A $40 Bottom in Oil?

By Michael Kanellos

Oil prices are wallowing in the $65 a barrel territory these days, less than half the level crude hit this summer. It even dipped below $60 briefly. But the real number to think about is $40 a barrel, a former oil exec turned investor told me.

Why? $40 a barrel is the level that many Middle Eastern OPEC nations need to achieve to continue to fund their somewhat lavish public works and social programs, the exec estimated. Dubai, Abu Dhabi, Saudi Arabia and Kuwait aren’t cheap countries to run. The economic explosion in the past few years has caused a building boom in Dubai, which in turn has meant more public works projects. Some of the newest, smoothest pavement in the world can be found there.

Many countries also offer massive incentives to U.S., European and Asian institutions to install offices and facilities there. In Dubai, for instance, chip companies can qualify for tax holidays that last 50 years. Texas A&M, Cornell, Northwestern, Georgetown and Carnegie-Mellon have all opened satellite campuses in Qatar while NYU and MIT are opening campuses in Abu Dhabi. Building a school out of scratch isn’t easy. The hospital associated with Cornell’s medical school has an endowment in the billions.

Citizens often also tend to expect cushy, well-paying jobs from their home governments. Many governments are trying to phase out these programs, and hope that the universities will generate opportunities for private sector jobs in the region, but workfare-like employment persists.

OPEC nations probably aren’t too terrified of oil skirting the $40 a barrel level just yet. The current drop in prices has largely been caused by a decline in demand due to economic conditions and the bursting of the speculative bubble in commodities. It did not result from new oil strikes outside of OPEC or the sudden availability of cheap ethanol or electric cars. An economic turnaround, combined with a further dwindling of existing supplies, could perk prices back up.

Nonetheless, the outlook for oil producers is certainly less optimistic than it was a year ago and transportation technology continues to improve. So keep that number in mind.

Comments

[DVW:]

Funny, at $140, there were predictions of $225. We see how that ended. Now at $60, projections are $40. Yeah, maybe, who knows but the market. However, huge projections to upside or downside should be noted as they generally occur at turning points.

China and India have spent the last 10 years putting in massive highway systems. I wouldnt expect oil to drop to a chronically low level and stay for any length of time.

2008 Nov 05 04:54 PM

[blu:]

The pendulum has swung back to the low side and has clearly dropped prices below what we be seeing in the near future.

It will take a terrible world wide recession to keep prices below $80 for very long.
The screaming and gnashing of teeth at $147/bbl will resound again when the economies straighten out some. We have to find alternatives very soon.

The Dems will be throwing money at the problem and although most of it will be squandered, perhaps some good will come from it before we are bankrupt.

2008 Nov 05 05:18 PM

[wdhalgren:]

Makes sense to me. The world has a dwindling supply of oil and a booming supply of dollars. I hope it does go to 40, that would be the long term investment of the millenium.

2008 Nov 05 05:47 PM

[timToolTime:]

I would stick with the facts we control here in the US.
stocktruth.com/chart.p...

If Exxon is going down we know gos is not at the bottom right?

2008 Nov 05 07:27 PM

[bryanz:]

I don't necessarily think this is a projection that oil is going to $40. It's more like a expect-this-to-happen-...

2008 Nov 05 07:46 PM

[Dame Daxx:]

I read that Oil bear markets erase 75% of the gain, which would get us to $37, or close to $40.

2008 Nov 05 08:13 PM

[mrshihtzu:]

Your premise is right, but your price is too low. The Saudis generally have the cheapest oil, and they need $50-$55 not $40.

2008 Nov 05 09:06 PM

[logicalthought:]

Your "analysis" makes no sense. The price that an oil producer "needs" to run its government programs has nothing to do with where the price of oil will go. Assuming that worldwide demand plunges below production, the price of oil will fall until the market once again reaches a state of balance. No oil producer would "settle" for $40 if it had any control over the situation and, in fact, if demand falls off badly enough, they might pump more and more in order to make up the lost revenue, sending the price all the way down to the marginal cost of production. I'm not saying demand will necessarily evaporate to that degree; all I'm saying is that once there's a glut of oil, OPEC-- due to its own capital needs-- can kiss its pricing power goodbye.

