Canadian urge to produce expensive oil reminds us why world prices have hit a ceiling: Don Pittis

Despite Tuesday's sharp risein the price of oil, new evidence this week providesa reminder thatwishing for a return to the boom that propelled the glory days of the Canadian energy sector is not going to make it so.

What matters is the race between supply and demand.

The main thrustforCanadian producers is to build more pipelines so they can expand capacity and push evermore of their relativelyexpensive oil into the world supply chain. If that's the strategy for high-cost producers, how could anyone think the world's lower-cost producers wouldn'tbe doing the same thing?

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Only a few days ago, resourceconsultants at Deloittepredicted oil was going to stay at $50 USa barrel this year,heading for$60in 2017. Just because other optimists have been wrong repeatedly,such optimism cannot be ruled out.

Oil's ups and downs

Perhaps world demand for oil is on the verge of a large rebound. That's certainly what the oil producing cartelOPEC expects to happen.

Or perhaps something bad will happen toone or moremajor global producers, drying up production and draining the world's glut of oil in storage.

OPEC suggestswe are going to run short of oil as demand begins to outpace production as soon as next year. But that is all in the future. Right now, OPEChas downgraded world growth prospects, and therefore oil demand, due to fears aboutBrexit.

Oilsandsgoldmine

Suddenly there is the beguiling idea that after a brief pause, we're about torun shortof oil, once again turning theoilsandsintoa goldmine for an energy-starved world.

World oil prices, both Brent crudeand West Texas Intermediate (WTI), rebounded sharply yesterday.

But the reason may have less to do with OPEC's long-term optimism. OPEC is often optimistic in the long term.

Experts saythe four per centrise back above $46 USper barrel was part of a market move to risk assets, as stocks shot back upon a new wave of confidence. As we've seen before, those aretraders making short-term bets and not to be relied upon.

Until yesterday, thetrend has beena decline from the recent$50 dollar highs. And annoyingly for Canadians, it feels as if $50 has become a world oil price ceiling.

Other news out of Brazil yesterday may be an indicator of why.

More pipelines needed

Just as Canadian producers are anxious to extract more oilsands bitumeneven with world prices under $50 demanding more pipeline capacity to get their product to market other world producers are thinking the same thing.

Despite years of low prices and weak global demand, Brazil's oil company, Petrobras, announcedit has pushed output to a new record.

"Brazil's state-led oil company Petroleo Brasileiro SA said Monday that new wells helped push oil and natural gas output to a record high in June," says aReuters reporton the announcement.

So if deep offshore producers like Petrobrasare drilling new wellsand oilsands operators like Suncor want desperately toincrease capacity despitecurrent low prices, where are all those production cutbacks that are supposed to be pushing prices up?

The fact is oil producers around the world, both high cost and low, know that the only way to cover the sunk fixed costs of existing operations is to produce as much as the market will bear even at prices well under $50 US.

According to Shawn Driscoll,an oil investment managerwith the fund company T.Rowe Price, at the $40 to $50 range, oil companies all over the world, not just Brazil,find it worthwhile to start drilling new wells.

Supply-demand race

"We think we're very close to incentive pricing, that's why rigs are coming back," Driscoll told the Wall Street Journal last month. He says he has a $5 billion US bet that oil prices won't rise.

Traditional economics tells us that rising oil demand is a very good sign for the economy. Oil, as the proxy for shipping and driving and industrial expansion, tends to rise as everything else gets better.

Of course that has all been turned on its head byworries over climate change. In the balancing act between supply and demand, global commitmentsto limit greenhouse gases should theoretically reduce demand and helpkeep prices down.

The only true indicator that oil prices face a sustained rise is an equally sustained decline in the global amount of oil in storage. And until that steady decline starts to happen,a simple supply and demand analysis would say maybe producers should get used to prices below $50 for a little while yet.

• Why we need to be cautious about the recent surge in oil prices: Don Pittis

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