors is shaping up to be a very interesting affair. I'll let you know more about what happens on Friday.
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