The Case for Cheaper Oil

By Steve Rosenbush As a general rule, average folks don't sit around talking about commodity prices. Few people can quote the price of aluminum, cocoa, or even gold. Oil is a different story, though. It's linked to the most emotional aspects of our lives, from hearth and home to national defense. Petroleum and its byproducts power our cars, heat our houses, and provide hidden ingredients in countless daily products, from plastic forks to paint.

Oil is lurking in the background whenever we talk about the Mideast, the environment, or debate SUVs. As a result, most people know that the price of crude spiked above $50 this year. And it's certainly common knowledge that crude's first progeny, gasoline, costs well above $2 a gallon at the pump. Ouch.

BULLS VS. BEARS. If $50 a barrel sounds expensive, how does $100 grab you? Some analysts believe the price could eventually shoot that high. Timothy Guinness of Guinness Asset Management told BusinessWeek Online that he expects the price to drop into the $30 to $40 range next year -- but soar to $100 by the end of the decade. He thinks that explosive economic growth in China will put enormous pressure on available supplies, driving the price through the roof (see BW, 11/15/04, "Oil: The View from a Long-Term Bull"). Crude oil is now trading at $47.

For every oil-price bull like Guinness, there's a bear like Tim Evans, senior energy analyst at International Financing Review. Like Guinness, he expects oil to drop to the $30-to-$40 a barrel range over the intermediate term. And looking ahead to the end of the decade, he expects it to finish in the same range.

"It's a huge difference [of opinion] based on a very, very different world view. If you believe that the geological depletion of oil is imminent, then you are looking at $100," he says. "If you don't believe that geological depletion is imminent, you arrive at a different conclusion. And I certainly don't think it's imminent."

THE SUPPLY SIDE. Evans says that while no one really knows how much oil is in the ground, he believes global supplies are unlikely to run out for at least 100 years. Big companies have proven reserves that are good for 20 years, he asserts. While growth in Asia is sure to push global demand ever higher, Evans thinks that the supply of recoverable crude oil is likely to expand. Here's why:

Economic pressure. There is a powerful incentive to find more oil. "Oil companies pride themselves on being able to find more oil than they use each year," Evans says. That's the only way that they can convince Wall Street that they have a viable future, thereby maintaining their stock prices at a decent level.

Low costs. The underlying cost of recovering oil is actually pretty low, according to Evans -- around $7 to $9 a barrel. Oil companies will sell it for $50 a barrel if they can, but they can still make a reasonable return on their investment by charging customers much less. Oil companies made money even when oil was selling for $12 a barrel in the 1980s.

Better late than never.Big Oil is in no particular rush to find every last proven reserve. They know they have enough to see them through the next 20 years. And it isn't a good investment to tie up capital now to find resources that won't be used for 30 or 40 years.

Technology: The biggest variable in the outlook for crude oil is technology. Improvements in exploration and refining technology will expand the idea of what recoverable oil is, according to Evans.

BOOSTING YIELD. Contrary to what you saw on the opening credits of The Beverly Hillbillies, oil doesn't come gushing out of the ground like a geyser. It's very rare to find a big underground 'swimming pool' filled with crude that rushes to the surface when you tap it, Evans says. In most cases, the oil saturates rock and sand, and it's difficult to extract. "It's not like a wet sponge," says Evans. "You can't just wring it out."

There are many oil fields where only 20% of the oil has been extracted, says Evans. If exploration companies can boost that yield to 30% or 40%, it will make a huge difference. And it appears that drilling technology is improving by the day, the same way computers and TVs keep getting more sophisticated.

Refining technology is getting better, too. Many companies focus on refining sweet crude oil, because it's relatively easy to process. But other companies are getting better at refining sour crude, which has higher sulfur content and therefore requires more time and effort to get into usable shape. As companies get better at refining sour crude, the supply of usable oil will grow.

DRIFTING LOWER. A catastrophic attack on oil-supply lines is always possible. But Evans thinks that's a reason, perhaps, to boost national oil reserves in the U.S. and elsewhere. "It's not a reason to keep paying $50 a barrel for oil," he says.

No one really knows how much we'll be paying for oil at the end of the decade. But there's a good argument to be made that the fundamentals aren't all that frightening. And given that oil prices are drifting lower, it looks like the market agrees -- at least for now. Rosenbush is a senior writer in New York. He also moderates BusinessWeek Online's political blog, Party Lines.

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