How High?
Although the price of West Texas Intermediate crude oil (WTI) may be the most frequently reported indicator of the oil market, it is not necessarily the best measure. Most oil trades at a discount to WTI, because of quality, location, or timing. But for looking at big trends and market shifts, the WTI market, and specifically the WTI futures contract on the New York Mercantile Exchange, has the advantage of being highly transparent and liquid. And what a story it tells for 2004!

WTI started the year $9 lower than it is today, at a level that many thought was already quite steep, reflecting problems in Iraq and other producing countries. In fact, the average for 2004 will be more than $10 per barrel higher than for 2003, which itself was nearly $5 higher than for 2002. Even ignoring the $55 peak in October of this year, oil is up about $15 in the last two years, putting it about that much above the long-term average price in nominal dollars. So is this an anomaly, or a trend that we should expect to persist?

Here are some of the issues that support the idea of persistent higher-than-normal prices:

• Demand has grown faster than expected, largely driven by China and other Asian markets.
• Many key producers continue to experience shortfalls due to weather, labor unrest, politics, and a host of other factors.
• Mature areas such as the North Sea and North Slope are in decline.
• The reserve base of the major oil companies looks less secure than in the past, partly for accounting reasons, but more importantly due to constraints on access.
• OPEC is enjoying huge revenues, most of which are needed to alleviate domestic social problems.

But on the other hand:

• The global economy is expected to slow somewhat next year.
• Inventories in consuming countries are growing, indicating slower demand.
• New production will be coming onstream in West Africa and Russia.
• Many speculators have reduced their exposure to oil.
• The market has a long history of reverting to the average, despite countless projections for continued increases.

When I tally up all of these factors, I see enough constraints to keep prices above the long-term average for the next year or two, but not enough to keep it at quite today's level, barring another crisis. OPEC's discipline in cutting production to prevent an inventory bubble will get a real test if this winter continues to be mild. So when I look at the NYMEX futures market's price for delivery in December 2005 of $41, I don't see a forecast of stability, but rather a market that is probably just playing it safe and might rather wish to bet that the price will be either $30-35, or over $50, depending on world events.