Does the International Energy Agency Want Oil to Go Higher?

The economics of energy are not that difficult to understand. As with every goods or service, there is a relationship between supply and demand. This relationship and the shifting of supply and demand over time are responsible for movements in the price of oil. Recently, a barrel of crude has dropped by more than 75%, from the record highs in the high $140’s all the way down to the mid-thirties. Clearly, there has been a severe decline in demand in the economic downturn and prices reflect the overabundance of oil produced by projects undertaken when prices were sky-high. Now, in the appropriate reaction to this unbalance, suppliers are cutting back drastically as companies are slashing cap ex budgets and OPEC has reduced output continually - to little avail.

The International Energy Agency (IEA) said Monday that there was a serious threat of a supply crunch in 2010 when the global economy resumes its growth. The clear implication of said supply crunch would be that prices would spike, thus straining consumers and the broader economy. The Paris-based IEA’s executive director Nobuo Tanaka expects world oil demand to rise by 1 million barrels per day (bpd), or about 1%, in 2010 as growth resumes. The current investments in place will not be able to keep pace with the new demand, as many wells are not profitable to drill for oil in the mid-thirties or marginally higher. Strangely, Tanaka does not want to see OPEC cut production again at their next meeting on March 15th, as CNN Money reports,

“The IEA chief urged the Organization of the Petroleum exporting Countries not to seek rapid rises in oil prices through further supply cuts as current prices are helping the economy.”

So, what exactly is the IEA advocating? On the one hand, he says we need to continue to produce more oil so that when growth resumes prices will not skyrocket. However, if oil producers continue to produce more than is necessary, price will stay low, and may go significantly lower. Many oil companies are struggling at current prices and it is necessary for supply to constrict when the price is this low. It would seem reasonable that the IEA would rather see OPEC cut production in an effort to raise oil prices again. If a short term cut in production from OPEC did in fact raise the price for crude, then more private and corporate producers would be enticed into the market. If they were successful in raising prices, then more investment dollars would be put towards exploration and when the economy does truly recover - there would be more supply to meet the growing demand. As many oil producing projects take time before they begin to actually produce, a higher price of oil now would likely make the spike in 2010 less intense.

However, the point is really moot because OPEC has historically been ineffective in enforcing production cuts, especially in this economy, when many oil producing nations are running budget deficits and need revenue. The fact that the IEA does not want OPEC to issue another production cut is at least surprising as the price of oil continues to drop. In order to reach equilibrium the world needs to either demand more oil or supply less; there really isn’t any way around that fact.

Comments

[john s. gordon:]

to the extent that lower production rates from existing wells are less damaging to the oilfield, perhaps there is a benefit. lots of stories going around about the decline of cantarell.
> jack

Feb 17 08:34 AM

[Ferdinand E...:]

The author of this article says that the economics of energy are not difficult to understand. That's funny, because when I was writing my last energy economics textbook I looked at the other textbooks that were available, and for the most part they were pathetic. Ergo, the students of that discipline must be in pretty poor shape.

As for the future oil price, the people who sell it more or less understand that when the international macroeconomy gets back on the rails, they are going to be in a position to rake in some big bucks. The question is, will they attempt to get that money before the international macroeconomy has been cured, because if they do a complete cure might be a long time coming.

Recently I was informed that energy is an important subject for voters in the US. Is it, because thus far the new government has failed to discuss a new (comprehensive) energy policy that will enable the US and other governments to deal with another ruinous oil price spike when the economy starts to come out of the present malaise.

By the way, a new energy policy does not mean antagonizing OPEC. They have an important role to play on the global energy scene, and as you have been told in your courses on game theory, if cooperation between oil sellers and buyers is possible, then it should be tried.

Feb 17 09:22 AM

[cjwirth:]

It is likely that the IEA knows what most studies indicate, we are at Peak Oil production now and on the decline. If OPEC cuts at the same time, we will have a double whammy and oil prices will go very, very high again. This would be followed by another severe economic downturn. This is not good for the oil industry, which the IEA represents. Clifford J. Wirth, Peak Oil Associates International

Feb 17 09:27 AM

[User 357446:]

It is just the opposite, there won't be any recovery until we see higher prices for commodities. We are loosing an awful lot of jobs in the oil and gas industry, as well as in the mining industry. Does that help ? Does that create jobs in the steel or car industry ? NO !

Feb 17 11:50 AM

[ROLEX18:]

To understand the Oil market, you have to live in Texas and trade on NYMEX.
Investors like what moves, when Oil moves down it will go down to 10$ when it will go up it will go to 200$.
But the real price for Oil depending on the country, is between 1$-50$.
With average about 20-30$, this is exacly it's long term average.

Feb 17 12:57 PM

[C.Wayne Borum:]

Why, I often wonder, doesn't anyone stop to think how this much talked about "Oil" gets here? My family is in the Oil business. We pay our bills, feed our children, and pay our taxes. When Oil goes down, we suffer. No one in the business wants prices to be too high. But when they are lower than the cost to produce it, there are many unseen faces that are wondering what they will do to survive. Its hard to squawk about spending $5.00 more on a tank of gas when you think of it in terms of someone eating or not. We are not Exxon, or Conoco, merely a small outfit that is the unknown and rarely talked about element in the "Oil" picture.

Feb 17 06:54 PM