Thursday, May 27, 2010

Despite Current Lows, High Production Costs Will Force Rising Oil Prices in Years Ahead

Oil prices have fallen steeply in the month of May and prompted analysts to reassess their expectations for oil prices and oil demand in the rest of 2010. Yet prices for more distant crude oil futures contracts have barely budged, signaling that short-term volatility has little impact on the long-term trend of higher oil prices, reports Bloomberg Businessweek.

The spot price for crude oil dropped 10 percent in the last three months (and nearly 20 percent from its May 3 high above $87 a barrel), but crude oil futures for December 2018 stayed above $90. Investors pointed to the high price of drilling and processing the large potential reserves outside of OPEC—deepwater reserves in the Gulf of Mexico and off Brazil’s shores, and the oil sands in Canada and Venezuela—as a fundamental driver of higher oil prices. Those reserves will be needed to cover growth in global oil demand, but won’t be tapped unless oil prices are high enough to make it profitable.

The fact of high production costs puts a floor under the price of oil in the coming decade, and the causes behind oil’s recent slump do nothing to change that, said Mike Wittner, head of oil market research for Societe Generale SA:

Concerns over a Eurozone-centered debt crisis, and the Chinese economy, and U.S. financial regulations, have no impact on full-cycle production costs or on the medium-term view…. And the medium-term view is one of global oil demand growth bumping into a mature supply base.

Forecasts from the Energy Information Administration (EIA) and Bank of America Merrill Lynch this week supported Wittner’s position. Bank of America cut their forecast for the average price of crude oil in 2010 from $92 to $78 a barrel after factoring in the plunge in oil prices during the last three weeks, but left its oil price forecast for 2011 untouched. The EIA looked ahead to 2020 and 2035 and predicted average crude oil prices of $108 and $133 a barrel, respectively. A growing global population, growing energy demand in emerging economies, and the difficulty of finding substitutes for oil make it hard to envision a future in which the price of oil declines.

Barring a dramatic shift in the world’s energy use, oil prices will march relentlessly upward as more expensive sources of oil are exploited. From this perspective, the heating oil industry’s turn to biodiesel is not just an environmentally friendly decision; it’s an economic necessity. Biodiesel feedstock can come from a variety of sources—soybeans, waste cooking oil, algae, and others—that are renewable and that get less expensive, not more, as producers develop more efficient methods of collecting the feedstock and processing it into biodiesel.

With all signs pointing to higher oil prices in the next decade, if not sooner, why not turn to a heating fuel that’s not just cleaner-burning and more efficient, but getting cheaper with every advance in technology?

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