Oil's New Floor Price: $75?

Oil analysts, pundits and commentators are getting a hold on the rising threat of what is called "severe correction" hitting oil markets. The 2008-2009 sequence where Nymex prices crashed from a peak around $147 a barrel to about $40 is relatively fresh in the mind. The rebound was also dramatic, pushing prices through 2010 back over the 100-dollar mark into low triple digits by Q1 2011.

The present outlook certainly includes the potential for gung-ho traders working another downside then upside miracle, but fundamentals dictate otherwise. The basics of world oil have changed, even in the 4 years since 2008: neither further price growth beyond $125 a barrel for WTI, nor a crash below about $60 to $75 a barrel for WTI are realistically possible - although traders do not need (or want) to know that! Prices far below $100 a barrel for the two major reference grades, WTI and Brent, are however the new rational "market equilibrium" outlook, meaning several things.

NEW REALITIES FOR NEW ENERGY
Back in 2008 the global economy was at the end of maybe its last classic growth surge, which operated through 2004-2007 and was weakening fast by 2008, when "financial expectations" and market rigging were able to briefly drive Nymex, ICE and other oil market prices near $150 a barrel. The surge was so special there was almost no spread or prime on Brent against WTI and heavily compressedremiums on less-traded "regional reference" crudes such as Urals, Bonny, Dubai, Tapis, ESPO or others.

Also during the 2004-2007 global economy growth surge, it was still possible to have annual growth rates of world oil demand near 2 percent, another rearview mirror item in global energy history. Betting on if, rather than when world oil demand can again rise by even one half of that Belle Epoque rate, that is 1 percent or about 890 000 barrels per day in a 12-month period, is integrated in oil market trading as a background bet, still today.

Despite that, both the IEA and EIA, since 2008, have on multiple occasions been forced to backtrack on their growth forecasts, always trimming their estimates of global oil demand growth going forward. In the case of the IEA, recent and ongoing oil market analysis and forecasts still include claims that "by about 2017" global oil demand could recover Belle Epoque annual increments, that is growth of well above 1.25 million b/d each year. Even with accelerated output of shale oil and natural gas liquids, and gas-based synthetic oil, and biofuels, and oil saving the two energy agencies still say, global oil shortage could or would return with prices forecast or guesstimated by the IEA of "well above $150 per barrel", even $200 a barrel.

It is not presently possible to say when the IEA and EIA will throw in the towel on "high growth-high price" scenario building, but the facts and trends are stacked against them. What we can say is that another oil price surge to near $150 per barrel would, more than ever, trigger oil saving and substitution which is already in high gear - but first we would have to accept it is even possible to attain $150. The current outlook, and increasingly the betting by traders is no.

Conversely and poorly analyzed and identified, the "new floor price" for oil is a lot higher than in 2008-2009. Another price crash to $40 per barrel would have fast and drastic impacts on world oil, world energy and the economy - all of them negative! The drastic cut in oil E&P (exploration and production spending) through 2008-2009, only reversing in 2010, estimated by analysts at around 40%-45%, could easily be topped when or if oil prices fall below $60 per barrel, let alone $75. Any sustained period of oil prices at below $50 per barrel will be disastrous for Big Energy, triggering showdown time for their corporate strategies and identities in the energy world.

WHY THE NEW PRICE FLOOR?
One simple reason is that if oil E&P declines from its current high rates (probably above $350 billion per year), even maintaining current global oil output will be difficult: taking Exxon Mobil (XOM), its current E&P budget for oil is around $36 billion per year (for 2012), with the corporate goal of raising Exxon Mobil's total oil production capacity by about 1 million b/d by 2016. When or if Exxon takes its foot off the spending pedal, or shelves the program aimed at covering annual depletion loss of capacity and also expanding total oil output - by 1 million b/d in 4 years - this major oil producer could only produce less oil. The same story applies to almost any other major oil & gas corporation, even including the NOCs of OPEC and non-OPEC states, for a variety of reasons which feature the extreme high costs, and therefore risks of expanding total oil output, for a global oil market that is going south.

Right behind those reasons and especially for the "historic oil majors" (including Exxon, Chevron (CVX), BP, Shell (RDS.A), Total (TOT), Enersis (ENI)), the rush to develop and produce shale gas and stranded gas - in unexpectedly huge quantities - has added a new dimension to world oil & gas. Basically, gas can and will only become cheaper everywhere outside the US, even if oil gets more expensive.

As oil prices grow, energy consumers find ways of not using it, and these ways expand fast when oil prices rise fast. Every "demand domain" of oil is in fact threatened: even the semi-sacred private automobile, which can easily, cheaply, and cleanly run on gas. Oil fired electric power production is an almost extinct species in OECD countries - but developing countries still consume around 2 billion barrels a year for power generation, according to IEA data. The alternatives to oil-fired power are simply massive, and always getting cheaper, and now include the new renewables, wind and solar. Oil-fired marine transport (using about another 2 bn barrels a year) was another "reserved domain" for oil, but ships can run on coal, gas and wind, as well as oil. Also, both bulk cargo and container shipping are in decline as the global economy downsizes, re-localizes and constantly raises its energy efficiency.

The above and other energy-economic fundamentals are likely not so important for explaining why the coming slide in oil prices may have to stop at around $60 to $75 per barrel: the knock-on to a basically deflating real economy (well sheltered from or starved by the rain of QE bank bailouts) of a major cut in oil prices will be deflationary - and bad. For Big Energy companies and corporations the impacts may be disastrous, really disastrous, including bail outs being needed for what were imagined to be Win Only cash machines generating shareholder benefits, supplying energy and oil products supporting a huge web of state tax revenues. Cheap energy is a danger for economic growth, the exact opposite of any political party pitch on the subject - and the US experience with cheap shale gas is a real time, real world example of what cheap gas energy has done for the economy: almost nothing for growth, and major damage across the energy patch.

We can however be rather sure oil traders will not be interested in this type of analysis - when the right signals come, barrel prices can fall far and fast, in $10-a-week increments, to be sure with highly predictable dead cat bounces when "market sentiment says the downside was exaggerated". Finding the right price level for oil is however easy: in the US, natural gas is now priced around $20 per barrel equivalent; the cheapest coal in the US is priced at $1.60 per barrel equivalent; wind power and solar power plants operate on "fuel" that is 100% and perfectly free: beat that with 100-dollar oil!

From the danger price level of $75 per barrel on the downside, however, the action by oil producers will go into high gear. Saudi Arabian claims, from its oil minister al Naimi that "he likes $75 oil" will disappear off the newsfeeds coming out of Saudi Arabia, and Russian reaction to $75 oil is easy to predict. Further price erosion to $60 per barrel will produce a rout, with a major downward impact on oil production and supply, enabling oil traders to excel themselves with an hysterical surge in prices, but that is business as usual.