November 13, 2008 / 4:17 PM / 10 years ago

How low can oil go? A lot lower, but it'll recover

LONDON (Reuters) - World oil prices could easily fall below $50 a barrel and might even slip toward $40 or perhaps $35, but they will recover and could do so fairly quickly, analysts and economists say.

Benchmark U.S. crude futures dropped to a 22-month low under $55 on Thursday as evidence mounted that the deepening recession would have a severe impact on demand, reducing the use of oil by industries and individuals alike.

Oil has now fallen more than 60 percent from July’s record $147.27 a barrel and is moving close to what is widely considered to be the average operating cost, or “cash cost,” for the world’s oil major oil companies around $50 a barrel.

Many analysts think the market is likely to fall further, breaching the psychological $50 barrier before recovering.

“How low prices go is rather random: $50, $40, $35? It could be any of those numbers,” said Kevin Norrish, analyst at Barclays Capital in London. “All we would say is that the lower it goes, the further out of equilibrium the market is headed.”

The oil price collapse over the last four months has reflected several factors hitting the market at the same time.

As the gravity of the global recession has become clear, economists have recalibrated their views of oil demand.

The International Energy Agency (IEA), which advises 28 industrialized countries, on Thursday slashed its global oil demand growth forecasts.

It says demand has grown this year at the slowest rate in a generation and next year it is expected to expand by only 350,000 barrels per day (bpd).

CONSERVATIVE

World oil demand is now expected to average 86.2 million bpd in 2008, rising to just 86.5 million bpd in 2009.

Some analysts say the IEA’s assumptions are too conservative and that a dramatic contraction in demand in the major developed economies will offset growth in oil demand elsewhere and produce a rare absolute fall in global demand.

Falling demand forecasts have led to widespread assumptions by oil traders that oil markets will be oversupplied.

The Organization of the Petroleum Exporting Countries agreed last month to cut its oil production by 1.5 million bpd from November 1 and many analysts think it will trim its output further.

An Iranian oil official said on Thursday OPEC members would meet in Cairo on November 29 for “consultation” on the market, a move which temporarily helped push up oil prices off their lows.

Rob Laughlin, senior oil analyst at brokers MF Global, says the market could begin to turn if OPEC, responsible for pumping around 40 percent of the world’s oil, trims production.

“Already some OPEC members are struggling to make money at these prices getting oil out of the ground,” he said. “Look at Iran and Venezuela where the costs are relatively high. These countries are seriously feeling the pain.”

Prices are already well below the average cost for the most expensive new projects — known as the marginal cost of production — at about $75-$80 a barrel, according to London-based analysts Bernstein Research.

David Dugdale, London-based energy analyst at MFC Global Investment Management, says future oil production could be curbed if oil prices fall much below $50 as many oilfields, particularly in sub-sea developments such as the North Sea, are more costly to develop.

OVER-REACTION

“If it goes to $50 or below you are going to see some supply reaction ... some cut in discretionary spending,” he said.

But the impact on supply will take time to be felt: “For example, the cuts by OPEC last month could take two or three months to work into the market,” he said.

In the meantime, the momentum appears to be downwards.

Driven short-term as much by sentiment in futures markets as rational calculations over fundamental costs for production, many analysts say the oil price is likely to go well beyond the level justified even by a dramatic fall in demand.

IEA chief Nobuo Tanaka said on Wednesday the price of oil was already “overshooting” to the downside: “The market is over-reacting,” he told Reuters.

Analysts liken oil price moves to a weight on a piece of elastic: most of the time it swings within fairly narrow ranges, reacting to signals on supply and demand and other news but occasionally a big shock makes it swing to wild extremes.

“Just as on the upside we went too far, so on the downside, we are going too far as well,” said Dugdale.

Most analysts see prices recovering fairly quickly in the next few months, according to a Reuters poll of 34 analysts last week, which produced an average forecast for WTI next year of $81.30 and almost $90 in 2010.

Barclays Capital sees the price for U.S. crude recovering to average almost $78 a barrel in the fourth quarter of this year and bouncing back to more than $105 for 2009.

“Whatever the low is, the price won’t stay there for very long,” Norrish said.

Editing by James Jukwey

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