Oil Prices to Rise to $7/Gallon by 2012

        The price of oil is likely to soar to an average of US$150 /bbl by 2010 and continuing to rise to over US$200/bbl by 2012 said Jeff Rubin and Peter Buchanan, analysts with the Canadian Imperial Bank of Commerce.
        The CIBC report says this will translate into steadily rising prices at the gas pumps, rising to as much as US7 a gallon by 2012.
        Here are highlights of the CIBC report
       "We have reduced our estimates for net global supply increases by nearly 1 mn bbl/day for the 2008 through 2010 period, and by over half a million barrels for the two years after that, leading to a discernibly tighter oil market than we had previously projected.
       "At the same time, there is little evidence to suggest that there is any compensating reduction in global demand growth. Instead, aggregate crude demand remains robust as burgeoning demand for crude oil outside of the OECD, and in major oil-producing countries in particular, has more than offset demand destruction in OECD markets. Juxtaposed against more limited supply gains, the resilience of demand in developing countries points to increasing global competition for increasingly scarce oil resources.
       "While the International Energy Agency (IEA) estimates continue to peg current oil production at around 86 mn bbl/day, over 9% of this daily production is not oil at all but rather, natural gas liquids (NGL). While natural gas liquids such as propane and butane are valuable hydrocarbons in their own right, they are not a viable substitute for oil. Neither can be economically used as a feedstock for gasoline, or diesel. Propane is used as a transport fuel, but in less than 2% of all the motor vehicles in the world. Hence, increases in the production of natural gas liquids cannot satisfy steadily growing global demand for gasoline and diesel, as car ownership rates in BRIC countries, and other parts of the developing world take off.
       "Car purchases in Russia, for example, are exploding as US sales stagnate, while in India the advent of the Tata Nano, a car that will sell for as little as US$2,500 will allow millions of households in the developing world to own automobiles when they otherwise could not. It is the savings necessary to buy a car, not the price of gasoline that poses the greatest obstacle to fuel demand growth in those countries. But between rapidly rising domestic incomes and rapidly falling car prices, that obstacle is becoming more and more surmountable.
       "The inability of existing supply sources to meet that demand growth has been highlighted recently by the fact that virtually all of the increase in so-called oil has been in these other hydrocarbons, which come largely from natural gas and are ill-suited for gasoline and diesel production. The ratio of natural gas liquids to total "oil" production has been rising steadily and is likely to continue to rise for the foreseeable future. Whereas these hydrocarbons represented only about 4% of total oil production back in the 1970s, they are likely to account for over 10% of total production by 2012.
       "The increasing ratio is coincident with accelerating depletion rates in many of the world's largest and most mature oil fields. Beyond methane which is what the home consumer burns, natural gas at the wellhead contains a range of readily liquefiable gases, which agencies like the IEA have traditionally included in total oil supply. These products - propane and butane, along with smaller amounts of pentanes, hexanes and heptanes - are removed at specialized upstream processing facilities, in part to expedite movement of the treated gas through the pipeline distribution network.
       "While natural gas can occur on its own, much of the world's natural gas is "associated" gas - found together with oil. As an oil field matures, the resulting loss of reservoir pressure releases dissolved natural gas. The released gas forms an expanding cap over many mature oil fields, resulting in a rising ratio of natural gas to oil and hence, a rising ratio of natural gas liquids to oil production. This is precisely what is occurring in rapidly depleting fields like Mexico's Cantarell.
       "While the steady, but very gradual rise in the ratio of natural gas liquids to total petroleum liquids production may not, in itself, trigger particular alarm, recent developments do. What counts in terms of meeting future transportation fuel demand growth is what percentage of new supply that is coming on-stream will be oil and what percentage will be natural gas liquids? While natural gas liquids only account for 10% of total supply, they account for virtually all of the increase in petroleum liquids production since 2005. Stripping out natural gas liquids, oil production has not grown for over two-and-a-half years, which certainly goes a long way to explaining why oil prices have doubled over that period.
       "In light of these developments we have re-examined our projected supply increases, stripping out the expected increases in actual petroleum production as opposed to natural gas liquids. The distinction turns out to be critical. Roughly 50% of the increase in expected production is likely to come from natural gas liquids, leaving only small marginal gains in petroleum supply over the next two years.
       "Indeed, stripping out natural gas liquids, underlying world oil supply will rise from 78 mn bbl/day (equivalent of 86 mn barrels today with natural gas liquids) to only 79 mn barrels by 2010. And looking beyond, it is unclear whether that level can be much exceeded in the following years, at least through the end of our forecast horizon in 2012.
       "Our new estimates suggest that we are likely to see barely more than a million-barrel increase in global production between now and the end of the decade. Oil production edges up another 200,000 bbl/day in 2011 but then falls again in 2012.
       "Whether in fact, these levels will define ultimate production peaks or not, cannot of course be known at this time, but whether they do or do not define such peaks, they indicate at a minimum that world oil markets will remain as tight over the next five years as they have over the last two years.

