[A-List] Oil: high price here to stay

["Michael Keaney" <michael.keaney@xxxxxx>]

The Short View:
Market Comment by Philip Coggan
Financial Times: November 25 2004

Oil's stubborn refusal to drift far from the $50-a-barrel level is proving a
disappointment to those who believed the surge in crude prices would be
temporary.

Some analysts believe there has been a significant upward shift in long-term
oil prices that consumers and the global economy will be forced to absorb.
The problem is not a terrorist-related risk premium, it is supply
constraints.

Jeffrey Currie, of Goldman Sachs, says the world is not running out of oil.
But there has been long-term underinvestment in oil infrastructure. Oil
tanker capacity peaked in the late 1970s, while refining capacity and the
number of oil rigs reached their highest levels in 1981.

This lack of investment was not surprising. From the mid-1980s, returns on
energy-related investments were poor relative to those made in the rest of
the economy. The result is that Organisation of Petroleum Exporting
Countries output is now far closer to capacity than in the mid-1980s. The
problem has been deregulation of the industry. In a competitive market there
is little incentive for oil companies to maintain expensive spare capacity.
As a result, extensive investment is needed. Mr Currie says the previous
investment phase lasted 10 years.

Oil prices will need to be high to make such investment worthwhile. The
marginal producers (some 14 per cent of the non-OPEC total) need a price
above $30 a barrel to earn a return on capital above 8 per cent. Naturally,
as the industry tries to raise its investment, costs will rise. The recent
upward pressure on steel prices is a case in point. Meanwhile, governments
that were subsidising the industry 30 years ago are ratcheting up the tax
take. According to Goldman, rising producer taxes have added $6 a barrel to
the price over the past decade.

All this has carried the long-term equilibrium level of oil prices, Goldman
believes, to $30-$40 a barrel. Long-dated oil prices are now running at
about $35 a barrel, up $15 a barrel from the average 1990s level. That
leaves the gap between short and long prices at about $14 a barrel,
suggesting the market is not excessively tight, because of terrorism fears.
The historic high is $20 a barrel. The burden of high oil prices could be
with us for a while yet.