A few observations on the price of oil, one macro, the other micro

 The Barrel brings you a few perspectives on price from a variety of observers.

Here's one from Steve Kopits, a Managing Director with Douglas Westwood, a well-known consulting firm covering oil field services.  Steve writes regularly on macro oil issues, including a recent piece in Foreign Policy. He has been analyzing supply and demand trends in oil markets and in an email expanded on a conversation we had earlier this week. He writes:

Global oil demand growth has slowed to a crawl.  For March, US consumption is down 5% or about 1 million b/d compared to the same month in 2011. China's demand is up a measly 0.2 mbpd (2%).  So, overall, the global economy visibly can't afford oil at the $125/b Brent prices we've seen recently.  In fact, the statistics show that the OECD economies can't even afford $95 oil. Consumers around the globe are giving up.  Far from being addicted to oil, Americans are fleeing the stuff.  That's why prices have been easing on the demand side.

Now, what does that mean for the oil supply? Well, let's see what it costs to produce an incremental barrel of oil.  For 2012, the average approval threshold for oil companies around the world is about $98 Brent, according to Barclays Capital December 2011 E&P Survey. This means oil companies are literally approving projects requiring an oil price above the level OECD consumers can sustain.

The operators are banking on higher price tolerances from the emerging economies.  But if they continue to raise approval thresholds at the rates of the last few years, then next year they'll be sanctioning projects above what emerging economies can afford as well. 

That's not going to work.  Approval threshold increases will have to be smaller.  Do the math and it suggests the maximum price increase the operators will be able to achieve in the future will be approximately global GDP growth plus dollar inflation plus efficiency improvements in oil utilization. We don't have a good handle on what this latter number is, but figure oil prices can rise by 5-8% per annum from here on out, allowing for the occasional price spike. That's not a disaster, but the approval price for projects has been rising by 18% per annum. Clearly that can't continue.

And then he gets to the ominous bit of his analysis:  

If 18% price rises haven't been able to increase the crude oil supply, what do increases at half or a third of that pace imply?

The response would be: at that price, demand for the oil services that were contributing to that 18% increase would decline, lowering the cost of developing new reserves. But the key takeaway from Steve's remarks is that narrow gap between the cost of oil services and the price of oil. It doesn't leave a lot of room.

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A few weeks ago, we wrote about the sudden collapse of differentials in Midcontinent US and Canadian crudes.

During the period from March 1 through March 27, Platts assessed Bakken crude at consistenly wider than $15/b under the NYMEX front month calendar average for light sweet crude, known more commonly as WTI. Its widest point during that period sas $21.50. During the same period, Western Canada Select was no tighter than $27.50.

But on Monday, the differentials stood at minus $6.90 for Bakken, and minus $17.50 for WCS. So what happened? Platts' Lucretia Cardenas, who covers both markets, recaps:

The main reason is that it has narrowed on the combination of in the spring, when you're in Canada, the ground is thawing and things don't move that easily, like trucks. So production can get stalled as a result. So some of what was happening a few months ago is that there was overproduction, but they now don't have quite the oversupply issues that they had before.

The differentials in the market are for May barrels. In May, there are going to be a lot of refineries coming off spring turnarounds, and the refineries will be running at full capacity by then. So the market for Bakken and WCS has been much stronger.

For sweet grades, like syncrude, they were weaker because Suncor had taken its #2 upgrader down in March for unscheduled maintenance. But that came back online earlier this week. So that's helped demand for sweet crudes.

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