Good news – the price of oil could be set to fall for a long time

published 16 October 2012

Since the early part of this century, the oil price has done very little but go up.

Apart from 2008, when oil plunged along with everything else, consumers have had little relief from ever-increasing energy costs.

Remember the days when $40 a barrel seemed ridiculously high for oil? That unthinkably high barrier was breached back in 2004. Now the only unthinkable notion is that the oil price could ever fall that low again.

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But prices don't stay at these elevated levels for this sort of time without encouraging change. And it's just possible that the coming decade will see oil prices take a very different pathway.

Here's how that could affect you.

Oil supply is set to outstrip demand comfortably

Last week, the International Energy Agency (IEA) said that demand for oil will grow by less than it had previously expected between 2011 and 2016. It expects oil demand to rise by less than 7% between now and 2017. Previously it had expected demand to grow by around 8%.

This is partly because global economic growth is slowing down. However, it's also because high prices have done their job. Oil consumers have become more efficient in their use of oil. Oil producers have worked harder and developed technology to find more of the stuff. And everyone has tried to find substitute energy sources.

By 2017, demand is expected to come in at just under 96 million barrels of oil per day. Meanwhile supply is expected to have risen to 102 million barrels per day.

About a fifth of this extra will come from Iraq's oil production surging. Iraqi oil exports reached 2.6 million barrels per day last month the highest in more than 30 years. The figure is expected to rise to 2.8 million per day this month.

But about 40% is expected to come from North American oil sands and shale oil' which is produced using the same fracking' technology as natural gas.

Now there are plenty of reasons to take these figures with a pinch of salt. These agencies produce forecasts all the time, and they very rarely get them right, because none of us can predict the future.

There's a good chance that predictions for future Iraqi oil growth will disappoint. The political situation is fragile. Investment in the nation's oil infrastructure may not meet the most optimistic forecasts. And who knows what other nasty geopolitical surprises the region might spring on us over the coming years?

And while North America is clearly more politically stable, environmental issues are a potential sticking point for unconventional' oil drilling. It's also possible that the IEA's growth outlook is too pessimistic. Maybe we'll end up needing a lot more oil than the agency expects.

Don't be fooled oil prices could fall hard in the future

However, it seems increasingly hard to make the case that oil prices have reached some sort of plateau that they can never fall from. There's a realistic chance that we will one day return to an era where we comfortably have more oil than we need. And if it wasn't for quantitative easing, and general jitters over Iran, I suspect the oil market would be pricing that in more aggressively than it already is.

Falling oil prices would be great news for just about everyone except maybe oil producers. A drop in raw material costs for both consumers and manufacturers would put more money in people's pockets, and act as a far more efficient form of stimulus than anything the government or central banks can produce.

But what does it mean for investors? The energy sector is always an exciting area for anyone with a more speculative streak. Almost regardless of what happens to oil prices, small explorers who make big finds are going to see their share prices do well.

But as fund manager Giles Hargreaves noted at our recent Roundtable on small caps, it's important to find explorers who are operating within helpful jurisdictions. You want to look for places where explorers who strike oil can actually make a decent profit, even if prices fall back. That means finding governments who aren't going to snatch away assets, or take a hefty chunk of any returns. Giles had one suggestion, which subscribers can read more about here.

My colleague James McKeigue wrote about another intriguing small-cap oil play in Money Morning the other day.

But perhaps of more interest is an energy source that is in a similar position to where oil was in the early 2000s. There's lots of it, its price is low, and few people can see it rising much higher from here. We're talking about natural gas in the US.

While the oil price may have seen a long-term top, the natural gas price is just the opposite it may well have bottomed out, according to David Stevenson of the Fleet Street Letter. That has major implications for investors. We'll be looking at the latest developments in the next issue of MoneyWeek magazine, out on Friday. If you're not already a subscriber, subscribe to MoneyWeek magazine.

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John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.