Should Oil Be $40 or $70?

…Will oil drop to $40? Or go back to $70? Or $80?

There are no easy answers to this question, but let’s see if we can frame some of the issues. First, demand is going to increase over time as an energy-hungry developing world needs more and more energy. Take a look at this chart from the Bank Credit Analyst showing the percentage of global oil consumption that comes from China and India. It is going from the lower left to the upper right, and only slowed down during the slowdown in global growth around 2001 (a point we will come back to later).

Crude prices closed today at roughly $53, down considerably from the $77 of recent memory. Prices are down 10% over the last month. Why? Inventories are high and the northern hemisphere is having an unusually warm winter.

OPEC has cut their production and will likely cut again, as they would like to maintain prices closer to $60. The problem is that OPEC members cheat. It is one of the few reliable factors in the oil business. Much of the actual burden of production cuts falls on the shoulders of Saudi Arabia. They have done the work so far, but will it be enough? There is reason to think they might let oil prices drop even further in the near term. And here, I want to highlight some fascinating research by Ben Dell and his team at Bernstein Research.

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