At present, the attention of most observers of the international oil industry is firmly on the current price of oil and the prospects for an immediate price shock. There is much discussion as to the causes of the relatively high prices. These are clearly complex and controversial. There tend to be two schools of thought. One argues high prices are cyclical and arise from a coincidence of potentially reversible factors pushing in the same direction. Thus physical shortages as a result of booming demand and problems in Iraq and other producers combine with a bull run in the paper market. The other school argues that we are witnessing a fundamental structural change in the oil market reflecting insufficient investment over the last 10 years or so. The difference between the two schools is crucial. If current prices are cyclical in origin they will eventually go down, if structural they will stay high
Part of the argument from the “structuralist” school, is that the evidence for a structural change lies in the futures curve for oil prices.Between 1986 and 2002 the price curve fluctuated between $10/B and $40/B.Hoerbrt, the back-end remained stubbornly around the $18-21/B.range. However towardd the end it increased by over $10/B. Indeed. It was speculated then that to buy a barrel of oil in December 2010 will cost $34.70/B. However, as we know as a conseuence of the Iraq conflict the prices in 2-004-5 the prices reached the astronimical height of $70/B though they have now (in 2006)stablised around $57/BIt is argued that this signifies a fundamental change in view by the industry towards impending shortages of crude compared to the views of ample sufficiency which dominated the 1990s.Sellers of crude and the refiners wish to lock in prices to hedge price risk. Given these players and motives, trading so far into the future tends to be a fairly thin market with limited liquidity.There has always been a strong disconnect between costs of producing oil and the price of oil. This disconnect arises from differences in geology and the presence of market controllers – since the 1970’s OPEC. Thus the recent rise in prices reflects the industry’s views that oil supplies in the future will be significantly less plentiful than in the past because of too little investment and hence prices will be higher.
The rise in prices also concerns the practice of spread trading on the futures markets .Hedging price risk by users was the original function of commodity markets.If it is felt that the spread between the near and future price is too wide, ie the near price is artificially high, it pays to sell paper oil a couple of months ahead at the near price and then buy paper oil several years ahead at the future price.part of the explanation of the rise in back-end prices is a growing belief in impending shortages, it is worth speculating on why there has been this apparent change of view. One possible explanation for the change is that the “depletionists” have finally found an audience who believe their view of the future. The “depletionists”, who have been around for a long time, have been arguing that the world is running out of oil as reserves are depleted.
It is generally agreed that a great deal of money needs to be invested in exploration, development and production to sustain an increase in crude oil supplies for the next five-to-ten years at least. The IEA estimated earlier this year that some $2,188bn would be needed to be invested in exploration In many cases, the national oil companies in the major producers are being starved of funds. Governments are increasingly suspicious of their behaviour and in any case have locked themselves into a high spending world where they need revenue for other things and investing in new capacity which may bring down prices makes less sense. The national oil companies may not be able to fill any gap arising from the major companies’ unwillingness to invest.As a result, investment in new mines was restricted; shortages began to emerge as the demand for minerals increased sharply from the rapidly expanding economies, especially China and India. As prices and profits rose, the companies decided they rather preferred this higher priced world and decided not to invest too much in new capacity for fear of reverting to over-supply.
2006-11-14 22:07:23
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answer #1
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answered by Prabhakar G 6
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