Economist sees $20 oil amid 'devastating' glut

In the future lies $200 oil or $20 oil. Take your pick.

University of Calgary professor and former U.S. government advisor Philip Verleger says the price of oil will collapse to $20 per barrel this year, as the recession reduces demand far below what OPEC and other oil producers have forecast, Bloomberg News reported Thursday.

"The economic situation is not getting better," Verleger, 64, a professor at the University of Calgary and head of consultant PKVerleger LLC, told Bloomberg News Wednesday. "Global refinery runs are going to be much lower in the fall. If the recession continues and it's a warm winter, it's going to be devastating." Verleger expects a 100-million-barrel oil surplus by year's end to strain storage capacity and trigger a massive decline in prices.

Global oil inventories continue to rise

Depending on the survey, the oil market is accumulating a 1.0-2.0 million barrel per day (bpd) surplus, as the pronounced global recession, which has reduced demand, and the unwillingness of non-OPEC suppliers to cut production, swell inventories. However, up until now, traders in the oil futures market have looked the other way, keeping oil at the lofty price of about $60 despite the build.

The oil bulls argue that expectations of a recovery in global demand, led by China/Asia, and concern that the U.S.'s monetary/fiscal policies will lead to inflation and/or weaken the dollar, make oil a good investment.

Verleger disagrees, arguing that OPEC does not recognize the severity of light demand conditions. "OPEC don't realize the magnitude of the cuts they need to make," which should include about another 2 million barrels a day, Verleger told Bloomberg News. "Storage is going to become tight. It's not clear if there's going to be enough storage available."

OPEC displays production discipline

Historically, OPEC nations have tend to 'cheat,' or produce more oil than their reduced quota, during times of production cutbacks, in order reap extra revenue from oil sales. That extra oil produced has often proved to be self-defeating, as it has forced oil's price even lower. However, this time, OPEC's production discipline has been good, and a high price, despite the recession, has held. Meanwhile, most non-OPEC producers continue to pump as much oil as their production capacities allow.

Oil last traded at $20 per barrel in February 2002.Oil, which has recovered about 75% in price since hitting an economic cycle low of $35 last winter, traded down $1.05 Thursday to $60.50 per barrel.

Further, while others have predicted a softening of oil prices on a protracted recession, the bulk of the forecasts for the next 1-2 years see substantially higher oil prices.

Goldman Sachs sees $75 per barrel oil by September, The Associated Press reported. And Energy/Oil Billionaire T. Boone Pickens expects a fairly rapid return to sky-high oil, seeing a return to $150 per barrel in three years.

Oil Analysis:
The oil bears have continually argued that oil's inventory build justifies a much lower price for oil, particularly when both the U.S. and global economies are in recession. But since 2005, some factor has managed to keep oil lofty - geopolitical risk, oil as an inflation hedge, oil as an asset play, and most recently, the prospect of increased demand during a probable global economic recovery in Q3/Q4. As UCalgary's Verleger correctly points out, oil's supply/demand fundamentals dictate a considerably lower price for oil, but up until now, this has been a market that has largely ignored or been decoupled from fundamentals.
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