Most forecasts are wrong and rarely more so than in the oil market. For the last four years prices have turned out higher than expected. But recent forecasting errors pale into insignificance compared with the range of expectations for the long-term oil price.
Rising demand within a global oil system running at full capacity, rather than a withdrawal of supply, underpins the current high crude price. Concern over a lack of spare capacity has pushed forward prices higher, further into the future, than during earlier oil price shocks. Based on forward swaps, the price of Brent crude in 2010 is $33.50 per barrel. The oil majors, meanwhile, are using a long-term price of about $21-$22 to evaluate investment projects.
Either the forward market or the oil companies' assumptions are incorrect. If it is the latter which are overly conservative, investment may fall short of the level needed to rebalance the market. The altenative source of new supply is through government investment within the Organisation of Petroleum Exporting Countries. However, to fund investment and maintain social welfare programmes, Opec requires prices well above $20. There is no guarantee that Opec can engineer a high oil price, but, if it cannot, investment could be at risk.
With the oil majors yet to consider the supply opportunities which are economic at $25, the new equilibrium price of oil is unlikely to be as high as current spot prices above $40. What is increasingly clear, however, is that a long-term oil price of $20 is too low.
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