Oil hit nearly $112 today. The debate now is not over whether oil will be at $100 for the near-term. Traders and economists are focused on whether a recession will take oil demand, and prices down, or whether falling supply will keep prices high.
The bets are beginning to move in the direction of a long, long period with oil at or above current prices. The FT writes that "Crude oil futures prices for delivery until 2016 have surged above $100 a barrel as investors bet that oil costs will remain high in the long term." While the news is enough to cause wide-spread despair, it is not a complete surprise.
The market is now willing to gamble that OPEC may never push production up very much. The high price of oil is just too good to resist. It is swelling the value of sovereign funds in Middle East nations by tens of billions of dollars a year.
The school of thought that new discoveries will not offset aging fields is also gaining some currency. While Alaska and the North Sea begin to lose some of their pumping power, the largest new reserves are underwater, down thousands of feet from the surface, and are unproven in terms of capacity.
The Saudis announced yesterday that they will spend $40 billion to improve their own water supply. That money has to come from somewhere. It is a great incentive to keep prices up, but it also may indicate that the country may need to keep more of its production to build an infrastructure of very significant proportions. Other old-producing economies like Venezuela and Mexico need their own crude to power a growing number of cars and trucks and to build out their own roads and cities.
Jeffrey Currie of Goldman Sachs warned that the need for further investments was “likely [to] lead to explosive prices in the next couple of years, with oil prices potentially spiking toward $175 a barrel”. That number is up almost 60% from the current price and it becomes more believable by the day.
Douglas A. McIntyre