Crude Oil Prices-The Direction?

Abstract

Summary Through the mid-1980's, real crude prices should be flat to down, and thereafter increase at a rate equal to or less than inflation. This forecast assumes that free-world energy demand will he down by about 5% during that time period to about 106 million B/D [16.9 × 10(6) m3/d] crude oil equivalent (COE). If a compound annual growth rate in excess of 4% is assumed for nonoil supplies-to about 59 million B/D [9.4 × 10(6) m3/d] COE-the free world's oil requirements are expected to total about 47 million B/D [7.5 × 10(6) m3/d] COE in 1985–86, up about 3% from 1982's level of less than 46 million B/D [7.3 × 10(6) m3/d] COE. If these assumptions are correct, they suggest that supplies from OPEC will amount to about 68% of their productive capacity, or about 23 million B/D [3.66 × 10(6) m3/d] COE, down 26% from 1979's peak level of 31 million B/D [4.9 × 10(6) m3/d] COE. Thus, OPEC will have to exercise self-discipline to prorate itself and thereby be able to maintain price controls over its supplies without seeing the crude price rupture to the mid-$20/bbl [$153/m3] level. During 1973–80, the demand for energy per $1,000 real GNP declined in excess of 14%, after the real price of energy advanced some 30% in 1973–74, suggesting a price elasticity of -0.48 for the seven countries in the Organization for Economic Cooperation and Development (OECD), which consume about 68% of the world's energy supplies. The current uncertainties associated with conservation, substitution, efficiency, and the general economic climate raise serious questions as to what the level of demand for petroleum products will be when the western world regains its economic momentum after the current recession. At that time, we may have a better handle on the price elasticity of energy and the ultimate market clearing price for crude. Introduction Since early 1982, the oil equities have lost favor with investors because of what Wall Street perceives to be a rupturing of worldwide crude prices, resulting from persistence of OPEC in overproducing in spite of a declining demand. Whether the crude price ruptures (declines sharply in absolute terms), increases at rates equal to or less than inflation, or increases in real terms has enormous implications regarding supply/demand relationships, industry fundamentals, stock market action, and investment strategies. This paper expands on these issues in greater detail. The external factors associated with the geopolitics of oil also are discussed. Supply/Demand In an attempt to provide a potential supply/demand scenario for crude oil for the 1980–85 period, a price elasticity model for worldwide energy demand has been developed. It has been derived from our experience on the basis of the initial 1973–74 "oil shock" through 1980. The Appendix provides the details of that model and the derived matrix based on a declining demand for energy of about 4%, 8%, and 17% and for real worldwide GNP growth rates of 2%, 3%, and 4%. Briefly stated, the seven OECD countries (U.S., Canada, Japan, U.K., France, West Germany, and Italy), which consume about 68% of the world's energy, experienced during 1973–80 a 14.3% decline in energy demand per $1,000 real GNP. This occurred after real energy prices in the OECD countries increased by 30% during the first oil shock of 1973–74 and thus suggested a negative elasticity of about 0.48. In the 1979–80 period, the free world once again experienced an oil price shock, which increased crude prices in real terms by about 35%. A linear extrapolation of the 1973–80 elasticity to the most recent real price increase suggests that over the next 5 years demand for energy per $1,000 real GNP could decline by about 17%. To develop two other cases, I have arbitrarily assumed that the demand would decline by only 50% and 25% of the original extrapolation because the western industrialized world is further along on conservation, substitutions, and energy efficiencies. Also, the recent recessionary environment has contributed to the decline in demand. By making further assumptions as to growth rates in nonoil supplies (gas, coal, nuclear, and hydro) (see No. 5 in the Appendix), and deducting those nonoil supplies from the free world's total energy requirements, one can arrive at the following free world total oil requirements in million B/D in the 1985–86 time period. Real GNP Growth Demand (%) 2% 3% 4% (4.2) 42.6 47.7 53.0(8.3) 38.3 43.2 48.2(16.6) 29.5 34.0 38.5 By making additional assumptions about non-OPEC oil supply growth and Soviet oil exports (see No. 7 in the Appendix), we can also arrive at the following requirements in million B/D for OPEC crude. Real GNP Growth Demand (%) 2% 3% 4% (4.2) 18.6 23.7 29.0(8.3) 14.3 19.2 29.2(16.6) 5.5 10.0 14.5 JPT P. 811^