The Independent

The Future of Oil Futures

Crown Prince Sultan
Crown Prince Sultan
Sultan bin Abdulaziz Al Saud (30 December 1930 – 22 October 2011), called Sultan al-Khair was the Crown Prince of Saudi Arabia, from 2005 to 2011. | Photo: Associated Press | Crown Prince Sultan, Saudi Arabia, Royalty, Oil,

OPEC is betting the farm that prices will go way up.

Boy, what a mess. The price of a barrel of oil is down, down, down. And one pundit predicts prices will rise, while another pundit predicts prices could go even lower. Professor Frank Wolak, a Stanford economist, said on Monday that the price of oil could remain low for decades. Yet six weeks ago, in an article in The Guardian, Anatole Karetsky asserted that history and economic trends indicate that the present price of oil may in fact be the new ceiling. In other words, Karetsky was stating that the price of a barrel of oil could conceivable drop as low as $20 per barrel.

Still, the rig count in the U.S. is plunging. Rig count is important because it usually indicates that the price of oil has found its bottom and things are turning around.

In the last month, gasoline futures dropped 2.06 cents (1.1%). Meanwhile, the price of gas went up 0.7%, gaining 24% over the last quarter. Diesel futures dropped 0.8% or 1.33 cents, accounting for a 7% quarterly loss.

Essentially, there's a lot of information floating around - some good, some bad - and no one really knows what to expect, which means investors don't know what to do.

Don't worry, be happy. Why? Based on predictive analysis, which uses historical trends and economic data, it seems clear that the safe bet is that the price of oil will rebound and will most likely attain new highs.

Let's look at the economic reasons for this prediction. First, OPEC is betting the farm on prices skyrocketing in the near future. OPEC is holding steady on production levels and has stated categorically that it will not reverse this decision. OPEC knows, better than anyone, that oil field production drops an average of 5% per year. To counter this natural drop in production, the oil industry needs to find 200 million barrels of new oil in the next ten to fifteen years. And that's just to sustain demand at its present levels.

To develop 200 million barrels of new oil will require an investment of $8 to $10 trillion. But since cash flow has dropped off, oil companies are leery of pumping a bunch of money into new development projects. This reluctance for new development will only exacerbate the problem because there is a gap between going out and locating new oil fields and actual production. The gap is usually a minimum of two to three years.

Chevron began development of two new projects in the Gulf of Mexico in 2011. It took three years, until 2014, for the projects to produce any new oil. Likewise, Chevron initiated a new $6 billion development project in 2014. The company doesn't expect to see any positive results until about 2018.

Even if talks with Iran go well, Iran only produces 2.8 million bpd, which will hardly scratch the surface of the required 200 million barrels of new oil needed in the next ten years.

In other words, developing new production is similar to running a marathon. If you wait until you're thirsty to start hydrating, it's already too late. If the oil companies wait until demand increases and they have lots of cash on hand before they begin new projects, it's too late.

As stated previously, OPEC knows this. And they are counting on it.

The historical reasons for escalating oil prices are less concrete, but just as cogent. The Middle East was, is and always has been a very unstable and volatile region. Someone is always going to war with someone else. Referring to the area, a famous religious leader once said, "There will be wars and rumors of wars until I come again." He hasn't come. So historical trends indicate that something will go wrong somewhere and then prices will rise artificially.

Finally, there is the Black Swam scenario: the impact of the highly improbable. If and when the Black Swan enters the picture, prices will soar to unbelievable heights.

Setting aside the historical factors, which may or may not achieve fruition, the economic factors alone support the view that oil futures are due for a rebound. The next six to twelve months will see the tide turn. Global production will remain where it presently resides, demand will increase and oil futures will rise dramatically. And if new production isn't developed in a hurry, the price of a barrel will approach $200.

What does this mean for oil futures? Already today - Wednesday April 1 - North Sea Brent is up 3.7%, due to reserves being lower than expected and demand increasing. This trend will continue.

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Updated Aug 12, 2017 12:01 PM EDT | More details


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