Tulsa World

Return to Story

What are the fundamentals of the crude oil market?

by: JOHN STANCAVAGE World Business Editor
Sunday, January 18, 2009
1/18/2009 2:43:55 AM

When oil rocketed past $100 on its way to $147 a barrel last summer, analysts frequently commented that prices "were not supported by the fundamentals."

Now, with oil trading between $35 and $50 in recent weeks, a few questions keep crossing my mind.

Do the current "fundamentals" support $40 oil?

What price do the "fundamentals" support?

In 2009, with the world a different place after an economic meltdown, just what the heck are the modern "fundamentals" of the energy market?

I called John Olson, the co-manager of Houston Energy Partners, for some answers.

Olson told me that the fundamentals of pricing haven't changed. They remain supply and demand, with additional forces provided by Mother Nature, demographics, and global politics and related tensions.

"We're going through a down cycle right now," he said. "Things will sort themselves out in the next few months or quarters."

One thing is clear: Huge price swings bring huge problems. That's when fundamentals fly out the window, replaced by optimism and greed, or pessimism and fear.

"No one in the world could afford paying $147 a barrel for oil last July," he said. "And, in a different respect, no one can afford $38 oil now. Oklahoma can't afford it."

Sky-high crude helped bring on the global recession, while cheap oil hurts the energy industry, Olson noted.

While the average consumer may not tear up over oil companies reporting lower profits, those businesses do need to be able to drill the wells that will produce tomorrow's gasoline and other products.

'Drilling already is being cut back," Olson said. "The situation is that we produce about 86 million barrels a day, but the rate of decline now is about 6 percent. So, that's five million barrels a day we need to replace."

Every year, that decline curve will get steeper, he predicted. And, it will be more costly to reach the newer reserves.

Along with supply issues, a glance at the other fundamentals indicates that sub-$40 oil may not be around too long.

Mother Nature, Olson said, will affect supplies at some point. The global population still is growing. China and other countries continue to add large amounts of infrastructure. And, the recession will end eventually.

"Also, the world remains a dangerous place," Olson said, noting that an incident could restrict output from large producers.

Oil futures traders seem to recognize these fundamentals, he pointed out. Oil on long-term contracts ranges from $63 a barrel for the full-year 2009 to $74 in 2013. Some analysts even have predicted a return to $80 to $90 oil by 2011.

Speculators already are beginning to circle like sharks. In fact, they are out in the water right now, swimming around huge tankers they've leased and filled with cheap crude, waiting for prices to rebound.

"Circumstances have created some of the strangest spending cycles ever," Olson said. "The market is going to be sloppy and messy for a while."

Just watch out for those fins.

Return to Story