Last Updated on Wednesday, 10 June 2009 18:03 Written by Alan Callow Tuesday, 09 June 2009 06:57

In a recent article 'The Economist' warned that the downward pressures on oil prices were over and the return to oil price inflation had already commenced.

Between July and December 2008 the world saw the sharpest ever decline in oil prices.  The key factor behind this decline was the global economic downturn. Whilst this continues it should be expected that prices would continue to fall or at least stabilise at a low level for a number of reasons:

- Demand for oil continues to fall; the International Energy Agency (IEA), forecasts that global oil consumption will fall by 2.6m barrels (bbls) a day (around 3%) in 2009 (after a fall of 200 000 bbls/day in 2008).
- Oil stocks are high.  The USA’s oil stocks are higher than at any time since the run up to the 1st Gulf War.  Developed countries’ stocks cover 62 days’ consumption, the highest since 1993.
- Oil companies are pumping less than they could do - OPEC has announced three production cuts since September 2008.  Saudi Arabia alone says it could pump 4.5m bbls/d more than it is doing.

In spite of this picture of excess demand, the price of oil has risen steadily, increasing by more than 100% since its low point in February to over $68 bbl by 2 June 2009 with some analysts forecasting $75/bbl by the end of June.  The reasons for this increase are structural:

- The ‘easy’ oil has already been taken.  New fields are usually difficult to get at - both geographically and technologically.  Outside OPEC production fell even during the price boom of early 2008.
- Most new fields are smaller than their predecessors
- Just to  maintain current output a huge amount of new oil must be brought on line each year – the equivalent of a Saudi Arabia’s worth of oil every two years.
- The oil industry is short of equipment and manpower – a result of cost cutting in previous hard times.
- Unlike in recent price downturns, new kids are ‘on the block’  - China and India are already significant users and their consumption will only continue to rise.  Already China's economy is starting to grow again and demanding more oil.
- As soon as the global economy starts to grow again demand will rapidly outstrip supply and today’s stocks will be quickly run down.  In any case the global downturn, whilst deep may not be as prolonged as has been feared.
- The industry is cutting spending – forecasters believe that there will be a drop in investment of upto 20% in 2009 whilst there are over 30% fewer drilling rigs in operation compared to this time last year.

So whilst the world is in recession, oil companies have reduced investment and are putting pressure on suppliers to reduce costs.  These policies are short sighted.  The factors that underlay last year’s rise in prices have not gone away, they have just become temporarily dormant.  Whilst demand, and consequently costs, for drilling rigs has fallen now is the time to drill exploration wells in order to take advantage of the inevitable rise in oil prices that are just around the corner.