Oil Prices : The New Reality

Everyone knows it: oil prices have gone through the roof. The price of benchmark crude rose 11% this year alone, to about $67 per barrel, before pulling back a little. But many in the industry have always figured that prices would sooner or later simmer down. As new supplies came onstream, traders figured, prices would drift back down to their long-term average, which for years was about $20 per barrel. This thinking still influences the big oil companies, who have held back from investing massively in new projects.

But the futures market is now sending a radically different, and disturbing, message. Until 2002, oil futures rarely moved above $20 per barrel, and by 2005 they still lagged current prices. But in the last year long-term futures prices have been soaring, reaching $62 per barrel for benchmark West Texas Intermediate crude for delivery seven years out. Paul Horsnell, an analyst at London-based investment bank Barclays Capital, says the markets are sending a message: "Whatever the long-term price is," he says, "it is not $20 per barrel."

Horsnell and other analysts believe a profound rethink about prices is occurring, and the world has to prepare itself for a long stretch of oil at $50 to $60 or higher. New reserves from non-OPEC countries aren't materializing. Countries with big reserves such as Iraq and Iran are either unable or unwilling to develop them. Spare capacity is a razor-thin 1.5 million to 2 million barrels a day, nearly all of it in Saudi Arabia. That's around 2.5% of world production, a very small margin for error. And it's even worse than it seems because refiners sneer at the heavy sulphurous crude oil that makes up much of the extra oil supply.

The rest of the oil patch is struggling, too. Year after year the growth of production in non-OPEC countries, where big international companies have focused most of their efforts, has been disappointing. Last year, despite a surge in production in Russia and Angola, non-OPEC output did not grow at all because of sharp drops in output in the U.S. and the North Sea fields off the coasts of Britain and Norway. At the same time, world demand grew by 1.52 million barrels a day. All of the excess had to be made up from OPEC.

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