He’s back. Philip Verleger, long time quoted oil analyst who likes to make extreme price projections, has emerged this week with a new assertion: oil could collapse to 10.00 dollars a barrel.
I’ve been following Verleger for a couple of years. In fact, after President Bush’s biofuel speech in the January 2006 SOTUS, Verleger made the outrageous claim that all global growth in oil demand for 2-3 years would be met by biofuels. Thus leaving the call on oil flat. Verleger made this claim in a WSJ article that week, and I wrote to him asking if he was quoted directly. He wrote back, and said yes.
Although it’s my view that Verleger has made very poor price forecasts over the years (always too extreme), let’s briefly consider what would be required to get oil back to 10.00 dollars.
Certainly, a synchronized global depression would be required. A global recession would simply not be enough. Demand growth globally for oil, in the aggregate, tends to plow right through recessions. Some countries see falling demand. Others see rising demand. We also have to remember that the natural, annual decline rate for global oil production stands already at 5.00% minimum. Most professionals in the industry feel it stands higher, at 7.00%. The world therefore has had to come up with 3.7 Mb/day of new oil, every year for the past 3 years, just to match the loss from declines, and to stay even. The world has been running in place now since 2005, at 74 Mb/day–of Crude Oil.
This is why, as I have tried to explain to others, that supply would be likely to chase falling demand, down the price ladder. We are no longer in a world where falling demand and falling price triggers a glut of supply. We are in a world where new oil–the new oil required to replace the declines–only showed up when we got above 80, 90, 100, 110, and 120. Look at Russian exports. They are falling. When oil falls below 100.00, the profit margin for an exporter of Russian oil goes to zero. This is just one example. Already, future expansion plans in the Alberta oil sands are being canceled. It doesn’t matter that Saudi can bring on some new supply. Or that Angola can bring on some new supply. What matters is that the world has needed 100% of new supply over the past several years, just to keep up with the declines.
If oil were to fall below 80.00, I think it would only be 6 months or so before the decline rate–masked by new supply–would start to reveal itself. The entire internal structure of oil’s price is massively higher now, than it was just 5 years ago. All the new oil is expensive, hard to reach, in war zones, or is in harsh climates. Even the new oil that does not face those types of risk, faces higher export duties, production sharing agreements, and royalties.
I agree, however, that the price of oil in 1-12 week periods is hyper-sensitive to supply changes. When global diesel supplies were tight in the first half of 2008, oil skyrocketed to its all time high. But not for long. When warm weather bathed the US East Coast in early Winter 2007, oil fell to 50.00. But, not for long. So Philip Verleger’s assertion that price risk exists to the 10.00 dollar level is not absurd. It’s merely that a perfect storm of events would be required to take us there. He also is of the view that oil could go to 200.00 in light of a different set of risks. Well, that too is possible. My issue with Verleger as an analyst comes from his extreme price projections, which have been noted also by Laszlo Birinyi. In addition, when Verleger claimed that 2-3 years of global demand growth could be met by biofuels, that claim was easily refuted in real-time, as no such supply of biofuels globally was even available, at that time.
In general, I believe there is an antiquated and calcified generation of oil analysts that are dead-wood and have been cluttering up the place this decade with their structural bias to be bearish on price, or, their penchant for dramatic calls. There is a new generation of analysts like Jeff Rubin at CIBC, who have been much more comprehensive and measured and as a result much more accurate over the past few years. I include Murti at Goldman Sachs and Norrish at Barclays also, in this group. What consistently marks their work is solid rationale and an absence of attitude. I tip my cap to these people.
-Gregor
