Shocking as it sounds given the meteoric rise of the past few years, oil prices are back to where they were more than four years ago. This puts that back down below the price at which many oil projects, let alone renewable energy projects become uneconomical.

So what does this mean and where are prices likely to go in the near and long term?

Now that oil Demand has gone down, bringing prices down with it, the opposite phenomenon occurs: Supply destruction. Current prices are too low for the development of many oil reserves, especially those on the fringe of technology. The perfect example is the sub-salt layer reservoirs identified in the Santos Basin off Brasil. A recent study by Deloitte pointed 90 $/barrel as the break even for production from these fields. An optimistic figure possibly, given that as indicated by Brazilian scientists last year, the technology for doing is so is yet to be developed.

With time, new projects needed to offset aging fields won’t be there, either because of lack of exploratory activity or lack of financing. Even healthy fields can become unprofitable and be mothballed or abandoned. Supply will go down to the point it can’t fulfill Demand any more at low prices, the cycle will be closed and a new “boom” phase will unfold with corresponding spikes in prices.

Predicting when this new cycle will start is anything but easy, and is made even more difficult by unpredictable monetary policy shifts. Looking at the present futures market, it doesn’t seem like an oil price rise is due anytime soon.

The impossibility of predicting long/mid term oil prices is a serious problem for governments and businesses planing ahead. If a steady increase in prices was the outcome, business would be able to plan ahead, for instance hedging on the futures market. Instead, these unpredictable price swings are very disruptive. Taking the example of an airline company, if it plans for a high oil price and prices go down, it will likely loose competitiveness. On the other hand, if it plans for a low price and it happens to go higher, the company will lose profits and eventually have financial difficulties. If Queueing Theory applies fully to the oil market, prices are effectively impossible to predict in the long term, guaranteeing losses to all airline companies.

So the likely future outcome is two scenarios:

1. A “bust” phase permanently erases an important part of Demand.
2. A “boom” phase eventually takes place supported mainly by alternative energies.

Via The Oil Drum