Rising oil prices: Eurozone’s next big problem?
Summary
As the euro zone is so far behind other developed nations in its attempts to return to growth, it could struggle to meet rising oil costs.
After the banking crisis, the oil price is the next major threat to the euro zone, analysts told CNBC, arguing that prices will rise once the shale oil revolution in the United States dies down and that the weakened region could be priced out.
The longevity of the shale oil revolution in the US has divided analysts, with PricewaterhouseCoopers (PwC) predicting the boom in shale oil production will shave as much as 40 percent off oil prices by 2035.
Others argue that ultimately, exports from the Organization of Petroleum Exporting Countries (OPEC) drive supply and demand for the European Union (EU) and as they shrink, oil prices will rise, leaving the euro zone facing an energy supply problem.
Brent crude prices fell by USD 1.80 — their biggest slide since May 1 – on Wednesday after a report from the American Petroleum Institute showed a 4.4 million barrel increase in US crude inventories for the week to May 24. The figure was much higher than a Reuters forecast of a fall of 400,000 barrels.
“I think oil prices as they are right now are going to be unsustainable. There is all this ‘oomph’ about shale oil, but it does not alter the fact that there is still a shrinking amount of exportable capacity in OPEC and that’s what drives the supply and demand scenario for the European Union,” said Daniel Lacalle, senior portfolio manager at investment management firm Ecofin, on Tuesday.
“I think Brent getting stronger to WTI (light sweet crude) is a very likely picture in the coming months,”
As the euro zone is so far behind other developed nations in its attempts to return to growth, it could struggle to meet rising oil costs.
“If the EU doesn`t understand that affordable energy is an absolutely critical part of the solution to the growth problem, it is going to continue digging its own hole, with subsidies and with extremely expensive energy,” added Lacalle.
Lacalle is long oil, predicting that private companies producing shale oil will ultimately need to see a higher return on their capital.
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“There is very little return on capital employed to deliver from this revolution, so it also needs a price signal. But they are private companies, they want to make money and they need to make, 15 or 16 percent return on capital employed – that is not happening at USD 100 a barrel,” he added.
Nitesh Shah, associate director of research at ETF Securities, said Brent will be driven higher as a result of supply forces within the Middle East and Europe. But he added that OPEC countries manage the price with a “strong hand” and a decline in demand from Europe would trigger the price to fall.
“If the demand from Europe starts to wane significantly, that would move the price and they would tighten up supply. That is a key issue for the OPEC countries – they need make sure whilst they maintain the price, they also maintain the volume of sales to have sufficient revenues to maintain their spending programs.”
Shah said dwindling demand from the EU would be enough for OPEC to become more flexible on the USD 100 a barrel level, which is deemed to be minimum price before supply cuts are considered to boost prices.
“Whilst most of the focus tends to be on the price, each individual country is thinking of the price times the volume – the actual revenues they are going to get – so I think there will be flexibility. If the price was to fall down due to lack of demand form Europe, I think they would be a lot more flexible on that USD 100 level,” he said.
Nancy Curtin, CIO at Close Brothers Asset Management, said shale may hurt some of the African oil producers, but the Gulf States, who are the main exporters to the EU, will not be hit.
“Part of what will prop up the price in oil is structurally, shale gas is more expensive, so it creates cost pressures in the industry. If the world begins to grow again, you are going to have ongoing and continued demand from the emerging world,” she said.
–By CNBC`s Jenny Cosgrave; Follow her on Twitter @jenny_cosgrave.
Copyright 2011 cnbc.com
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