What Happened to the Oil Boom?

Oil is slipping down to $50 a barrel. Will it keep declining?

What goes up must come down

It is amazing how short our memories can be. Just last summer, crude oil was trading at $77 a barrel. In five short months, the price has fallen more than 30%, and it now sits near two-year lows. Being heavily invested in the oil patch, I decided it was time to dig into the market fundamentals to find out if the oil boom is really over, or if the current weakness has created some blue-light specials in the oil patch.

Supply and demand

Pundits, politicians, and prognosticators have been talking about the tight supply and demand situation for the past several years. With the recent fall in prices, are we suddenly facing a supply glut? According to the International Energy Agency (IEA), the situation remains tight. The agency claims current world crude supply stands at 85.4 mb/d (million barrels per day), only 0.9 mb/d above demand, which is 84.5 mb/d. The IEA also projects demand growth of 1.7% in 2007, following slower demand growth of 1.1% in 2006. The American counterpart to the IEA, the Energy Information Administration (EIA), claims that world demand is running slightly ahead of supply.

One thing that has changed in the market is that spare production capacity has increased. Saudi Arabia recently announced that when it implements production cuts on Feb. 1, its spare capacity will have risen to 3 mb/d. This is up from the roughly 2 mb/d a year ago that the Saudis claimed as spare capacity. However, spare capacity in the remainder of the world is very limited, and even 3 mb/d represents only 3.5% of global demand.

For now, it appears that the Peak Oil folks will have to wait. Companies like ExxonMobil (NYSE: XOM) have been claiming there is no supply shortage, and that high prices would lead to increased production. Companies have expanded their drilling efforts in tough regions like the deep-water Gulf of Mexico, using drilling companies like Transocean (NYSE: RIG) and Global Santa Fe (NYSE: GSF). In the Gulf during the summer of 2006, Chevron (NYSE: CVX), along with partners Statoil and Devon, announced one of the largest discoveries in American history, perhaps as much as 15 billion barrels of oil.

Motley Fool