Jim Jubak: Why oil and gas prices will rise; stocks to buy

Jubak's Journal3/15/2010 7:00 PM ET

Will oil hit $200 a barrel after all?

Those 2008 predictions of sky-high prices may not have been as wrong as they were premature. Plus: Investing ideas for crude's comeback.

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By Jim Jubak

What ever happened to $200-a-barrel oil?

Maybe it's just been delayed in transit. A recession in the world's developed economies can do that.

Remember Arjun Murti's time in the sun when, in May 2008, the analyst at Goldman Sachs predicted that oil would soon hit $200 a barrel? A number of other prognosticators weren't far behind. T. Boone Pickens predicted in 2008 that oil would hit $150 before the year was out. Some guy named Jim Jubak in April 2008 called for $180 a barrel within two years.

In case you haven't noticed, all of us were wrong. Oil peaked at $147 a barrel in summer 2008 and then plunged to $35 a barrel by June 2009.

Let me rephrase that: We weren't wrong; we were early. (All financial fortunetellers are told over and over again in their training at the Frogwarts School for Financial Wizards that you never, never, never forecast both a price and a date. One or the other. Never both.)

A little thing called the Great Recession killed global demand for oil. For a while.

A prediction delayed, not changed

But none of the supply-side problems that led me and others to predict $150-to-$200 oil has gone away. As soon as oil demand rebounds with a global economic recovery, I think we're going to be right back on the road to $150-, $180- or $200-a-barrel oil.

There are global trends that could scupper that prediction, too, but I don't think those forces are moving fast enough to change the price trend over the next 10 years or so. (But I will outline those countervailing trends later in this column.)

The global recession wiped out roughly two years of worldwide demand for oil.

In April 2008, the International Energy Agency was predicting that global demand would hit 87.2 million barrels a day in 2008. That would have been an increase of 1.3 million barrels a day from the 85.9 million barrels a day in global demand for 2007.

By spring 2008, the IEA already saw a slowdown in the U.S. economy but didn't think it would significantly depress global oil demand that year.

The slowdown, however, turned out not to be limited to the United States, and in developed economies it hit hard enough to earn comparisons to the Great Depression.

Global oil demand fell to 85 million barrels a day in 2009, down 1.4% from 2008, and lower than in 2007. As of March 12, the IEA was forecasting that global demand will climb to 86.5 million barrels a day by the end of 2010. That would mark a total increase in global demand of less than 1% from 2007.

Before the fall and then stagnation in global demand for oil, the IEA was worried that global investment in finding oil, developing those finds and increasing production from existing fields wouldn't keep up with global demand and would send oil prices surging. The three examples that I cited in my column were Russia, where the oil ministry was predicting a decline in production for 2008; Nigeria, where massive corruption left the country's plans to double oil production laughably underfunded; and Mexico, where underinvestment in oil fields, including the huge Cantarell oil field in the Gulf of Mexico, had already resulted in an 18% decline in production in 2007.

Fast-forward to 2010: The IEA is worried about, you guessed it, underinvestment on finding oil and developing reserves. Global capital spending on those activities -- including spending on maintaining or increasing production from existing fields -- fell $90 billion, or 19%, in 2009. That decline, the IEA reports, was the first in a decade.

Three trends make this decline particularly troubling to the IEA:

  • First, the world's most deep-pocketed oil companies, the Western oil majors, are increasingly excluded from the most promising areas for exploration and development. National oil companies control access to those geologies but often don't have the capital to exploit them fully because national governments siphon off oil revenues to fund government budgets.

  • Second, the cost of finding oil continues to rise. Western oil majors have recently reported a rise in the drilling failure rate. Chevron (CVX, news, msgs), for example, reported that 35% of the wells it drilled in 2009 came up dry. In 2008, the rate was just 10%. More dry holes mean spending more money to find less oil. (For more on the dry-hole surge, see this post on my blog; registration required.) And more of the wells that actually find oil are in extremely challenging geologies. On March 11, for example, BP (BP, news, msgs) paid Devon Energy (DVN, news, msgs) $7 billion for assets that included Devon's stake in the promising Campos deep-ocean region off Brazil. The oil and gas in this region are under more than a mile of water and a thick layer of salt. Drilling a single well could easily cost $100 million. Energy analysts estimate that BP needs a price of $70 a barrel or more to break even on the assets it purchased from Devon. If break-even on new oil is $70, that would suggest that oil prices aren't about to drop under $70 a barrel in the future, right?

  • Third, the IEA estimates that output from existing fields will drop by almost two-thirds by 2030. The world is counting on oil from BP's deep-water wells, from Canada's oil sands, from Venezuela's tough-to-refine heavy oil deposits, and from new finds and increased production from fields in high-cost environments such as Siberia and the offshore Arctic.

Continued: What could slow oil prices?

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