So, to get us started: Earl, where do you think the price of oil headed?
Near term, it's a tough call, given uncertainties with respect to Middle East and North African geopolitics and the Euro Zone crisis. We expect oil to trade in the $80-$90 range this year, averaging $89 reflecting higher prices earlier in the year. Next year, we see oil averaging $93 as China and other emerging markets grow faster.
That drop -- from $110 to $87 -- would be positive for a wide range of businesses that rely on oil and its products as inputs -- say, transportation, heavy industry that uses oil for process heating, or petrochemical industries that use oil products as feedstocks. It wouldn't be too bad for the oil ilndustry too. Persistent high prices above $100 lead to weaker economies and lower demand. So, a price in the $80 range could be considered the sweet spot, good for both users and producers.
The volatility in prices reflects uncertainty regarding Middle East and North African supply risk. Fears of a disruption -- say from the embargo on Iran's oil -- could lead to stockpiling by users or speculation, causing prices to jump. Additionally, the economic newsflow has been quite confusing, leading to oscillating expectations about whether the economic recovery will be sustained. There's large risks from: hard/soft landing in China; outlook for Europe; and the U.S. year-end fiscal cliff. Volatility will be here until there is greater clarity on these issues, which won't be anytime soon.
Over the past year, gasoline prices have fallen, in per cent terms, by about half the decline in oil prices. This makes sense, given that crude oil accounts for about 50% of the price at the pump, the rest being accounted for by taxes which mostly don't change with prices and by refining margins and retail marketing costs. Closure of refineries in the Northeast U.S. have caused refining margins to widen, although this will only be temporary.
Prices over $80/barrel for West Texas Intermediate, the U.S. benchmark, have stimulated substantial investment in the oil industry. A survey taken late last year showed that firms producing unconventional oil (oil sands) planned to raise investment 25% this year. This fast pace of development has led to a shortage of individuals with appropriate skill sets, putting upward pressure on labour costs.
Canadian producers in Western Canada are facing the problem that output of oil there and a little further south in North Dakota, is rising faster than the availability of pipelines to bring it to market. Therefore, with oil inventories building to high levels, Canadian prices are at a large discount to the U.S. benchmark WTI. Canadian exports to the U.S. have been rising sharply, but production in the U.S. is now beginning to ramp up and U.S. reliance on imports is declining. Thus, it is essential that pipeline capacity to the West coast, or East coast, be developed so that rapidly growing Canadian production can find alternative markets, such as Asia or the Atlantic Basin.
Would you be able to elaborate on that question?
Adrian, we'll move on to another question while you elaborate. Just send the comment through when you're done.
Although American oil production is rising and net imports are declining, the U.S. still depends a lot on imported oil and Canada is by far the largest supplier. By better integrating the North American continental market through expanded pipeline systems, security of supply is greatly improved for Americans. This is pretty important, given the volatility we have been seeing in the MIddle East and also in Nigeria. Also, U.S. gasoline prices are driven by global oil prices, not WTI. They're driven off of Brent. It's not clear that more pipelines will ultimately lead to higher prices. In the near term, it would close part of the gap with Brent, but Brent would also probably come down as more oil would find its way to the Gulf Coast and be available to export abroad if the price is right.
The USO is designed to track WTI on a day to day basis. As mentioned earlier, huge uncertainty about geopolitical and economic risks will likely continue to keep oil price volatility high -- and therefore lead to high volatility in the USO. A sustained increase would likely require more meaningful steps taken by European leaders to contain the debt cris there and a political agreement in the U.S. how to phase in tax increases and government spending cuts next year -- ie, deal with the US fiscal cliff issue.
We're running short on time, so we'll only be able to do one more question.
Far too much emphasis has been placed on peak oil and corresponding forecasts that WTI would shoot up to $200. Given that the earth is finite, then yes, there is some point where oil production will peak and begin to decline. However, oil demand has already peaked in high-income nations, alternatives to oil are being developed in its largest market, transportation, and new energy technologies are being developed. For this reason, I don't think peak oil will be a particularly helpful concept in the next 10 years.
Looks like we're out of time for today's chat, but thanks to everyone for joining us. Earl, any final thoughts or comments on where the price of oil is headed?
It depends so much on the macro environment. It could break well below $80 if there is another global recession, which is not our forecast. It could push well over $100 if there were a major disruption to Middle East supply. But, both of those events would be temporary. Barring that, I feel that WTI will trade in the range of $80-$100 over the next three years.
Thanks again Earl for joining us today and taking questions from our readers!