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Where Now For Oil?

By Ed Bowsher (TMFArkle)
June 13, 2006

Last month I wrote an article on my favourite oil share, Sterling Energy (LSE: SEY), in which I cited some upbeat analyst forecasts for the company. However, a couple of readers reckoned the forecasts were too optimistic because they were based on an oil price of $55 a barrel.

As I write, the price of Brent crude is $69, but I wonder if my reader-correspondents might be right. Could the oil price fall below $55?

Let's look at some of the bull arguments first. There's no doubt that oil demand has risen over the last five years. Figures from OPEC show that worldwide oil demand in 2001 was 77.2m bopd (barrels of oil per day); that number had risen to 83.2m in 2005 and forecasters expect demand of 84.6m bopd in 2006.

Bulls often argue that the rapid growth of emerging market economies -- especially China -- is a big factor behind the rising oil price. There's some truth in that; OPEC's figures show that Chinese demand has risen from 4.7m bopd in 2001 to 6.5m in 2005. What's more, Chinese car sales for the year so far are 68% higher than the same period in 2005, according to Guinness Atkinson and the country's road network continues to expand.

On top of that the Chinese government has recently allowed the domestic oil price to rise. Paradoxically, that may mean that Chinese oil consumption will increase too. That's because it's been hard for Chinese oil refiners to make a profit on imported oil until now. With the higher prices, China imported 19% more oil in May compared to a year earlier.

I'm not suggesting that China's overall consumption will rise by 19%. The country still meets more than half of its oil demand from domestic production.

Bulls also point to geopolitical instability. Not only is Iran a significant oil producer, its control of the Straits of Hormuz could make it very hard to bring out oil from other Middle Eastern countries. Then there's unrest in Nigeria and Iraq.

Traditionally, Saudi Arabia has always helped out in times of crisis by increasing its production. However, some observers think that the country's reserves are lower than the Saudis claim -- over-production during previous crises may have damaged the quality of the wells.

Matthew Simmons, a Texan banker, expounded this argument in his book, Twilight In The Desert. Simmons also pointed out that no "great" Saudi oil fields have been discovered since the late-60s. On the other hand, plenty of people think that Simmons is completely wrong. It's hard to know for sure as the Saudi government doesn't provide much detail when it publishes reserve figures.

There are some other decent bear arguments out there too. For starters, recent price rises in Thailand appear to be reducing demand. Fresh oil is being discovered in the Caspian Sea and West Africa.

And if oil prices stay high, consumers and governments may make greater efforts to reduce their consumption. Alternative energy programmes may grow faster too. I also suspect that Chinese economic growth may take a breather at some point in the next few years. All booms overheat eventually.

What's more, recent price rises may have had little to do with the balance of supply and demand. Instead they may have been driven by speculative demand from traders.

It's also worth noting that most forecasters appear to be reducing their predictions for demand growth for the next couple of years.

But what about $55?

If Iran does turn into a really nasty crisis, then the oil price will probably move higher. If the political situation stays unchanged, the price may well fall in the short-term. That's partly down to the evidence from Thailand and partly because I reckon the Chinese economy may falter.

So yes, it's possible that the oil price may fall to $55, but I can't see it going a lot lower than that. And over the long-term, global economic growth should mean greater demand, so I think the long-term trend should continue to be upwards.

I'm not losing any sleep over my Sterling shares.

More: Is The Oil Boom Over? | Oil & Gas -- Markets and Trends Discussion Board