Not only are the current oil prices, hovering between $65 and $80 per barrel, sustainable in the short-term, going by the recent developments they could touch $100 in the longer term, according to analysts.

"Long-term prospects look a lot different, with all market fundamentals pointing towards oil at $100 and more," Philipp L Lotter, Senior Vice-President, Corporate Finance Group at Moody's, told Emirates Business.

"Tomorrow's oil will be more expensive to find and produce, thus leading to much higher break-even levels for producer countries, and significant investments are needed to extend reserve lives, develop deeper, high-pressure reservoirs and tap into non-conventional sources, such as oil sands," he said.

"This will be exacerbated if important investments in longer term supply are shelved and thus lead to shortages in a recovering global economic environment.

"Our current forecasts see oil at [one-month WTI crude] $77/bbl in Q1 2010, $75/bbl in Q2 2010, $82/bbl in Q3 2010 and $90/bbl in Q4 2010," said Manqoba M Madinane, Commodities Strategist at Standard Bank in Johannesburg, South Africa.

"We are closely watching both DOE and US API crude and refined product inventory for signals on demand-side changes," he said.

Analysts are pointing to the demand from big oil-consuming nations in Asia, which can push up the price of crude. Of late, the growth story in China and India has given hopes of a renewed demand.

"If oil needs to break out above $100/bbl, it will need the help of demand resurfacing, especially from China and India. That depends on how soon world growth is going to fall in place. I don't think we have enough clarity on that yet," said Raghu Mandagolathur, Senior Vice-President-Research at Kuwait Financial Centre (Markaz).

"We still believe China is still an important factor to watch for," Madinane concurred.

Paul R Kleindorfer, Professor of Sustainable Development at Insead in France, maintains the current oil price is likely to see increases over the next few years as economic activity begins to swing back to full recovery.

"This is because the basic driver of crude oil prices is the level of economic activity. Add to this the fact that the industry supply curve is not likely to show much movement (though demand will grow) because making new discoveries and tapping existing reserves at greater depths will be more costly," he added.

"The average price is expected to be in the $70-75/bbl range in 2010 in line with expectations of a global recovery. Long-term outlook for oil prices is probably higher. Demand is expected to rise as recovery gets under way and supply is also expected to rise from Opec, but will be muted from non-Opec producers," said Giyas Gokkent, Chief Economist at National Bank of Abu Dhabi.

"The US dollar also remains an important risk factor for the oil price. The average five-day rolling correlation between WTI crude oil and the trade-weighted US dollar is at -45 per cent since the beginning of October [it climbed as high as -94 per cent on 15 October]," said Madinane.

"In the long run, there will be a balancing act between carbon prices and supply-demand dynamics in the industry. Traditional oil has reached its peak in terms of discoverable reserves, and it is this fundamental reality of peak oil and the growing concerns of climate change that has already launched the long phase-out of oil as the primary energy source for the world," said Kleindorfer.

However, shorter term forecasts remain subdued. "Current oil prices of about $70/bbl seem to be at a level at that both producer countries – in particular Opec – and consumer countries feel are fairly comfortable," said Lotter.

"They are also largely representative of a weaker, though gradually recovering, global economy. The short-term outlook for oil prices will be correlated with the speed of global economic recovery, particularly in Asia. Suppressed and only gradually recovering demand from the large consumer countries and fairly high inventory levels are likely to see oil prices remain in a $50-80/bbl band throughout this period of uncertainty."

Gokkent sees oil holding its ground but said the average price of oil will definitely be lower than 2008 – when it broke all records.

"The price of oil has been hovering roughly in the $65-75/bbl range in the past few months. Price is expected to remain at the top of this range for the remainder of the year. This will mean an average price of about $60/bbl in 2009, down from $94/bbl in 2008," he said.

According to Mandagolathur, "Structurally, oil has moved to a different band of $50-$70/bbl for the long-term from an earlier band of $20-$30/bbl".

The current run up in oil, he believes, is more due to the dollar factor than the demand-supply factor. "It is still not clear as to what the dollar premium is on the oil price. The depleteble state of the resource, lack of progress in alternative energy and political tensions surrounding major oil producers will all contribute to increasing oil price in the future," he said.

Jeff Currie, Global Head of Commodities Research at Goldman Sachs London, differs in opinion and believes that, "oil prices are poised to move higher, with the catalyst likely to be evidence of rebounding diesel demand. The normal Christmas retail seasonal effect suggests we should see a rebound in diesel demand to restock shelves".

"We maintain our end-of-year price target of $85/bbl. However, should demand not materialise by early November, we would likely revisit our assumptions behind this view."

"In the medium term, say three to five years out, one can expect some moderation in the growth rate of oil prices as alternative energy supplies, triggered by current low-carbon initiatives, begin to take greater traction. New supplies from coal liquefaction and from tar sands could also play a role in moderating upward movements of longer-term oil prices, playing the role of a backstop technology," said Kleindorfer.

The current level of oil price, although sustainable, is still buoyed by speculation in the wake of clear economic recovery, said some analysts. "I do not think that the recent rally in crude oil prices is in line with global supply/demand fundamentals, so from that perspective we could argue that WTI crude oil at the current $77-$80/bbl are overvalued," said Madinane. "There is still a large crude oil supply overhang in the US market and the recent rally in crude prices has been closely linked to dollar weakness (so there are fund flows coming into oil as a result of investors cross-hedging their dollar exposures) and also large draws on petrol inventories that have sparked investor optimism over a possible US crude oil demand recovery.

"Also, according to CFTC data, speculative net long positions for WTI crude have been steadily rising – a signal that there is a speculative premium in the current oil price."

On short-term price levels, Madinane said: "I'm still pricing in fair-value for WTI crude oil at $71/bbl in the short-term (a one-month horizon), so would expect a short-term correction – assuming the dollar stays within the current range. However, further dollar weakness could see oil finding support at the $80/bbl level, preparing crude to target the $90/bbl medium- to long-term resistance."


Fundamentals to sustain current price levels

At this stage of the economic cycle, and with the oil market reasonably balanced thanks to Opec action, near-term oil price movements have been in-line with the wider market and general economic sentiment.

The oil price has risen to $80/bbl more in anticipation of a recovery than any improvement in demand. We expect the fundamentals of supply and demand to tighten from this point onwards, sustaining current price levels.

Whereas we anticipate much of the lost demand returning in 2010, the missed investment in supply will have permanent consequences. We anticipate Opec spare capacity tightening in the short- and medium-term and the price to rise further. Our longer term view remains unchanged: the world is short of energy supply, pent-up demand in the developing world is overwhelming, and we do not believe it will be long before we return to a market as tight as that of late 2007/early 2008.

The key drivers are the twin fundamental factors of supply and demand, the supporting role played by perceptions of a weakening dollar and high inflation expectations. – As told to Emirates Business by Giles Parkinson, Global Research Analyst, specialising in oil and gas at Newton, an asset management boutique part of BNY Mellon Asset Management from the UK.

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