Oil: where we go from here

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If there’s been one bright spot amid all the economic and political uncertainty of late, it’s been the sharp and sudden 23% drop in oil prices this quarter – a drop as steep and deep as what occurred at the end of 2008, when the “Great Recession” began to make its unwelcome presence felt on the global stage.

Truckers, of course, are breathing a lot easier as this plunge in oil prices translates into big declines in diesel fuel costs. In fact, Wall Street investment firm Robert W. Baird & Co. noted in its most recent Freight Flows that diesel prices have retreated for 11 consecutive weeks, with the U.S. average price for diesel falling another 5.1 cents to $3.678 per gallon this week alone. Indeed, diesel fuel prices have fallen 11% since they peaked at $4.15 per gallon in early April, the firm pointed out.

Additionally, the Energy Information Administration (EIA) reports that diesel fuel is now 21 cents per gallon cheaper compared to the same time last year. Gasoline is also in retrograde, down 9.6 cents this week to a U.S. average of $3.437 per gallon – which is 13.7 cents lower per gallon compared to the same time period in 2011.

Yet now the question must be asked: where do we go from here? Many experts believe that we’re at or very near the “bottom” in terms of how low oil prices will go, while others think the continuing European sovereign debt crisis added to the still-sluggish trend line for the U.S. economy will keep the cost of oil down for an extended period of time. But for how long?

Indeed, what might the cost of oil be, say, 20 years from now? I know that’s a long ways off, but any number of companies that rely on energy to conduct business (and trucking is certainly one of them) need to think in such strategic terms.

Thus it should be no surprise that EIA believes that there are three possible tracks oil prices could follow in the future, each influenced by specific set of conditions.

In the agency’s Annual Energy Outlook 2012 (AEO2012), these three “alternative paths” for world oil prices in 2035 based on different production and economic assumptions with “real” oil prices (that is prices per barrel calculated in “constant 2010 dollars”) ranging from $62 per barrel in the “low oil price” scenario to $200 per barrel in the “high oil price case, with the “middle of the road” scenario pegging oil costs at $145 per barrel.

The oil price “platform” EIA used in compiling the AEO2012 report, by the way, is defined as the average price of light, low-sulfur crude oil delivered to Cushing, Oklahoma, which is similar to the price for light, sweet crude oil traded on the New York Mercantile Exchange – West Texas Intermediate, or WTI, crude.

Other factors the agency believes should affect supply, demand, and prices for petroleum in the long term are: World demand for petroleum and other liquids; Organization of the Petroleum Exporting Countries (OPEC) investment and production decisions; the economics of non-OPEC petroleum supply; the economics of other liquids supply.

OK – so let’s examine some of EIA’s future projections regarding oil prices.

First, the middle of the road or “reference case” posited within the AEO2012 indicates a short-term increase in oil price, returning to price parity with the Brent oil price (a far more global oil pricing indice) by 2016 as current constraints on pipeline capacity between Cushing and the Gulf of Mexico are moderated.

Then there’s the “low oil price” case – the one everybody likes – that results in a projected oil price of $62 per barrel in 2035. This “low oil price” prediction though assumes that economic growth and demand for petroleum and other liquids in developing economies (which account for nearly all of the projected growth in world oil consumption in the previous reference case by the way) is reduced.

Specifically, the annual gross domestic product (GDP) growth for the world, excluding the mature market economies that are members of the Organization for Economic Cooperation and Development (OECD), is assumed to be 1.5 percentage points lower than that of the reference case in 2035 (which posits only a 3.5% annual increase from 2010 to 2035), thus reducing their projected oil consumption in 2035 by 8 million barrels from the reference case projection.

While non-OECD oil consumption is more responsive to lower economic growth than to prices, oil use in the OECD region increases modestly in the low oil price scenario. In this lower price case, the market power of OPEC producers is weakened, and they lose the ability to control prices and to limit production.

Then of course there’s the big bad alternative, the one nobody wants to face: the “high oil price” case. This scenario assumes prices rise to $186 per barrel by 2017 (again in 2010 dollars) and then increase to $200 per barrel by 2035. These higher prices result from higher demand for petroleum and other liquid fuels in non-OECD regions than projected for the reference case.

In particular, the projected GDP growth rates for China and India are one percentage point higher in 2012 and 0.3 points higher in 2035 than what occurs in reference case. Overall, in 2035 it is projected that 4 million barrels per day will be produced above the reference case level, even though projected oil consumption in the mature industrialized economies actually drops.

In any event, truckers must remain on their toes one way or the other to ensure they can benefit no matter which way oil prices might turn. 

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