Oil producers over a barrel

The sudden rise in the oil price on the eve of the OPEC meeting tells us a lot about future price trends for black gold (Oil hits six-month high, May 28).

And although metals fell last night, what is happening in the oil market has parallels in copper and other metals.

In simple terms the production discipline of OPEC combined with the looming long-term fall in oil output from major world oil fields means that although there will be major fluctuations in coming years, oil is most unlikely to collapse.

Indeed, although the US does not like it, OPEC and others have concluded that the world can stand between $US60 and $US80 a barrel without crumbling, so we are going to see strenuous efforts to get into the higher regions of that range. Unless there is a further collapse in world economies we could see the oil bulls emerge on the winning side.

And underpinning the oil price up-thrust is the failure to discover major fields to replace the giant middle eastern fields that are in gradual decline.

The biggest potential source of 'new' oil is from Iraq, which says it can more than double its output if it can attain a level of security to enable the $50 billion investment that is required.

Most the world's oil majors are jockeying for position in the great Iraq oil race and IF there is to be a big short-term rise in Iraq production, it will require considerable OPEC management to avoid another slump.

Nevertheless, leaving aside short-term considerations, it is actually important for the world that oil stay around the $US70- $75 a barrel level, because at that price there is encouragement for the multitude of new oil projects that are required to cover the falls in production.

When oil was in the doldrums last March oil consultants Cambridge Energy Research Associates warned that if the oil price remained below $US50 a barrel then the potential drop in production capacity could create a "powerful and long-lasting aftershock”.

Cambridge said that the global slowdown had forced oil companies other than Exxon and Shell to slash their investments, postpone or cancel expansion plans, and delay drilling in many corners of the world.

The Cambridge report said that about 7.6 million barrels a day of future oil supplies were "at risk” of being deferred or cancelled, including heavy oil and deepwater projects.

As reported in Business Spectator (G8 energy leaders urge stable oil prices, May 25) Italian oil company Enid's president, Roberto Polio declared that the "magic range" for prices which is high enough to spur investment without hurting the economy, was $US60-$70 per barrel. Edison CEO Umberto Quadrino says the magic range is $US60-$80 per barrel.

While in theory we might say that a price of $US75 a barrel does not harm the global economy yet is sufficient to attract much needed investment to avoid a price blow-out in three or four years, in practice we will see wild oil price fluctuations.

It's important to realise that the oil story is duplicated in copper and to a lesser extent in metals like zinc. If the price of copper had stayed at around the $US1.20-$1.50 mark for an extended period then the large number of projects already being cancelled or mothballed would have become an avalanche.

Like oil it would have then set the stage for an enormous price hike in a few years. The Chinese, who think longer term, have moved in and bought copper over and above their needs to create a stockpile. The Chinese buying boosted the price above $US2 a pound. This was a very important development for Australia and the world (A two-pronged recovery, May 5).

In a strange way it delivered a similar boost to the copper price as OPEC cutting production.

The good news for Australia is that whether it be iron ore, copper or oil, the tightness in supply and the willingness of producers to adjust output quickly when demand falls is underpinning the prices of our major exports. Moreover, global governments are basing many of their stimulus packages on metal intensive infrastructure projects. This again helps Australia and contributes to Alan Kohler's 'best kind of recession' (May 27).