2008 Nov 05 09:35 PM

[Steven Hansen:]

the price of oil depends on so many factors. the reason for the projections of $200 oil was on the now faulty premise that economic growth would continue. a $40 oil requires severe economic weakening around the world. although this is possible, only a few are predicting this much economic contraction.

there are other dynamics for oil. for sure it would be an economic stimulus at $40, but it would fuel expansion based on oil - and we would be back to where we are now in a few years as demand would outpace supply.

i think it is in our best interests not to have oil fall further.

2008 Nov 05 11:32 PM

[ChickenLips:]

I don't think it will fall below $60. OPEC will cut production faster than you can swipe your gas card if it does go below $60. Serious production cuts may even happen next year if the new administration gives credible tax breaks to solar/wind producers. Investors will probably sell their oil stocks and move the cash into solar stocks. This would make oil prices fall fast, but not if OPEC can help it.

2008 Nov 06 12:06 AM

[JohnniePhenom:]

I have a hard time believing oil will make it to $40, much less stay below $80 due to a few reasons. First you have the global demand aspect. Although the global economy has slowed, asia is still growing at ~7%, this region and the rest of the developing countries will require oil, coal, etc...as economies pick back up to continue economic growth and increased infrastructure development. The second being OPEC. you have a large discrepency in what the price is that countries need to, or are willing to, accept in order to maintain their economy and infrastructure. The above mentioned $40 maybe true for Saudi Arabia, Abu Dhabi etc...but it's probably closer to ~$50+ if anything (although Saudi Arabia is playing more of political game in regards to prices and demand destruction). But countries like Iran and Venezuela must have prices at $100+ a barrel to sustain their infrastructure as 95% of venezuela's export earnings come from oil and 85% of Iran's government revenue comes from oil (50% for gov't rev. for venezuela). On the complete opposite side you have quatar who only needs $10 a barrell to keep a positive trade balance (but this is also due to the fact they are sitting on one of the largest natural gas deposits in history and the possible formation of a natural gas cartel, plus they don't have much influence on oil prices). Next you have to take into consideration that oil is priced in dollars. As the valuation of the dollar drops the price of oil will tend to increase (generally the same inverse relationship seen with the dollar and gold). A decrease in lending and capitalization has caused the recent increase in dollar valuation, as the bailout money pours in there will be an increase in the supply of dollars in circulation resaulting in a decrease in the value of the dollar, which can inturn put upwards price pressure on oil......

2008 Nov 06 12:26 AM

[JohnniePhenom:]

ps. the price of $100 for Iran and Venezuela is what they "need" to maintain their economy not "have to have." that's why Iran wanted to cut production by more than 2.5million barrels a day....as logicalthought mentioned above supply and demand play the largest roles, so in attempt to manipulate demand and stifle destruction they decrease supply, but we'll see how long demand at it's current levels.

2008 Nov 06 12:37 AM

[Big Shaker:]

Myself, I really think Oil runs in tandem with the US. Times are Hard now, as long as they do, Oil will continue to follow suit as far as its price. Once the US economy improves, then so will Oil. For what it's worth??:)

2008 Nov 06 02:54 AM

[Big Shaker:]

My opinion, as long as the US remains in a down state, Oil will do the same. Once the economy here picks up, then so will the price of Oil. You see Both run in tandem. Afterall, those that produce Oil aren't stupid. We still remain the World's biggest consumers:)

2008 Nov 06 02:57 AM

[Timothy Stolz:]

What a mess we would find ourselves in with oil at $40 a barrel. How many oil drilling, service, tubular and transporting companies would find themselves holding worthless "future contracts for work?" There would be a shrinkage of investment dollars into new exploration that in and of itself, would create a shortage, eventually driving the price of crude right back up to where it would then become economically feasible to produce and refine.
My concern is that the opposite is likely to occur in the near term. The post above by JohnniePhenom suggests that the inflationary outcome of the influx of a hugh amount of new dollars into the worlds financial system could devalue the dollar causing the price of crude to rise. I think Johnnie is right.
And, another concern of mine comes from the words of Joe Biden...."He will be tested in his first six months" comment will likely ring true. I do not believe the Middle East is at all that stable and the Iran/Israel nuclear issue may very well come to a "head" early in Obama's Presidency. Just a hunch and I hope that I am wrong.
As wdhalgren said in his post....(this)(meaning oil) "could be the long term investment of the millenium."
I think oil will settle in the range of $62 - $72 until the market is "stressed" one way or the other.