Rationing Demand:
How High Must Prices Rise?

       "Demand must ultimately be constrained by supply so the price equation, given a fixed supply, depends on how price-sensitive demand is. As we have argued before there are essentially two world oil markets, one fairly price-sensitive and one not at all. In the still-senior oil market, the OECD, consumers are not only expected to bear the full costs of world oil prices, but also pay substantial excise taxes as well. This is where the rubber meets the road insofar as price rationing global demand. The virtual doubling in world oil prices since 2005 has led to back-to-back reductions in OECD consumption for the first time since the early 1980s.
       "In the rest of the world, however, soaring oil prices have had little traction on demand. In many countries outside of the OECD, first time car buyers have no memory of past gasoline prices, and by virtue of car ownership, now have a claim on the world's rapidly shrinking oil reserves.
       "The extent to which prices ration limited supply over the next five years depends to a significant degree on how much oil will be diverted from world oil markets to meet the consumption needs of major oil exporters themselves. Last year, OPEC together with independent producers Russia and Mexico, consumed over 13 mn bbl/day of oil, constituting, next to the US, the second-largest oil market in the world. Unlike the US however, where total crude demand has been basically flat over the last three years, domestic oil consumption is soaring in those other markets. Over the last three years, consumption inside of OPEC has grown at an astounding over-5% average annual rate, while domestic consumption growth in Russia and Mexico is not very far behind.
       "For the most part, soaring rates of domestic fuel consumption, particularly in OPEC countries, can be traced to egregiously low pump prices. Gasoline in the 25-cents/gal range in Venezuela and in the 50-60 cents/gal range in Saudi Arabia, Kuwait and Iran, have not, surprisingly, spurred enormous fuel appetites in those countries. Not only is the demand for fuel there price-inelastic but the elasticity has the wrong sign. In other words, higher world oil prices only serves to boost demand, because they bring even more money chasing massively subsidized fuel.
       "With production faltering, soaring rates of domestic fuel consumption will soon cannibalize export capacity. Exports from OPEC, Russia and Mexico are expected to decline by 2.5 mn bbl/day in the next five years. To a large extent, that has already happened in OPEC, whose export growth has slowed dramatically in recent years. Soaring Russian exports had effectively filled the void created by OPEC, but now, as we recently heard from Russia's resources minister, both Russian production and exports are set to decline. Instead of offsetting what's happened in OPEC countries, Russia is soon to add to the problem. But markets will soon see an even more spectacular drop in exports from Mexico, home to roughly 1.5 mn bbl/day of supply to the US market. The tandem of strong domestic gasoline demand growth and plummeting production at its massive Cantarell field will see Mexico's exports virtually disappear within five years.
       "The more oil is consumed in oil-producing countries, the less oil will be consumed in the OECD. Since oil-producing countries effectively have first call on their own oil, the balance is the residual which the price mechanism must ration. Boosted by the explosive growth in oil consumption in oil-producing countries, we expect that by 2012, consumption in the rest of the world will exceed OECD consumption, a virtually unthinkable prospect a little over a decade ago, when consumption outside of the OECD measured little more than half of the OECD's annual oil intake.
       "The rise in world oil prices to over US$200/bbl should translate into steadily rising retail gas pump prices. US gasoline prices, already averaging US$3.60/gal nationally, should peak at well over US$4/gal this summer, rising to as much as US$7/gal by 2012.
       "Small declines in OECD consumption in 2006 and 2007 are likely to be followed by a 2.6% annual decline for the next three years, with declines averaging 3% per year after 2010. Referenced off its 2006 peak, oil consumption will fall by almost six million barrels per day in the OECD by 2012, with roughly half of the decline occurring in the US, the world's largest oil market."