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Have Oil Prices Stabilized? Don't Be Too Sure


There seems to be a new stable-oil consensus among the financial world, OPEC and the International Energy Agency. Yet not everybody concurs.

It's official now. Everyone agrees. Rising oil prices are so last decade.

A lot has happened in the world over the last three years. The Middle East has turned upside down. The eurozone appeared to be on the ropes then stumbled back into the ring. Barack Obama came back from the political dead. The Chinese economy lost altitude then took tentative flight again.

None of it has affected the price of oil much. The popular United States Oil Fund ETF (NYSEARCA:USO), which tracks the price of West Texas Intermediate crude, is virtually flat compared to April 2010. Brent crude, which trades in London and serves as a benchmark for the rest of the world, has also remained in a historically tight range.

Wall Street is now nearly unanimous in its opinion that this is the new normal. Until recently, the analytocracy took the intuitive view that oil would climb upwards again once global economic recovery gained traction: more activity, more demand, higher prices.

Then Goldman Sachs (NYSE:GS), as is its wont, changed the discussion. The giant squid declared last October that the "oil super-cycle is over" and slashed its price projections. "Net, we see a return to a strategically stable market," Goldman's big brains wrote.

It took a while, but other commodity prognosticators gradually fell in line behind Goldman. Late last month, Citigroup (NYSE:C) published a report predicting "the end is nigh" for tight oil. Analyst Seth Kleinman predicted a slow decline in prices with Brent sinking to $80-$90 a barrel by 2020 from about $110 at the moment.

Barclays was the last bull to cave in this week, cutting 2013 price expectations by more than 10% to near current market levels: $112 a barrel for Brent, $95 for WTI. Perhaps not coincidentally, Barclays' chief of commodities research, Paul Horsnell, left the firm.

The new stable-oil consensus is based on two underlying factors: first, rising supply from "unconventional sources" like shale oil, tar sands, and deep water drilling; second, moderating consumption based on improving vehicle and building efficiency.

It's not only the financial world that is repeating the comforting mantra. OPEC's secretary-general, Abdullah el-Badri, yesterday called current crude price levels "comfortable." Saudi Arabian oil minister Ali al-Naimi dubbed oil at $100 "reasonable." The International Energy Agency, whose statistics are industry gospel, predicts a gentle upward slope to prices of $120 per barrel by decade's end.

Unless you happen to be a sheikh or a big oil company shareholder, this all sounds like great news. Everyone loves to grouse about why oil is not cheaper. But steady, predictable prices would still be a great boon to industry and consumers alike compared to traditional volatility.

Yet history suggests that when all the authorities agree on something -- say the safety of mortgage-backed securities or the value of telecommunications stocks -- that is a particularly dangerous time to agree with them. And then not everybody does concur.

The Organization for Economic Cooperation and Development, a 26-nation club known for erudite research that no one really listens to, lodged a ringing dissent on the oil outlook last month. OECD economists predicted 2020 prices between a reluctantly palatable $150 per barrel and an outright scary $270.

Why such a big difference from the Wall Street/IEA prognosis? OECD assumes that world oil production will increase by a robust 14 million barrels a day, nearly 16%, during the coming decade. But consumption will rise even faster, assuming that global economic growth returns close to its trend in the 2000s. That is one big "if." The world economy expanded by 4-4.5% annually for a number of years before the 2008 crisis. Five years later it is puttering along at 3%. Each 1% difference in GDP growth translates to $40 a barrel in oil prices over a decade, the OECD estimates.

It is also important where growth comes from. If a developed economy expands by 1%, its energy consumption will rise just 0.5%, the OECD says, as consumers and businesses react with fuel-saving measures. In the emerging markets the correlation is 1:1. More money for a previously impoverished population means more cars on the road, and probably bigger ones that eat more oil. The organization expects just such runaway consumption growth in the population giants of Asia: China, India, and Indonesia.

For investors, laying off oil-related investments probably makes sense in the short term, with economic recovery still half-hearted and production rising at a healthy clip. If and when the world economy returns to full strength, one should watch closely where the engine of prosperity is: US and Europe means less oil bang for the buck, Asia/emerging markets means more.

And remember that commodity price predictions can be as volatile as commodity prices themselves. Once upon a time a celebrity analyst made headlines by announcing that crude oil would soon fetch $200 a barrel. The date was May 2008. The analyst: Arjun Murti of Goldman Sachs.
No positions in stocks mentioned.


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