2008 Nov 06 11:08 AM

[VSD:]

AT $48/b Saudis will start running a budget deficit. You will see bigger cuts in production as oil drops from current levels.

2008 Nov 06 12:09 PM

[bowman711:]

How low does oil have to go to bring about a 1973 type oil embargo by OPEC?

Let me tell you from experience it is no fun to sit several hours in line to get a few gallons to last you until you have another several hours to spen waiting in line.

2008 Nov 06 12:55 PM

[Urbane Gori...:]

Watch the dollar. Right now, when the dollar goes up, the VIX goes up. When the VIX goes up, oil and the market goes down.

jegan ;-)

2008 Nov 06 04:02 PM

[NOWHEREMAN:]

Good points all, a superfluous addition: Iran's Nuclear Reactor will be activated within 3 months adding who knows how much to their exporting capabilities. Iran's views
will be respected more than they are now.

Iran could export more, unlikely but possible.
Iran could export a lot less and still meet electrical requirements in the country, also possible.

But as the only Arabian Nuclear Power, there will be a shift of authority in the rest of the Gulf. IMHO

Where that leads in just a few short months, is my greatest concern.

2008 Nov 06 04:54 PM

[Socialism c...:]

"It did not result from new oil strikes outside of OPEC or the sudden availability of cheap ethanol or electric cars."

Well...that's not entirely true!! While the economic slowdown and demand destruction are big factors, there WERE big strikes by Brazil...and the bubble burst pretty suddenly when Bush revoked the executive order against offshore drilling and called for Congress to do the same legislatively! So big new oil finds and the possibility of expanded drilling DID play a part.

Also...hybrid vehicles like the Prius are selling like hotcakes -- Toyota could not keep up with demand during the $4/gallon months!! Quite a few people got rid of their SUV and went with a Prius -- think about it: if you go from 15 mpg to 45 mpg -- that means 1/3 the gas usage. And a whole lotta Priuses are driving around now.

Last but not least: as we ponder the price per barrel and where it will go -- let's not forget those countries (including China!) who subsidize the cost of gas!!

2008 Nov 06 05:52 PM

[Old Wizard:]

Lots of good discussion. I hope no matter what the price of oil in the near term, the US keeps its eye on the stategic ball. One can draw several very plausible scenarios whereby our energy supply is strangled by a hostile adversary or our current account increasingly negative balance stangles our economic system and our ability to make correct political decisions or both. The wake up call we got this year should convince us that we must develope an independent domestic energy supply with all the tools in our arsenal. this includes off-shore oil, nuclear, hydro, natural gas, hybrids, wind and solar. It's not our technology that is limiting us; it's the over constrained political decision process that limits both the timelines and in many cases creates prohibitive costs. The CAPE WIND project on Cape Cod is a cannonical case that the new Obama administration should study. Unfortunately, for this administration to remove the obstacles to progress in that case, it would have to reject its own political backers.

2008 Nov 07 09:53 AM

[http://www....:]

A little gauging this week at the pump but it has a little while further to go. I have noticed more cars lately on the read which will increase demand.

2008 Nov 11 12:41 AM

[A Peak Oil ...:]

One of the biggest reasons for the fall of oil is the liquidation of hedge funds at the end of '08. The redemptions were massive. All the media talks about is "demand destruction." This is but a blip on the timeline of oil w/ respect to Global usage. What we will hear about at some point "is supply destruction" which we all know has to be coming. One last thing to think about, there was a distinct reason oil ran up to 147$ and it was as simple as it gets. Economics 101. Institutional Investors represent today's mindset of get it while you can with the greatest greed possible. This situation will only exacerbate the problem with this finite resource. As Matt Simmons says, the Era of Cheap Oil will be over. Watch out, as someone said in an earlier post, this is the opportunity of a lifetime. DON'T MISS IT...I'M NOT!!!

Jan 10 01:10 PM