Thursday, April 1, 2010

Oil prices at "sweet spot"?

After a tumultuous year in 2008 (see this, this and this), when prices fluctuated between a record $147.27 a barrel on 11 July, 2008 and $32.40 in December of the same year, oil prices have remained remarkably stable in the $70-83 band for a barrel since August 2009. Gasoline prices have stabilized along with oil prices, with the average national price for a gallon of regular gasoline ranging from $2.50 to $2.80 since June 2009. The Times points to Ken Rogoff who calls the oil price band a "sweet spot" - one that encourages further exploration and also investments in renewables, besides leaving prices affordable for consumers.

In the decade from 1999-2008, oil prices climbed from under $20 to nearly $150 a barrel, unleashing large investments in expensive exploration and production projects around the globe - while at the beginning of the last decade, fewer than 20 drilling ships were capable of finding and developing deepwater oil, there are well over a hundred today. The recent price stability has only given time to consolidate those investments, including exploration of the Canadian tar sands.

In another boost to exploration, the Obama administration is close to opening vast expanses of the Atlantic coastline, the eastern Gulf of Mexico and the north coast of Alaska to oil and natural gas drilling, thereby ending a longstanding moratorium on oil exploration along the East Coast (covering 167 million acres of ocean). The proposal is intended to reduce dependence on oil imports, generate revenue from the sale of offshore leases and help win political support for comprehensive energy and climate legislation.

However, the argument that the ample spare capacity, five-year high commercial inventories, and large drilling and exploration activity in progress makes markets well positioned to absorb any potential supply disruptions, cannot hide the fact that oil prices have been steadily rising for the past five consecutive quarters. The strong recovery in emerging Asia and signs of recovery in the developed economies is likely to put more pressure on oil prices in the days ahead.

In this context, The Economist has an excellent graphic that captures the reality that the depths of even off-shore drilling is increasing fast. This reflects the fact that the easy to drill fields may have already been discovered and exploited and the average depth (and therefore cost) of off-shore drilling is increasing. This year Shell's 22,000-tonne Perdido rig is set to begin operation. Few big new oil fields that are easy to reach and cheap to exploit have been discovered in recent years. Standing nearly as tall as the Eiffel Tower, it is chained to the seabed 2.4km metres below and is capable of extracting oil at a maximum depth of 2.9km.

Another interesting graphic captures the relationship between oil prices and the number of rigs working. When prices fall, the incentive for exploration reduces and naturally the numbers of oil rigs at work comes down.

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