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Another price surge predicted

Enjoy cheap oil while it lasts – it’s heading up again

Oil priceSuddenly we are awash with cheap oil, the industry’s Christmas present to us all. It effectively equates to an unexpected tax cut.

Cheap oil means lower petrol prices – now below an average £1.20 a litre for the first time in four years – and airlines are considering lower fares. Other oil-dependent products should come down in price.

That’s the good news. For the North Sea it is devastating. Thousands of jobs will be lost as many of the already marginal fields become uneconomic and are mothballed or abandoned.

So what are the short and long term expectations for the oil price?

One wag joked yesterday that the independence-supporting Sunday Herald would today launch a Christmas appeal for readers to buy barrels of oil at $113 a barrel.

Ho, ho, ho. Of course, this is a reference to the White Paper which built an economic case around such a level. By Friday it was trading at almost half the peak price – $61 – a five and a half year low. And the likelihood is that it is heading lower – possibly to $43-$45.

Certainly, as I pointed out in a blog in October here, the SNP has to think hard about its economic policy. It used the higher price to expect revenue of £6.8 billion by 2015/16. That is now likely to be closer to £2.4bn.

Understandably, the SNP has gone quiet on the topic. However,  it ought to have a little more courage and force the argument back in its favour: oil prices are notoriously volatile and the indications are that the price will be on the rise again, maybe as early as the second half of next year.

Oil prices have fallen precipitously since the summer, 47% lower than in June, and as stated above the trend is for them to keep falling. Experts are now looking to a pick up so that the price could be back at about $80. This is still around 30% lower than the June trading figure, but at a level that operators would consider sustainable and aided by recent tax cuts announced in the Autumn Statement.

What caused prices to fall so quickly? First, the emergence of cheap oil alternatives, such as shale and sand oil which also helped the US become less reliable on oil imports. Second, a slowdown in economic growth in emerging economies.

Third, a glut of oil from the Opec nations who cannot afford to cut production because of fiscal deficits in their own economies. Higher output from more stable regions such as Iraq, Iran and Libya has also contributed to oversupply. Fourth, the imminent ending of money printing and the prospect of higher interest rates has turned investor interest away from commodities.

All of this was predicted. Forbes magazine was reporting in the summer that the price was about to crash. The oil companies certainly cannot claim to have been caught by surprise and will have been planning for this eventuality – including job cuts.

The price in fact rose – arguably – to an unsustainable level. After the crash of 2008 it leapt 140% as a result of booming economies in China and other emerging markets, low interest rates and depressed currencies. Without the boom in US production there was a view that the price could have hit $150 a barrel.

So what might cause the price to resume its upward trend? The easy answer is that the low price will prompt a burst in industrial activity and consumer spending, thereby raising demand for oil in countries that have flat-lined or slowed down.

Another factor is the impact of shale oil and gas, still a nascent industry with no track record. Some analysts are beginning to wonder if there is too much hype around the sector and whether it will prove to be a viable long-term source of cheap fuel. Once oil falls below $70-$80  it makes it less economic to produce and there is an expectation that some shale firms will fail.

Less easy to predict is monetary policy. Some debt-ridden countries may need to revert to money printing (quantitative easing), again depressing currencies and making oil a more attractive investment proposition.



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