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Oil can fall to $50-$60 if credit stays tight
October 13, 2008 / 12:37 PM / 9 years ago

Oil can fall to $50-$60 if credit stays tight

By Richard Mably - Analysis

LONDON (Reuters) - World oil prices are likely to fall further if the rush to cash across global financial markets continues but crude is unlikely to dip for long below the oil industry’s $50-a-barrel average operating cost, analysts said.

Benchmark U.S. crude has fallen 45 percent from July’s record $147.27 a barrel to trade at $81 a barrel Monday after settling at $77.70 on Friday, its lowest close in 13 months.

“We believe the deepening banking sector crisis and the significant slowdown in global growth that lies ahead will continue to put downward pressure on commodity prices,” said Deutsche Bank in a report released on Friday.

“A combination of fear, de-stocking and disruptions across the supply chain owing to frozen credit markets is currently depressing oil demand far below where underlying economic fundamentals would suggest,” Goldman Sachs said on Monday in a note to clients.

Goldman said it expected crude to average $75 in the fourth quarter and end the year at $70, but added: “Should the financial and economic crisis cut deeper into demand, the market could fall as low as $50 a barrel.”

That is the price threshold that is widely considered to be the average operating cost, or “cash cost,” for the world’s oil major oil companies.

The average cost for the most expensive new projects -- known as the marginal cost of production -- is about $75-$80 a barrel, according to London-based analysts Bernstein Research.

“In the long run we continue to believe that oil and gas prices will trend up in line with the marginal cost of supply,” said Bernstein.

“However, prices should continue to cycle between the cash cost at the bottom, $45-$50 a barrel, and the price of demand destruction, $110-$125 at the top.”

An economic slowdown could reduce the cost of new supply by cutting the price of steel, energy and rig hires, reversing some of the rise in production costs of the past 5 years.

DEUTSCHE BANK SAYS $60 “CHEAP”

While oil prices longer-term are likely to find support from the cost of bringing new production onstream, near-term prices remain hostage to frozen credit markets.

“Sure, we’re at the marginal cost of supply, but if equity markets continue to fall it will be hard for oil to resist further price declines,” said Gary Ross, CEO at New York-based energy consultancy PIRA.

Deutsche Bank said oil was still more expensive in real terms, allowing for inflation over the 26-year period to 2008, than other commodities.

“We find oil prices would need to fall to $35 a barrel in order to bring prices in real terms back to their long run historical averages. However, we believe that important changes in the market especially the geographic location of marginal demand and supply suggest that $60 a barrel represents a more realistic characterization of ‘cheap’ oil,” it said.

Unlike other commodities, oil has a producer group that can step in to support prices -- the Organization of Petroleum Exporting Countries.

“What makes oil unique among commodities is that there’s a backstop on the supply side in the form of OPEC,” said Ross.

OPEC’s ability to defend prices will be tested at an emergency meeting the producer group has called for November 18.

“We expect the organization to be more vigilant in keeping to quotas now that prices have slipped below $90 a barrel and to vigorously defend $80,” said Standard Chartered bank.

At its last meeting in September OPEC trimmed back production, effectively starting to defend prices -- albeit only cautiously -- at $100 a barrel.

Now OPEC price hawks Venezuela and Iran are pushing for a more aggressive move.

Caracas is estimated by Deutsche Bank to need $95 a barrel to balance its current account.

Leading producer Saudi Arabia needs $55 a barrel, Deutsche says.

The level of prices that Saudi Arabia would seek to defend is of huge interest to world oil markets but an issue that Riyadh has long declined to discuss.

While Saudi may find it politically uncomfortable to prop up prices as the world economy moves toward recession, OPEC may be able to justify a production cut because less of its oil would be needed as global fuel demand growth slows.

Editing by James Jukwey

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