Carlo's Think Pieces

Reflections of a Filipino in the Netherlands

Oil Price may drop to $10/barrel

Posted by butalidnl on 14 December 2015

Last year, I posted a blog Oil Price will settle at around $35 predicting that oil will stabilize (on the medium term) at $35/barrel. On 14 December, the price of Brent oil was below $38/barrel. So, will the oil price finally settle at $35/barrel? Yes, but not right away. The nature of markets is that they tend to overshoot equilibrium points. Thus, the price will probably overshoot downwards; resulting in short-term prices well below equilibrium.

The limits of this is determined by cost. The average cost of producing oil is $35/barrel – with $25 as the price of development, and $10 the price of extraction.  The costs differ, based on the particular method of producing oil. Land-based shallow wells cost less than $25/barrel to develop; and also less than $10/barrel to pump. Deep-sea wells cost $50 or more to develop, and $10/barrel to pump. Oil from tar sands cost very little to develop, but $50/barrel or more to extract.

The present situation of every producer pumping as much oil as they can would mean that the price would continue to drop below $35 (at least in the short term). Since production from existing wells continue to be profitable (i.e. the price of the oil is higher than the marginal cost of production); owners of those wells will continue pumping oil. They will do so until the price reaches $10/barrel,  the point where it will be more profitable to stop producing (for a large number of wells).
This means that, in the short term, the oil price could reach as low as $10/barrel.

This is only for the short term, however. After a while of oil at extremely low prices, when little or no new wells are drilled; the total oil produced will decrease because the depletion of existing wells is not compensated by production from new wells. The lower production will drive prices up, until it reaches the point where it would again be profitable to drill new wells.
Thus, the price will gradually rise, until it finally would stabilize at about $35/barrel.

In the long term (more than 5 years), the average cost of production would inevitably increase, as cheaper sources of oil get depleted. Thus, more and more, deep-sea wells and tar sands will take on a bigger proportion of the total oil produced. This will raise the average cost of production, meaning that the equilibrium point will rise.

In short, here are the projections for the oil price:
– short term (6 months to a year): as low as $10/barrel
– medium term (2 to 5 years): stable around $35/barrel
– long term (more than 5 yearsr): price will rise gradually, reflecting rising average production costs.

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