Felix Salmon on his brand new RGE Monitor blog asks if $65 the new $30, and $50 the new $20. Some time ago, I observed that $55 could be reasonably taken as a floor for oil prices for medium term. Felix asks if there is a plausible scenario where oil prices could fall below this floor. Eric Chaney and Richard Berner at Morgan Stanley GEF think that there is a pretty good chance that oil might be heading down to the floor of $55 per barrel, and in case of an ultra cool scenario even further down.
Several pieces of news led us to consider a third alternative scenario. First, investments in alternative (to traditional oil) sources of energy, from bio-fuel in Brazil to sand oil in Canada without forgetting very deep oil, are soaring. Second and maybe even more importantly, the main bottleneck in the global supply chain, i.e., the limited capacity to refine heavy sour crude, might disappear faster than expected. In Saudi Arabia, two giants’ refineries are now firmly on track in Jubail, one by Aramco and ConocoPhillips, the other by Aramco and Total. Together, they will produce 800 kb/d from heavy grade crude oil. In India, our analyst, Vinay Jaising, expects the refining capacity to increase to 3.4 mb/d by 2009 from 2.4 mb/d currently. The bulk of the increase will be on account of two key greenfield projects:
1) Reliance Petroleum’s project to set up a 580kb/d refinery at Jamnagar, at an investment of approximately US$6 billion. The refinery is likely to be commissioned in 2009.
2) Essar Oil’s project to set up a 220 kb/d refinery at Jamnagar, Gujarat. This project has been under construction for some time now and is likely to be fully commissioned in January 2007.
According to press reports (Wall Street Journal, August 29), the Reliance-Chevron project could be completed before the end of 2008. We are not qualified to discuss these projections. But one thing strikes us: so far, major oil companies were very reluctant to invest in large greenfield projects, having had their fingers burnt by overly optimistic price assumptions made in the early 1980s. But several years of very high refinery margins and the emergence of new investors such as Reliance in India, or the ambition of states such as Saudi Arabia seem to have changed their views. In our ‘ultra-cool’ scenario, a combination of a longer-than-expected economic slowdown and unexpected increases in global refinery capacity could well send the price of crude where it was in 1999, in the aftermath of the Asian crisis. This is an outlier scenario, but history has taught us that the markets tend to under-estimate the reaction of economic agents to very large changes in relative prices.
This ultra cool scenario is built on top of a cool world scenario where supplies of crude and refined products increase, conservation accelerates, global economic growth slows down due to a US recession. IMHO, this is not an outlier scenario, and something that a lot of people should think about.