A Long-Term Oil Price Forecast
Authors: Adelman M.A. 
Published: December 2007

Governments have been taking oil companies at their word --- that prices are increasing, that oil is becoming more and more scarce - and have taken steps to protect themselves accordingly. In gambling away part of the energy market so as to keep most of it at higher prices, the industry may have lost. Some fresh thinking undoubtedly is in order.

Introduction

This forecast relates to the world oil market outside the U. S., and covers the next 15 years or so; what happens after that has such a low present value that ignorance of it can be borne. A change in U. S. import policy, which we do not consider, would not make policy, which we do not consider, would not make much difference, in my opinion. The forecast must be in four steps:determine what the price would be under purely competitive supply and demand;project the price into the future;look at interference with supply and demand, most especially the role of governments; andtry to predict the future of this influence. Needless to say, the reliability of the forecast declines at each step.

Supply and Demand

Supply and demand are united by the concept of incremental cost: the cost of maintaining and increasing output. The oil producing industry at any time is an array of reservoirs, some already exploited, others known and awaiting development. Output is increased by drilling more wells than are required to maintain the current rate of flow - that is, over and above the minimum required new wells and workovers. The higher the rate of output at any given time, the more the pressure of expansion is exerted on all known reservoirs, and the more development must be extended by reaching into higher cost reservoirs (Fig. 1). A fair approximation to the incremental cost of the whole oil production system is the cost of expanding output in the highest-cost pool needed to meet the demand for any given quantity.

Output, incremental cost and price form a mutually determinate system. None can change without affecting the other two. Price and incremental cost tend to equal each other. A surge of demand means that at any given price more can be sold than previously, or that the same amount will fetch a higher previously, or that the same amount will fetch a higher price. The demand curve of Fig. 1 shifts to the right. price. The demand curve of Fig. 1 shifts to the right. The higher price makes it worthwhile to produce more, at somewhat higher cost. Contrariwise, less demand means a leftward shift, which pushes down costs and prices, It makes no sense to say that costs determine prices, or vice versa - competition keeps them close together. In the highest cost unit, operation is barely worthwhile. More efficient units draw larger profits. Less efficient units lose money and drop out. In the principal producing area of the Middle East-North Africa, we need consider only the costs of the big five: Iran, Iraq, Kuwait, Libya and Saudi Arabia. Some smaller areas (notably Abu Dhabi) are as low cost or lower. Those with higher costs are simply not needed today. They stay in operation because - to anticipate - the price is more than enough to keep them going also.

JPT

P. 1515