The Era of Cheap Crude Oil Is Over

Crude oil is a commodity. For centuries commodities have been traded on international commodity markets. For decades the Texas Railroad Commission had monthly Proration Meetings and in essence set the price of world oil. When the US became less important in world oil production, with development of OPEC, and increase of US imported oil, the Texas Railroad Commission no longer is a factor in setting world oil prices.

Enclosed is a chart of the rising and falling and rising price of crude oil. In a relatively short time the price can rise from $30 barrel to $140 barrel and fall back to $30s barrel.

The international crude oil commodity futures market is a major financial market. Substantial amounts of speculation funds can enter commodity markets. If there are X million physical barrels being transported international, there can be a multiple of X million barrels being traded financially on the commodity markets. Those who can predict crude oil commodity market movements can make or lose millions or hundreds of millions of dollars. Supply and demand, economic instability, taxes, government regulations, military instability, expectations of political instability, US dollar exchange rate against the Euro currency, disruptive weather, processing costs, transportation costs, and boycotts all influence crude oil prices.

By setting production quotas, OPEC today is the dominant force in influencing crude oil prices. The next OPEC meeting is October 14, 2010. Unlike the former Texas Railroad Commission, OPEC does not meet monthly and fix production figures monthly. The last OPEC meeting which changed production quotas was a year and a half ago.

The trend today is that National Oil Companies (NOCs) control most of the world crude oil reserves. NOCs will control the leases, taxes, regulations, and final crude oil prices. Quotas and prices set by OPEC do not always mean OPEC member keep to their quotas.

Crude oil prices can be fixed by contracts, but there can be additional off balance sheet expenses. Some nations have “local content” regulations which increase price of equipment, local services, and labor. There can be environmental assessments. There can be high litigation costs. There can be military support expenses. These off balance sheet expenses can be substantial.

In the short term this summer and early fall, if the economy falls, crude oil could stay in the $70s a barrel or lower. If the world economy rebounds, crude oil could move back to the $80s or higher. It is impossible in the short term to predict a crude oil price top and bottom. The key is OPEC. In the past OPEC has over-reacted to supply and demand figures. If OPEC over-reacts again and increases crude oil supply, crude oil in the short term should fall in price. What is the crude oil bottom price if OPEC increases production substantially? A guess would be in the low $60s or even the mid $50s a barrel. In a short term crude oil prices can be volatile, strongly influenced by OPEC and other factors.

What is certain long term crude oil prices must increase. Crude oil consumption will increase. The world will be dependent upon fossil fuel for the foreseeable future. There can be no illusions regarding crude oil. Consumption will increase and supply will decrease.

The other key factor is inflation. The “free market” economist Arthur Laffer warns us that our federal deficit spending must result in increased taxes and inflation. Some estimates are that at current US federal spending rates by 2020 our federal deficit could reach $18.5 trillion. It is highly likely gold will increase in price in an inflationary period. Will crude oil increase in price with inflation or hyper inflation? That is an unanswered question. It highly probable inflation will increase crude oil prices. For example of the impact of historic inflation the following are actual crude oil prices and inflation adjusted prices for the past several decades: 1950 $2.77 – $25,36; 1960 2.91 -$ 21.47; 1970 $3.39- $ 19.04; 1980- $37.42- $99.11; 1990 $23,19- $38.57; 2000 $27.39- $34.65 and 2008 $ 91.48 -$92.31.

As a result of hostile military action, economic and political events, there will be crude oil price spikes, which temporarily could send crude oil prices back to $140 barrel or higher. How high crude oil price spikes will reach or how long they will last is impossible to predict. For decades the United States has unsuccessfully fought to become less dependent upon foreign crude oil. The result, however, is the US has become more and more dependent upon foreign oil, which is a major strategic mistake. In economic warfare control of another nation’s energy source is a key objective.

OPEC clearly understands that high crude oil prices result in international economic and political instability. How high is high and what is a reasonable price range for crude oil? When crude oil prices are high it benefits the crude oil producing and exporting nations and adversely impacts crude oil consuming nations. When the price is low it benefits the majority of non crude oil producing consuming nations and negatively impacts crude oil producing and exporting nations.

With consumption increasing and supply decreasing, expect higher crude oil prices over the coming decades. With the US production declining, the US will become more dependent upon foreign sources of crude oil. Current federal government proposed higher oil industry taxes, increased regulations, restrictions on offshore drilling, prohibitions to lease federal lands, etc. will all impact our domestic oil industry negatively.