Supply factors in oil prices
James Hamilton has a really nice running series on oil prices at his blog. From a recent post on how supply factors are keeping prices up:
One school of thought points to the $2 billion decline in global spending on oil exploration that followed the oil price collapse of 1997, along with inadequate investment in refineries needed to process the heavy, sour crude currently available. A second school of thought argues that it is not physically possible to increase production further, not in 2005, nor in 2010.
Obviously the peak oil school of thought is #2. I personally believe that #1 is mostly true although I am second guessing myself as the back end of the Nymex crude curve is still over $60, much higher than I would have expected. To the extent that I agree with #2 I still think that $65-70/BBL is higher than fundamentals warrant; trying to figure out the long term fundamental price based on the cost of new supplies is a complicated exercise that I haven’t attempted but off the cuff I would expect something more in the $40-50 range unless demand growth continues at the pace of the last 3-5 years (so it follows that I believe we will see a significant slowdown in demand growth due to a general economic pullback in the US or Asia over the next 2 years).
A chart I haven’t seen (but would like to see) is how much oil supply comes online at different prices; e.g., 16mmB/D at $20, then 2mmB/D conventional supplies at $30, 2mmB/D of oil sands at $40, etc. Even then this is a pretty difficult idea to convey since these prices are subject to other factors; oil sands production is highly dependent on cheap natural gas (or other heating fuel), incremental production of heavy sours isn’t really useful until the refinery capex cycle can add coking/hydrotreating capacity to process the heavy/sour (2-5 year cycle), etc.