Tight Global Supply to Underpin Long-Term Oil Price

NEW YORK Jul 17, 2007 (Dow Jones Newswires)

Tight global supply will ensure oil markets remain strong in the coming years despite concerns high prices could temper demand, analysts and traders said Monday.

Growing exploration and development costs alongside pared output from countries affected by political challenges, such as Nigeria and Iran, are expected to continue to choke global output.

Coupled with this, the growth in real incomes means demand hasn't been as responsive to high energy prices as expected.

Such a scenario has prompted New York-based analyst Adam Sieminski of Deutsche Bank to raise his 2010 estimate for WTI and Brent to $60 a barrel from $45 a barrel.

"A key justification for this move is that finding & development costs are rising rapidly and these are expected to rise further over the next few years," he said.

He estimates find and development costs have climbed 15% a year in real terms from 2005 to 2007 and expects a minimum 7.5% year-on-year escalation from 2008-2010, a move which would then put worldwide find and development costs at $18-$20 a barrel.

"The 'good old boys' in West Texas didn't have to have an MBA or a degree in economics to understand the oil business," Sieminski said in reference to the West Texas oil proverb: "If you want to make any money in this business, you need to sell oil for 3 times your drilling costs: 1/3 for the well, 1/3 for the tax collector, and 1/3 for yourself."

But costs aren't the only factor capping oil supply. The Organization of Petroleum Exporting Countries, or OPEC, also has a part to play.

Jeffrey Currie, an analyst at Goldman Sachs in London, said the only way to avoid a spike in crude prices above $90 a barrel this autumn is a ramp up in production by Saudi Arabia, Kuwait and the United Arab Emirates.

"These three countries are the only members of OPEC that took significant supplies off the market a year ago, have not increased production with the recent rise in prices and still have significant spare capacity," he said.

Currie estimates that keeping OPEC production at current levels, and assuming normal weather this winter, would mean total petroleum inventories will fall by 6.5% by the end of 2007, a move which could push the crude price to $95 a barrel.

OPEC, for its part, continues to plead innocence when the market looks for a scapegoat to blame on the current high oil prices. Instead it says high gasoline prices are underpinning crude as the U.S. refining system struggles to keep up with demand.

Gary Adams, oil & gas industry leader at consulting firm Deloitte & Touche in Houston, said tightening gasoline supply, caused by a lack of capacity in the U.S. refining system, will keep crude oil prices close to $70 a barrel and possibly $80 barrel in the next few months.

He expects the stuttering U.S. refining system to experience more maintenance issues in the months ahead.

"We're sitting on a time bomb," he said.

There's also a feeling in the market that tightness in gasoline could lead to tightness in the heating oil market over the winter as refiners are forced to extend gasoline runs to make up for curtailed production over the summer.

"Continuing strong demand, in combination with security of supply issues, is exacerbating the tightness in global refining capacity, which we believe will not begin to be alleviated until 2010 and beyond," said Andrew Williams, an analyst at Credit Suisse.

With high prices for both crude and oil products on the cards it would be fair to assume demand will taper off.

But, assuming global GDP grows an average of 4% a year to 2015, Sieminski expects oil demand to grow approximately 1.7% each year.

"We have entered a new phase where high oil prices, above $60 a barrel, are the norm and consuming nations are learning to deal with it," said a New York-based trader. "Suddenly the day when we see $100 a barrel oil doesn't seem that far off."

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