Headlines Pushing Oil Prices
In a world with almost no spare oil production capacity and a near-equilibrium between supply and demand, headlines are ruling the day. Volatility is to be expected in a margin business in which one half percent of over- or under-supply, real or imagined, has caused price swings of $5 to $10 per barrel. For evidence, look at the oil price collapse of 1999, caused by the Asian flu, or today’s persistent $70-per-barrel prices, largely the product of the ongoing Middle East wars.
But over the last few weeks, a headline that did not happen and one that did have combined to push down the price of crude from roughly $75 to $68 – that’s a 12 percent drop, and the lowest level in about five months.
First, the headline that did not happen: the United Nations deadline for Iran to comply with the resolution to stop nuclear enrichment passed, with barely a whimper from the United States, Britain, or France. The threat of a military option was noticeably absent, perhaps due to Iraq fatigue and almost certain lack of cooperation from Russia and China, both permanent Security Council members with veto power. Thus, there was no showdown with Iran, OPEC’s second-largest oil exporter.
The headline that did happen: the huge discovery in the Gulf of Mexico by Chevron, Devon, and Statoil. As usual, good news, especially in the oil business, gets less press coverage than bad news. But the discovery at the Jack field will have a huge impact on U.S. reserves and, even more important, on U.S. production. At full development (perhaps four years from now) the type of geologic formation, the flow characteristics of the crude oil, and the reservoir pressure from these new fields will reverse the declining trend of U.S. production, and do so for years to come. In my estimation, the find and associated structures could lead to as much as three million barrels per day of incremental production. Initial per-well production may reach tens of thousands of barrels per day, limited only by the size of currently feasible well completion tubulars and technologies.
We have often said that headlines control a huge part of the traded oil price, perhaps as much as $35 over what we have calculated as the equilibrium price of oil, around $40. The equilibrium price is the level at which oil should be traded, if the international petroleum business were run as a commercial, profit-making, re-investing enterprise. It has not been, and will not be any time soon.
Geopolitical unrest, in conjunction with corrupt and populist regimes – fed by oil revenues, and helped along by the fear factor – have held sway for the past five years or so. Over the last three years we have been just one large headline away from $100 oil: an Israeli pre-emptive attack on Iran, a devastating terrorist act on Saudi oil facilities, a radical move by Venezuela’s Ch’avez. Anything can still happen and if it does, the effect will be immediate.
But things can also go the other way, as recent events have shown. After its reality sinks in, the Gulf of Mexico discovery will have a much bigger, cascading, price-soothing effect, and this will occur before actual production comes online. The oil from the lower tertiary structures in the Gulf will soften the threat coming from the regimes of the energy militants. The costs of production from reservoirs like Jack are enormous. The deposit sits about 20,000 feet below the ocean floor at a water depth of 7,000 feet. But it can be developed profitably with oil prices at or above $40 per barrel. Further, the certainty of supply near the biggest market in the world will help stabilize prices. The new discovery should also quell – at least for a while – some of the rhetoric about peak oil, which has spanned the entire history of the business.
Finally, the Jack discovery should help open up deep offshore oil in California and Florida. For a country that has developed the technology needed to find and produce oil in ultra-deep water, to continue keeping such a veritable treasure locked up would be a difficult argument to make. I expect the luxury afforded by NIMBY environmental attitudes would be less desirable in the face of another oil war.