Oil Price Predictions and Break-Even Prices

Includes: BPT, OIL, USO
by: Richard Shaw

The US Department of Energy “Annual Energy Outlook, 2008″ predicts that oil prices will decline to $58 by 2106, measured in constant 2006 dollars, in their most likely scenario. They predict real prices will rise from 2016 through 2030 to $72 in constant 2006 dollars.

Today’s West Texas Intermediate crude prices are about $93.

The Dept. of Energy is therefore predicting an approximate 38% decline in oil prices over the next 8 years.

Their short term prediction for 2007 back in 2006 was for crude to be around $57 — way off the mark.

An interesting perspective is the $30 break-even price for Saudi Arabia, as reported by the National Bank of Kuwait in mid-2006. The table below shows the break-even oil price for the Gulf Cooperation Council countries, showing an overall break-even price of $38.

Canada’s oil sands are the second largest oil reserves in the world. The largest oil sands syncrude producer is Canadian Oil Sands Trust (OTCQX:COSWF) which reports a current break-even cost of about $33 per barrel.

The table below shows the oil reserves of key countries. Note that the Canadian reserves are overwhelmingly oil sands.

Oil sands have not come into full productive capacity, but their cost is significant. Canadian Oil Sands Trust is a large, if not the largest, player in the oil sands / syncrude market. While their break-even costs are about $33, Kurt Wulf of McDep Associates recently reported that PetroCanada’s (PCZ) new oil sands project will have a break-even cost over $50 per barrel up from $25 per barrel five years earlier.

Given these break-even figures and the willingness of producers to fund projects with $50 break-even costs, we should not expect to see much in the way of long-term supply below about $40 or $50, even in low price scenarios.

The GCC countries have undertaken substantial development of their non-hydrocarbon economies. They depend on profits from oil to fund much of that development. They cannot afford to sell oil near cost and still support their non-oil development programs. Don’t count on sacrifice plays from Saudi Arabia or other OPEC countries. Oil is way up and we think it will stay well above break-even costs for a long time.

There were periods in the past when oil was cheap, but then OPEC was non-existent or weak, and there was no global rise of emerging economies. With China and India alone needing ever more oil to grow their economies, and the possibility of peak oil being here or near, we don’t see any long-term scenario other than high oil prices.

Regardless of your view of whether we have hit “peak oil”, the fact of rising costs of production is clear.

With rising break-even costs and no clear evidence of near-term abatement of geopolitical risks and fears, we find the price predictions by the Department of Energy to be difficult to believe. We hope they are right, but doubt they are right.

This is probably bullish for oil commodity funds such as (NYSEARCA:USO) and (NYSEARCA:OIL) and for oil royalty trusts such as BP Prudhoe Bay Royalty Trust (NYSE:BPT) and Canadian Oil Sands Trust.

On the other hand if the Department of Energy is correct about a slide to $58 per barrel through 2016, oil commodity owners will see significant losses.

We think the Department of Energy is too optimistic about prices coming down. They are energy experts and we are not. Nonetheless, we have to make our bet within our portfolio.