Posted on Wednesday 24 February 2010 by Ulster Business

Oil Mine

Courtesy of Shell

Being able to predict the next move for oil prices would be a very useful skill but one which has proven difficult to learn for even the most long-serving energy professionals. David Elliott takes a look at how the experts expect the oil price to evolve over the next 12 months.

You only need to fill your car up with fuel or order home heating oil to realise the price of energy has risen sharply over the last few months. This not only translates into higher household bills but also draws on costs for a business and can seriously impact profit margins. As a result, putting together a business plan for an energy-dependent company can be fraught with difficulty as this volatile natural resource bounces up and down ‘like a fiddler’s elbow’, to quote an oft-used phrase used by traders familiar with its unpredictable nature. To get a handle on where the black gold of the commodity arena is headed can sometimes be described as a guessing game but in the absence of a crystal ball it’s certainly worth gathering together educated guesses from the experts in this slippery field. While markets for gas, diesel, petrol and the other elements which make up the energy complex are all influenced by a specific set of fundamental factors, the overriding benchmark for all these grades is the crude oil market. At the time of writing in early February, a barrel of West Texas Intermediate crude oil on the New York Mercantile Exchange for March delivery traded around $74 a barrel but this will no doubt have changed significantly by the time you read this. Putting a finger on whether the same barrel of oil is headed higher or lower – as Bruce Forsyth used to say – than $74/bbl is the $60,000 question for traders making their money from buying and selling oil and for businesses where energy of any form makes up a considerable proportion of monthly outgoings. Before taking a look forward, it’s worth taking a look at historical price movements for crude over the last few years. In 2003 crude was trading at around $30/bbl and had been for some time. Over the next few years it embarked on a steady climb higher on the back of growing demand from developing countries such as China and India, tightening supply as oil fields such as those in the North Sea approached the end of their workable life and the overriding spectre of peak oil, the theory that the world is running out of oil. By 2007 it had climbed to $80/bbl. By July 2008 it peaked at $147/bbl. With this the shackles were off. Experts weren’t ruling out a run up to $200/bbl and suddenly previously uneconomical alternative energy sources were coming into their own. But it’s this latter reason, combined with the fact more high cost oil extraction methods also became viable - thereby adding more to the supply equation - and that the global economy entered one of the worst periods of recession in years, that meant such high prices were unsustainable. What goes up must come down and during the latter half of 2008 and early 2009 prices plummeted to nearly $33/bbl and in doing so took the wind out of the sails of the oil bulls who predicted sustained higher prices. Obviously the market has picked up again since but where to next? For this we turn to the investment banks who, although not flavour of the month, year or indeed decade, tend to have huge investments in the oil market and therefore employ some of the world’s foremost experts in the field. Analysts at Deutsche Bank don’t think there’s much chance of further gains for oil “Over the past year, we believe oil prices have been driven higher by rising equity markets, a falling US dollar and more extreme weather,” they said. “In terms of physical fundamentals, we believe the high level of oil inventories in the US, rising OPEC (Organisation of Petroleum Exporting Countries) spare capacity and strong non-OPEC oil production growth will present a set of hazards of oil prices this year.” OPEC controls about 40% of the world’s oil production and while not as influential as it has been in years past, can still have a significant influence on the oil price if it decides to alter its output levels. Evolution Securities, a brokerage in London, believes $70/bbl is a fair price for oil in the next year. “Until the major oil producers begin to report an upswing in demand for their products, we maintain our long-term oil price assumption at $70/bbl,” it said. While this suggests the upside for oil prices if pretty much capped, there doesn’t seem to be much potential for significant downside. Mike Wittner, an analyst at French bank Societe Generale, feels this $70/bbls level will provide a floor. “If crude prices fall significantly below $70/bbl with some momentum and appear to have the potential to stay well below $70/bbl, we believe OPEC…will cut actual output in order to support prices,” he said. “In our view, OPEC intends to defend a $70/bbl floor.” Barclays Capital takes a more bullish view. “We expect the price of West Texas Intermediate (crude) to average $85/bbl this year and $97/bbl in 2011 versus an average of just $62/bbl in 2009,” it said. But as with all markets, nothing is certain. “Nigeria’s internal politics, Iran’s nuclear programme and the Iraqi parliamentary election increase price uncertainty,” the bank concluded. Price uncertainty probably sums up the oil market’s future best. While a period of relative stability around $70/bbl looks likely, any political disruption in any of these large producing countries could see prices spike higher. For how long is difficult to say but, given a weakening demand seems to be a constant amongst most experts, upside potential doesn’t look likely to last. Off course, nobody thought the crude price would spike to $147/bbl in 2008…

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