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Oil is about to get more expensive in 2018, says analyst

$80 per barrel estimated within possibility after Futures continue to rally after 22% gain over the last year

The Petrodollar is gaining strength. So is the Petroruble, to coin a phrase.

Yes, that was a pun.

The truth is that over the last twelve months, oil prices have been gradually and steadily on the increase.  At the beginning of 2017, the price for a barrel of crude was about $56.  It sunk gradually until June of last year, bottoming out in the mid $40’s, and has been on the rise again ever since.

This rise gave one market forecaster, Byron Wien, impetus to predict that the price in 2018 is likely to continue to increase, reaching the US$ 80 point this year.  He predicts this as a surprise for the market.

Oil is a uniquely regulated market, because the quantity of actual oil available to pump is far higher than the amount that the oil-producing nations decide to pump.  This is what gave the OPEC cartel so much power in the late 20th century.  The common knowledge at that time was that the American oilfields were depleted, therefore the US, as the chief consumer of oil in those times, would have to pay the fiddler for the tune, and that fiddler was, of course, the consortium of oil producing nations in the Middle East.

However, this did not work all the time.  While there are many stories to tell about this, and probably infinite reasons given by many people as to what exactly controls price and demand of oil, by the early 21st century, the price per barrel had dropped very low, as low as $18 or $19 a barrel at times, and below $40 overall for nearly the first five years of this century.  Then it began an overall rise, peaking in 2008 with a price of about $140 per barrel.  This was the first time many American drivers witnessed prices per gallon of gasoline in excess of $4. This author believes that this price shock was the kickoff point for what became known as the Great Recession. The prospect of paying $100 per tank of gas was overwhelming to many people who owned low-efficiency vehicles, such as SUV’s, and the market for these vehicles came to a standstill as people stopped driving them and stopped buying them.  At the same time the attention of the nation turned to AIG and several other large companies in urgent need of a bailout, and so, the crisis was on.  As the graph below shows, the effect on oil prices was drastic.

The next rise, from about 2009 to about 2014 was partly politically driven, or at least hoped for.  The Obama Administration hoped to change the energy policy in the USA drastically, but his approach was a negative one, wishing to keep oil prices high to force the population to choose then-inefficient electric vehicles, or gas-powered ones with very small engines, His Energy Secretary, Steven Chu, had openly expressed hope for $10 per gallon gas before his appointment as Secretary, and to be fair he later recanted this.  On the record, Obama and Chu do not insist on such a rise as policy. But in the rather crafty way Obama had, he was able to express his wishes “nicely” without having to ever be forced to take responsibility for his words.  The prices for oil increased again, this time staying between $100 and $120 a barrel for several years, and during this time fuel prices continued to climb back into the $4 region.

But a new force was about to emerge in the oil market, and it came as a surprise to the whole industry.

The extraction industry had refined the technique of Hydraulic Fracturing (fracking) over the years, and with it, a new drilling technique was also devised, where instead of punching a hole straight down to where the oil was, companies could now change direction in the ground, or drill sideways, and pump water or other chemical compounds into the substrata and force more oil out.  This, plus the discoveries of at least two new major American oilfields, the Bakken Formation in North Dakota and the Niobrara Formation in Colorado and Wyoming, coupled with $120 per barrel prices, drove a drilling boom in the United States, of which I was a personal witness to, since I lived in the Niobrara region at the time. This technology did not stay restricted to the USA of course, and now for the first time in a generation, OPEC had an extremely aggressive challenger in the market.  In 2006, Russia and Saudi Arabia held roughly two-thirds of the production volume, with the USA at about 20%, but by the beginning of 2015, the American share of output had risen to 25%, while Russia and Saudi Arabia fell a bit, to about 28% apiece.

Crude Oil output of Top Five producing countries, from 1972 through 2016.

This broke the back of high-priced oil, and again the per-barrel price plunged below $40 in about one year’s time.  Now this price caused some of the new wells in the States to become unprofitable, so they were turned off for a time.  But as the price increases past the profitability points for these wells (ranging from as low as $10/bbl to $70/bbl), production can be increased again at the flip of a switch.

OPEC no longer has absolute control over the market.  However, like any good enterprise it is in competition, mainly to maintain a price-level and production level that maximizes its own profitability.

We have presented all of this information to make the following prediction.  Mr. Wien’s idea of $80/bbl oil is not entirely insane.  But it is unlikely to happen.  It should be somewhat more clear to the reader that this market is not just a simple supply vs demand equation.  There matters of geopolitics, national, regional and global finance, and efforts to regulate this industry to control it.  The amount of oil that is available in the world is certainly finite, but the truth is we keep finding more and more of it, so exactly what that finite point is, is still unknown.  It seems unlikely that we will see $80 oil, because high-priced gasoline will not be supported in the USA, even with this stronger economy now reported there.  Further, the increasingly successful EV market is getting more and more attractive and affordable.  With the advent of affordable electric vehicles that have comparable range to gas-powered ones, the demand for oil for gasoline (the biggest single by-product) will top out, and then slowly start to fall.

It is a matter of timing, of course, and the fascinating thing about following this market is to observe when, and how, all these elements come together.

Our prediction, for what it is worth: Oil will not exceed $74 this year.

Let the games begin.

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The statements, views and opinions expressed in this column are solely those of the author and do not necessarily represent those of The Duran.

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