Pumping the fear factor out of oil
As more production comes online over the next few years, prices may ease by as much as $20 a barrel.
By Steve Hargreaves, CNNMoney.com staff writer

NEW YORK (CNNMoney.com) -- This morning oil dipped below $70 a barrel for the first time since late June - and prices may ease even further. Indeed, some analysts say that in two years, oil could be trading $20 lower than that.

Crude has already slipped more than 8 percent over the last week, pressured by the alleged plot to blow up airliners over the Atlantic, BP's decision to keep half its giant Alaska oil field open, and the truce between Israel and Hezbollah.

Most analysts don't expect oil to fall too much further in the short term, as demand remains strong and uncertainty surrounds supplies from Iran, Nigeria and Venezuela.

But the recent record-high prices have fueled a boom in exploration. And as that boom begins to yield more oil, the industry will gain a greater ability to ramp up production in one place in order to make up for any shortfall elsewhere.

This should reduce the impact of a supply disruption in, say, Iran or Nigeria, and ease what experts refer to as the security premium that's currently built into oil prices.

"That [premium] is in the neighborhood of $25 dollars a barrel," said James Williams, an energy economist at the consultancy WTRG Economics. "That number would go away, or most of it would go away, if we had more spare production capacity."

According to the Energy Information Administration, a few years ago the world had a spare production capacity of around 5 million barrels a day. That meant if something happened to Iran's oil exports, which ran at about 2.7 million barrels per day in 2005, other oil producing countries could ramp up production and cover the shortfall.

New production possibilities

But thanks to surging demand in the last few years, the world's spare production capacity has dwindled to only around 1.5 million barrels. That makes traders very nervous when the international geopolitical scene heats up the way it has recently.

To make matters worse, most of that 1.5 million barrels is heavy, difficult to refine crude in Saudi Arabia.

But the Saudis are working on the problem.

Last month the country had 46 rigs searching for oil in the country, up from 19 at the start of 2002.

"By 2008 or 2009 you're going to have a lot more spare capacity in Saudi Arabia than there is now," said Adam Sieminski, chief energy economist at Deutsche Bank, noting that there would be around 2 million extra barrels per day of high-quality crude.

Sieminski also said the Saudis should have more refineries built by 2011, which will help to alleviate the bottleneck at the refining level, which has also helped push up prices.

"That's how you get back to $45-$50 a barrel," he said.

There are of course a myriad factors affecting the price of oil.

Both Sieminski and WTRG Economics economist Williams point out that a drop in demand sparked by a worldwide recession would also bring prices down in a hurry. And the list goes on.

"Certainly it wouldn't hurt [to have] more crude in the supply chain," said Katherine Spector, an energy strategist at J.P. Morgan. "But that's just one thing on a long list of variables."

Ethanol could leave the world hungry

Gulf leaves gas supplies in precarious position Top of page

Follow the news that matters to you. Create your own alert to be notified on topics you're interested in.

Or, visit Popular Alerts for suggestions.
Manage alerts | What is this?