I read sports for a radio station for the blind each Thursday. I was listening, as usual, to Bloomberg radio in my car while on the way. I caught the tail end of a conversation in which a guest was apparently trying to explain the difference between a copper mine (a multi-billion dollar, multi-year project) and a shale oil well ( up and drilling for cheap in a month or two). This came as a revelation to the show’s hosts. Part was probably showmanship, but it also underlined to me how little knowledge about mining and basic materials industries survives on Wall Street.
A basic rule of any commodities business (regular readers will know I spent six years as an oil and mining analyst and another couple managing money in stock markets with large commodity exposure) is that in times of oversupply the price only stabilizes when it falls (and remains) below the out-of-pocket costs of the most expensive producers. The bottoming process may take a surprisingly long time. That’s because producers may choose to operate at a loss for a while, if the costs of starting up again are high (think: blast furnace steel) and the oversupply is perceived to be temporary.
–In the case of oil, Saudi Arabia is doing all it can to convince the world that the oversupply is not temporary. That’s one worry out of the way.
–The consensus belief is that the floor is around $40.
Presumably this information is being factored into today’s stock prices. Therefore, it isn’t so interesting.
The better question, I think, is how high the oil price might go once high-cost supply has left the market.
For a base metals mining project, reassembling a crew + machinery to restart a shuttered mine is expensive and may take half a year. And certainly no one is going to begin to develop a new mine until price visibility is very high.
For shale oil, on the other hand, startup might only require a handful of people and maybe a month. In addition, if I thought I could get, say, $70 a barrel for my oil a year or two down the road instead of $45 today, I’d deliberately pull at least some of my wells out of production and wait–assuming I had my debt repayments under control. For that portion of my output, I’d be ready to turn the spigot instantly.
I don’t know exactly what price level triggers a return of shale oil to the market, creating potential oversupply again. But production will return very quickly.
The trigger is clearly not as high as $100. If I were analyzing oil companies for their rebound potential, I’d hope for $70 but base my figures on $60. The analysis itself would tell me whether $60 is high enough.
My general conclusion, though, is that oil isn’t going back to the levels of a year ago for a long time.
The best petroleum economists in the world are in OPEC. It’s impossible that Saudi Arabia doesn’t know with much greater precision what I’ve been writing about. Why should it be talking of oil at $100 or $200 in the near future?
Maybe for public consumption at home. A more devious mind would suggest it’s to persuade lawmakers in the US, the most profligate user of oil, not to take the sensible course of raising gasoline taxes and thereby tempering future demand increases. The country’s lobbyists are doubtless hard at work in Washington, as well.