Where Is Oil Headed?

Oil's surge to near $70 a barrel has stoked fresh debate about what's driving the market -- and where prices may be headed if the economy is turning up. Edward Silver, a former Times staff writer who keeps a close eye on the energy market, offers some context on the latest price action, and the global supply/demand equation:

The world consumes 30 billion barrels of oil a year. Without it, our food doesn’t make it to the supermarket and our flights to Hawaii are grounded. Too bad the price is set by such a moody bunch.

Crude gained 3.2% to $68.44 a barrel in futures trading last week, but prices seesawed along the way. Again, bulls won the tussle. An $85-a-barrel yearend forecast from Goldman Sachs and more hints of economic recovery -- including surprising strength in Chinese manufacturing -- overshadowed flush oil stockpiles and other dismal data indicating a weak appetite in the United States, which still devours almost a quarter of global output.

Even before the economic signs turned more encouraging, oil was sizzling. Prices have more than doubled since crude visited the low-$30s in February. The falling dollar has helped, as some investors have turned to raw materials as a hedge against the greenback's slide.

Clearly, instability is in the DNA of our primary energy source. Only a year ago, oil was on an epic ascent, driven by exuberant traders to a peak of $147 a barrel in July. The industry was vilified. Priuses were sold out. Some analysts set targets of $200 a barrel.

Yet in short order, the recession and credit crunch rewrote the script for the rest of 2008. Those traders turned morose, vaporizing almost 80% of the commodity’s value in five chaotic months. Big oil companies and the petrostates of the world have been grappling with a surplus and paring production to shore up the market.

Demand for crude, however, is considerably less volatile than the price. Even as the rally unfolded this spring, commentators often repeated the view that higher prices made no sense because use of the fuel had collapsed. But "collapsed" doesn’t describe a world market that will shrink a measly 3% this year to 83.2 million barrels a day, according to the International Energy Agency.

Though fewer Americans took long car trips over Memorial Day weekend, China’s 8-million-barrel-a-day habit will see a dent of only 70,000 a day this year, the IEA says. In fact, the Asian giant burned more oil this April than last April. And all those tankers filled with surplus crude that bearish observers point out? Combined, these floating warehouses hold just over a single day’s worth of global use.

Wall Street, bullish oil traders and the Obama administration all are betting that the U.S. economy will look better in the second half than in the first half, of course. In its mid-May report, the Energy Department assumes the beginnings of a recovery in consumption. It forecasts only a slight pullback in U.S. oil use this year, to 18.9 million barrels a day from 19.4 million in 2008,and an uptick in 2010.

Even if U.S. oil demand doesn't rebound -- and greener cars, biofuels and conservation measures boost the chance that it won't -- the action is in the developing world. Masses continue to leave the land for the cities, where they become bona fide fossil fuel consumers. Fortunately or unfortunately, entrepreneurs and governments are trying to make that status affordable for them. Tata Motors, for its part, intends to put India’s Everyman behind the wheel of its $2,000 Nano car.

An internal-combustion engine in every Asian garage? To put it mildly, that would more than make up for the gas Americans didn’t use over Memorial Day.

Where the crude will come from to satisfy these new wants is a puzzle. Most of the cheap and easy oil has been extracted. For much of this decade, when demand already was pushing the supply envelope, drillers ventured into fields and waters that required high expense and high technology to yield their riches. Now, many of those projects have shut down.

At the same time, OPEC has taken oil off the market, and some analysts believe worldwide drilling has dwindled more than 30% from a year ago. On the face of it, that seems out of whack with the modest scale of the current oversupply, and could worsen a squeeze in the years ahead.

Even a glut doesn’t change the nature of a finite resource -- just how fast it’s depleted. One reason oil companies journeyed to second-tier sources is that formerly prolific fields are drying up. The most spectacular example: Mexico’s relatively young Cantarell field. Only a few years ago, it provided more than 2 million barrels a day, but 2009 estimates have tumbled into the 600,000 range.

If the realities of geology are disturbing, geopolitics present another kind of risk. In Nigeria, a guerrilla war poses a chronic threat to exports, and saber rattling in the direction of Iran still dependably hikes the price of crude.

Thinking about the future puts oil's price swings in better perspective. Few commodities are as vital, and none are as problematic. (Does that make it priceless, or worthless?) To investors seeking a natural or "fair" value for the stuff, wake up and smell the exhaust: As a practical matter, there is none, largely because of all the uncertainties in the outlook. And if there were, the momentum players who rule this murky market would pay it no mind.

But this much seems clear: The move from $33 to $68 a barrel -- during a time of surplus -- offers just a whiff of what will happen when supply tightens up again. If the recession passes and scarcity sets in, the return of energy angst, here and around the globe, will make for giddy prices in the oil market.

Source - Los Angeles Times