WASHINGTON (Dow Jones)--As oil prices threaten to spike above $110 a barrel Tuesday - daily setting new inflation-adjusted records - some industry experts say the bull run is in for a long ride and crude could surge even higher.
While in the short term, traders are concerned about inventory levels heading into the summer, Jeffrey Currie, chief strategist and managing director of global investment for Goldman Sachs (GS), says bottlenecks in global capital investment flows into new oil production will likely continue to put upward pressure on oil prices in the mid to long term.
The investment bank last week upped its crude price forecasts - tacking $15 a barrel to all of its oil estimates - expecting an average of $95 a barrel for 2008, $105 for 2009 and $110 for 2010. The bank said under some scenarios, including major supply disruptions, prices could lead to $150-$200 a barrel.
Despite a possible recession looming on the horizon that could curb global demand, a razor-thin capacity cushion, a raft of supply disruption threats and a weakening dollar have helped to buoy oil to their current levels. Last week, the Organization of Petroleum Exporting Countries decided to hold production steady, expecting global inventory levels to climb.
Currie, speaking at an oil conference here, said capital controls, such as Mexico's barring of foreign investment in the energy industry, was one of the major constraints to growth. "You have capital controls in all the major producing regions of the world at this point, and if you don't have capital controls, in some cases you have outright nationalization," he said.
"The commodities themselves flow freely across the world, the capital that goes into the productive capacity does not," he added.
That investment barrier is forcing international oil companies to invest in high-cost environments such as the tar-sands of Canada - long considered uneconomic until prices rose above $65 a barrel - or Brazil's and the U.S. Gulf of Mexico's major deepwater prospects, which require major, multi-billion dollar infrastructure developments.
Other regions, such as Russia and Nigeria, may be lower-cost, but governments are taking advantage of high prices to hike their tax revenues, says Mark Finley, general manager for BP America's global energy markets and economics division. BP America is a unit of BP Plc (BP). "Tax regimes have been a key driver of the inflating effective cost base of our industry...and that has the potential for supporting the high cost base going forward," he said.
Furthermore, national oil companies such as Saudi Arabia's Aramco are already investing tens of billion of dollars in new domestic energy infrastructure or industrial projects, fueling inflation to a point that is threatening to strain their economies. Any more new projects, despite access and low costs-per-unit, would only exacerbate that situation. "The capital requirements are so massive that such investment would distort their economies," said Currie.
James Burkhard, managing director of the Cambridge Energy Research Associates, said that he estimates exploration and production costs – not including tougher fiscal regimes - have more than doubled in the last few years.
Other Factors Contributing To the Bull Run
But Burkhard said there were a host of other issues besides cost that portend a bullish crude future, not the least of which is limited demand side alternatives. "There are no quick and ready substitutes," he said. Unlike previous crude price spikes in previous decades, where power generation switching from fuel oil to natural gas or coal prompted a fall in crude demand, alternative supplies are years from being brought online.
Energy efficiency, such as Congress' fuel economy standards, will take at least another decade to erode demand and although biofuels have marginally relieved pressure off gasoline prices, the technological breakthroughs necessary for major volume replacements of crude distillates are also several years distant, said Burkhard.
Adding to longer-term price pressure, Burkhard said that based on a recent industry survey conducted by CERA, the average scheduled petroleum project is expecting a 15% shortfall in qualified labor, likely causing major delays in new production coming online.
He also said that although CERA expects more liquified natural gas and condensate to help offset limited crude capacity growth in coming years, "the components of growth pose a real challenge, particularly downstream." He says that most of the projected global demand growth is for diesel, but most refineries currently in production are tuned for crude, and can't process LNG or condensate into products called "middle distillates" and not diesel.
The International Energy Agency Tuesday said it expected demand growth could remain robust in the face of high prices and an economic slowdown in the Organization for Economic Co-operation and Development, or OECD, countries.
"This is not least because the main centers of growth in the developing Asian and Middle Eastern economies are largely insulated from some of the pricing pressures affecting other markets," the IEA said.
The Paris-based agency, in its monthly oil market report, also said the OPEC's decision last week to rollover its existing production - rather than increase output - and to not meet until September helped to encourage speculation in global oil markets.
Currie, BP's Finley and Rob Wiener, a professor of international business and affairs at George Washington University's Global and Entrepreneurial Finance Research Institute, rejected the commonly-held view in the markets that speculation was adding a significant premium to oil prices.
Capitol Hill lawmakers and OPEC officials alike have said speculative capital, primarily from hedge funds, is adding up to a $25-a-barrel premium to current prices.
"While intuitively appealing, the view is not supported by research...and proponents have offered neither evidence nor a coherent rationale for speculator's effects on markets," Weiner said.
"The net stock of derivatives contracts is always zero - for every buyer there is a seller and both buyers and sellers have to reverse their positions as each contract expires...and so cannot cause a sustained increase or decrease in the price of oil," he said.
Source: Ian Talley, Dow Jones Newswires, 202-862-9285; ian.talley@dowjones.com