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Superspike report raises questions

A widely reported briefing by US investment house Goldman Sachs alerted markets to the possibility of an oil price superspike - a spike as high as $105 per barrel.

Yet the full report, obtained by Aljazeera.net, paints a more complex and volatile picture.

Notably it pits gas-guzzling American consumers against the geopolitical turmoil of oil-exporting nations.

One the one hand it notes that "geopolitical turmoil in key oil exporting countries coupled with populist rhetoric ... keep foreign oil companies from developing host country resources in a timely manner ... that could otherwise meet oil demand growth at lower prices."

These countries, notably Russia, the Middle Eastern producer nations and Venezuela, all come in for criticism. Goldman Sachs believes these nations in particular have not invested in enough capacity to create a supply cushion.

It sees that lack of investment as part of a 30-year cycle. Producer nations became reluctant to invest in new production facilities after the recessions and price collapses of the 1970s and 1980s.

On the other hand, its condemnation of US consumers is equally unrestrained.

"Perhaps the ultimate answer to how high oil prices need to go before demand destruction occurs is derived from knowing when American consumers will stop buying gas-guzzling sport utility vehicles (SUVs) and instead seek fuel efficient alternatives. We estimate that US gasolineprices may need to exceed $4 per gallon."

Demand destruction

For ordinary consumers around the world the phrase "demand destruction" is one repeated often throughout the report. As Aljazeera.net has pointed out before, in oil and energy terms this is shorthand for a major recession.

Goldman Sachs sees the lack of investment, coupled with increasing demand, as a factor that has caught out producers. But now producers, pleased with the high prices of oil, may also be unwilling to let such amazing cash bonanzas slip from their grasp.

The report is not positive about the Middle East's role in oil supply It is particularly bleak over the prospect of Middle Eastern nations adding to the supply chain.

"It is important to remember that the Middle East has been one of the few areas in the past 30 years to experience massive population growth - 2% to 3% per annum.

"The combination of rising populations, a lack of a diversified economic base, and the existence of governments that are not representative of, or responsive to, underlying populations all point to ongoing geopolitical turmoil and an inability to meaningfully add to oil supply."

Even more straightforwardly it says that, "persistent high prices are improving the financial position of key oil-exporting countries and could serve to keep potential revolution at bay. If future political crises are to be averted, we believe it is critical that oil-exporting countries reinvest cash inflows [to] allow the majority of their growing populations to have economic hope."

Peak oil

On the now popular subject of peak oil, Goldman Sachs takes the conventional view that global production is not reaching any kind of plateau. However it does give the subject some consideration.

"We are not subscribers to the theory that global oil supply has hit some magical inflection point that will result in permanent supply declines ... in the near future ... it appears to us that there exists a large known quantity of both conventional and unconventional oil resources to develop."

The company instead again blames the lack of investment from Russia, the Middle East and Venezuela. At the same time, in other areas of the report, it gives passing credence to the theory. Rather than calling it any kind of peak, it uses the phrase "geologic maturity".

With increased geologic maturity come increased extraction costs. Rising labour costs and the increased cost of commodities used in the extraction of oil, especially steel, are also helping to drive the price higher.

Rising costs

"Rising ... cost structures due to increased geologic maturity in many of the traditional areas of oil supply as well as service and materials cost inflation have driven an increase in ... prices," it says.

The so-called terror premium is irrelevant, some say In other words, old fields, unable to produce what they used to produce at the same cost, are driving up prices. Paradoxically, these rising costs eventually translate into increased profits for oil majors and exploration companies, as well as producer countries.

Both Opec whose "space capacity [is] essentially gone" and global refinery capacity "now running full out" are also cited as reasons for the conclusion of the report, a potential "superspike" in pricing as high as $105pb. On the other hand "speculation" and the "terror premium", as Aljazeera.net has already noted in previous articles, are irrelevant in the current market.

Positive negative

Goldman Sachs sees two sides to the superspike coin. The positive side is in oil stocks and equities which they believe could "see as much as 80% total return ... and believe investors should add to positions in the sector on dips, at current levels, or even after a rally."

Consumers need to be weaned off a high consumption lifestyle The negative side is about the global economy. They reject the notion that current investment can create a supply cushion, a significant gap between demand and supply.

Instead they see recession as the way the market will deal with the problem.

"Until new investments are made, we believe demand destruction will be needed to recreate a spare capacity cushion in order to return to a period of lower energy prices."

One question remains, however. Will producer nations and oil multinationals be willing to carry on investing in a collapsing market? Would they still be interested in spending heavily on exploration and development to create the reports' desire, a supply cushion? One that would inevitably end up earning the same producers less profit? That is not a question this report could answer, or ask.

What do you think? Leave a comment below.

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