$120/bbl oil

Eldon Ball • Houston

Several times a year, representatives of Deutsche Bank venture into the enigma that is Washington, D.C., to interview senators, congressmen, lobbyists, and the usual suspects regarding the current and probable future of the U.S. oil industry. Paul Sankey of Deutsche Bank then prepares an analysis for the bank’s clients.

We value them for the fresh point of view compared to their US counterparts. The latest is no exception, as we’ll illustrate in a moment.

But first we jump ahead to yet another analysis, also by Deutsche Bank – again regarding US oils – in which is buried unobtrusively a forecast for $120/bbl oil by 2012. Lest you miss the full impact of that prediction, we remind you that 2012 is next year.

That figure -- $120/bbl – is not so surprising now, in light of the protests occurring in North Africa and the Middle East, but remember that it was made weeks before any of those events occurred. It is based not on an anticipated disruption of supply, which may or may not happen, but on change in the supply-demand balance based on evolving economic conditions. If supply disruptions occur – and that seems a real possibility – then the effect on oil prices will be much more dramatic, though possibly short term.

Train wrecks and sharks

A full discussion on how Mr. Sankey reaches that price lies ahead in this column, but first, let’s look at what the bank researches found in Washington:

“In the bewildering frenzy of Washington, DC, politics,” they write, “you meet lobbyists, staffers, lawyers, and journalists who have huge areas of ground to cover, and not enough time. To simplify the point, they get vivid with metaphors. Without irony, happy post-election Republicans refer to “sunshine as the best disinfectant” in reference to the EPA. EPA regulation, the GOP/industry claims, is a “train-wreck,” and they show you a spaghetti regulation map (the EPA shows the same map, but with just three stops).

“The Democrats’ concession on offshore drilling weeks beforeDeepwater Horizon is described as ‘a child reaching for the cookie of an Energy Bill, and putting their hand on the burner.’ They won’t reach for the offshore drilling cookie again for a while…And so it continues. The metaphors are clear, but the conclusions are…we came away with little other than deepwater drilling in the Gulf of Mexico is massively delayed, beyond any previous thoughts.”

Deepwater delays

Note that their final and only clear conclusion was that deepwater drilling in the Gulf of Mexico “is massively delayed, beyond any previous thoughts.”

But if $120 oil is sailing into view on the horizon – and Deutsche Bank believes it is – can a return of offshore drilling be far behind? The answer is obviously in favor of increased drilling, since $120/bbl oil would translate into about $4/gal gasoline, which in turn would generate enormous public pressure to increase supply.

The question then becomes, how likely is $120 oil?

To answer that, consider how Mr. Sankey reached $120 as a near-term price (and incidentally, the “point of destruction” for US oil demand).

The report posits three developing market phases that will move to tighten supply:

• A drawdown of oil inventories at sea (held in tankers when prices and demand were lower)
• A drawdown of OECD inventories – a process that started in 3Q 2010
• A work-through of OPEC spare capacity until global demand growth equals OPEC spare Capacity (see accompanying table).