This weekend, Gene Epstein in Barron's tried to make a compelling case for oil dropping back to $75 a barrel. Barron's hardly has the best track record for predicting oil prices (or oil stocks for that matter), but it isn't alone in this forecast, citing Ed Morse of Citigroup as one top oil analyst among many who agree.
But oil will not see $75 again, and I'm going to tell you why.
The strongest argument Barron's makes for seeing dropping oil prices is also the most intuitive. Technologically advanced production techniques for deep-water, oil sands and oil from shale have exploded potential global reserves and put the immediate anxiety of "peak oil" in the rearview mirror. In the U.S., oil production has increased close to 2.5 million barrels a day since 2008, not counting liquids, and the International Energy Agency predicts another 2 million barrels a day of growth in the next five years.
That growth, along with other global offshore and shale possibilities so far undeveloped, has convinced Barron's and other oil analysts that price is inevitably destined to retreat, breaking an uptrend that has been firmly in place since the financial crisis of 2008.
Three reasons torpedo this intuitive analysis.
1. It has been $100 oil that has inspired shale and offshore development.
"Unconventional" oil is also more expensive oil. Barrels that averaged $5 to bring out of the ground are getting more rare, and the average cost of production now pushes $50. Marginal barrels, such as those in the Gulf of Mexico, are being left undeveloped, even at a $100-a-barrel price. Witness the Shenandoah find, where ConocoPhillips (COP) and Anadarko Petroleum (APC) have made the immediate decision not to develop this massive lode -- it's just not cost effective, at least not yet. These are the barrels that will continue to dominate new production as "easy" barrels continue to run out. Drop the price too much, and several shale plays will be equally under pressure to remain undeveloped.
2. Drop in demand because of natural gas and renewables is an Organisation for Economic Co-operation and Development phenomenon.
Barron's makes the mistake of viewing the globe through U.S. and European eyes. It sees, correctly, the inevitable move to natural gas and ultimately renewables as lowering the demand for refined products in the U.S. and Europe. What Barron's forgets, however, is the demand profile for the rest of the world, not just China and India, but particularly in the Middle East and Africa, which is where the real marginal barrel growth will be coming from in the following decades. Daily crude use has grown about 10 million barrels a day every 10 years since the 1960s. We are continuing on that pace now, and I see good reasons, in a developing Third World, why that could even accelerate, not slow.
3. Financial appetite for oil as an asset class continues to grow.
This one is close to my heart, as I wrote an entire book on the phenomenon, Oil's Endless Bid. But the desire to own oil as one would own a stock or a bond is only in its infancy, and it continues to accelerate every year, with increased investment in futures, swaps, exchange-traded funds and managed funds. This inevitably adds an upward pressure on price that only a financial disaster can remove, as it did in 2008.
I have been a lone voice since 2009, predicting ever-increasing oil prices, and we have seen higher lows in 2010, 2011, 2012, 2013 and so far in 2014. I see no reason to believe that this trend is changing anytime soon, and I see plenty of reasons to believe that an acceleration higher is in fact more likely.
Bet on higher oil prices in the future. Barron's has gotten this wrong.