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Editorial comment

At KBC Market Services we have been forecasting oil prices for 50 years. We have seen many periods of extraordinary volatility, but even our battle-hardened, crack team of analysts is astounded by what we have seen in the past two years or so, and the recent move by crude oil prices back up to US$ 80/bbl is another extraordinary development.

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From US$ 50/bbl at the beginning of 2007, prices surged to nearly US$ 150/bbl in the middle of 2008 before giddily sliding to US$ 35/bbl at the end of the year. Now we are back at US$ 80/bbl. Did we forecast this extraordinary move? Well, yes and no. Yes, we did forecast back in 2005 that prices would average US$ 65/bbl in 2009, which is roughly where we are today. So can we pat ourselves on the back? No, because we did not come close to anticipating the extraordinary turbulence in between. Mercifully none of our competitors got it right either. Why are oil prices back at US$ 80/bbl and where are they heading? First, in 2009 OPEC member countries removed 3 million bpd of oil from the market in an effort to place a floor under oil prices. Second, there are vast amounts of hot money looking for safe havens as investors flee weaker sectors of the economy. Property is one example where investors are bailing out and the financial sector doesn’t have too many fans either. Also, since spring time the US dollar has sunk versus the Euro by nearly 20% and against the Yen by 12%. So, where to put your money? Take a bow, commodities. Analysts believe that economic growth in Asia and the Middle East will remain strong for the foreseeable future; in Asia because there is so much more growing to do and in the Middle East because oil revenues are still robust. In 2009, major powerhouses such as China and India have essentially avoided the recession and GDP growth is strong; in China Q3 2009 growth was thought to be 8.9% versus last year. Developing economies are major users of most commodities and, on the basis of rising demand and the prospect of a safe haven for funds, investors have piled in. The result has been that most widely quoted commodities prices, including oil, have soared since 1 January. Third, it is believed that the worst of the oil demand collapse - the severest since the early 1980s - is behind us and from 2010 onwards demand will pick up sharply. This expectation has helped send oil prices up. But will the upward pressure be maintained? The answer is yes, probably. In saying ‘yes’ we acknowledge that oil demand will continue growing and by about 2013 the cushion of spare production capacity will shrink from today’s level of approximately 7 million bpd to approximately 2.5 million bpd. This last statistic is very important. In the first half of 2008 oil prices shot upwards partly because there was hardly any spare crude oil production capacity - about 2.5 million bpd as it happens. Each time there was a production shortfall (e.g. regular disruptions in Nigeria) or the threat of one (the nuclear war of words between Iran and the USA), the oil price would spike. In saying ‘yes, probably’ we hedge our bets because the actual trajectory of oil prices depends on how the world tackles the biggest challenge of all: will there be enough investment to make sure that new production capacity comes onstream to meet higher demand? The biggest barrier today to higher oil production is not dwindling reserves or a lack of fresh discoveries. The biggest barrier is access to reserves. Currently, those with the capital and the best technical skills to find and develop oilfields (the major oil companies) are not able to apply their resources in those places where the best oil prospects are. They cannot gain access for a variety of reasons (mainly political) to Iraq, Iran, Kuwait, Venezuela, Mexico, Russia and others. Elsewhere, there are insufficient tax incentives to invest (the UK is an example). If these problems are not solved at some point in the next five years, and arguably sooner, even the upstream successes seen recently in Brazil, the Gulf of Mexico and East Africa will be insufficient to offset depletion elsewhere. So, assuming that global economic recovery is underway and oil demand starts growing again, unless there is a major effort to find and produce more oil, we run a high risk of seeing oil prices returning to the levels we saw in mid-2008, and possibly higher.