Oil futures curve shows $80 oil on the horizon

LONDON // Oil contracts for delivery far in the future have held stubbornly above US$80 a barrel in recent weeks, indicating the long-term trend towards higher prices remains intact. Oil's rapid collapse from a record above $147 a barrel in July to below $55 a barrel last week has offered some relief to consumers facing tight credit conditions and economic insecurity. But lower oil prices are likely to be short-lived, as the slow growth of global oil production and rising costs should see crude prices increase when the economy begins to recover.

"The back end of the oil futures curve is reflecting the long-term trend, not the short-term cycle," said Harry Tchilinguirian, a BNP Paribas analyst. "Long-dated prices have fallen, but much less fast than prompt prices. They represent the marginal cost of new supply, and reflect expensive developments like deepwater projects off the coast of Brazil and oil sands in Canada, but also higher costs of project finance as a result of the credit crisis."

Oil contracts for delivery three years out initially fell in step with near-month crude after it turned aggressively south in mid-July in response to the global economic slowdown. However, the pace of decline for contracts three years forward slowed markedly last month and has held steady above $80 a barrel so far this month. "What we're seeing is part of the longer-term bullish story for oil," said Mike Wittner, an analyst at Société Générale. "Things might even be worse as lower prices and the credit crisis has cut investment, meaning we're actually losing supply."

Oil's rally to nearly $150 a barrel was based partly on the world's struggle to pump enough supply to meet strong demand growth in rapidly developing economies such as China and India. Most investment banks predict the prospects for the global economy should turn for the better from about 2010, with the developing world leading the pace of recovery. Helen Henton, the head of commodities at Standard Chartered, said the bank was predicting an average oil price of $80 a barrel for 2010, compared with $60 a barrel next year.

"When you see the global economy bounce back with the emerging economies leading the way, we're going to see severe pressure exerted on oil supplies, especially now a lot of investment in the industry is being delayed," she said. "Given how volatile things have been lately, it is difficult to predict what will happen next month, let alone in several years time, but I imagine the oil price will hold around $80 a barrel for contracts three to five years out."

The big slide in fuel prices together with swelling stocks has driven Opec to call another round of urgent talks in Cairo at the end of this month, aimed at shoring up the market. Since early September, the oil exporters' group has already agreed to cut supply by two million barrels per day (bpd). Some members, including its second biggest producer, Iran, have called for a further supply reduction of 1.5m bpd.

But it is not clear whether Opec will take urgent action at the Cairo meeting, or will put that off until its regularly scheduled Dec 17 meeting in Oran, Algeria. Yesterday, the group's president, Chakib Khelil, told a press conference that he saw the November meeting as a brainstorming session that might formulate recommendations for action at the later Algeria meeting. "Our objective is to reach a price of $70-$90," he said.

Mr Khelil said not enough time has elapsed since Opec's last emergency meeting on Oct 24 to tell whether the cuts announced then would revive oil prices. "We do not know if that will be enough because most of the producers have not yet completely applied their reductions. Therefore we will know that in one month or maybe two months," he said. Mr Khelil also pointed to the future curve as an indication that prices were headed higher in the longer term.

But analysts said Opec may not have the luxury of time to proceed step by step in order not to over-cut. "The price has put a gun to their head," said Mike Wittner of Société Générale. Instead of focusing on Opec's determination to reduce supplies, the market's attention has fixed on the impact of the worst economic slowdown since World War Two on fuel demand and the resulting rise in fuel inventories. The flurry of Opec meetings may therefore be aimed at reinforcing the group's message that it is determined to act.

In the short-term, "anything could happen", Mr Khelil said yesterday, including a price slide to $20-$30 if oil supply and demand become further imbalanced. * Reuters