$85 oil will whack producers

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Oil producers must come to grips with a new economic reality.

With global economic growth cooling as North American production of light oil ramps up, the mix of softer demand with solid supply is expected to weigh on crude prices.

Working with these assumptions, CIBC World Markets analyst Andrew Potter revised his long-term price forecasts, lowering expectations for light oil from $100 (U.S.) to $95 per barrel, and more significantly, for heavy oil from $100 down to $85 per barrel.

The root of these adjustments is a "structural change" in light oil cause by anticipated U.S. production growth that will ease the pressure on the balance between supply and demand.

That change, in turn, weighs on heavy oil, which typically trades at a discount. "We are generally more bullish on heavy oil pricing but note that will also be pressured somewhat by the significant discounting that will occur for light oil," Mr. Potter noted.

Running these assumptions, as well as a slight uptick in natural gas prices, through his models, Mr. Potter came away with significant revisions to his price targets for oil and gas producers. Integrated firms like Suncor were hit the least, falling about 6 per cent on average, while Canadian large cap producers such as Canadian Natural Resources and Nexen were down 13 per cent on average and pure oil sands plays saw their average price target fall 18 per cent.

Keep in mind that these are just one bank's revisions, but similar expectations are bound to be replicated as analysts respond to a new economic reality.

And if these changes do play out, it will be interesting to see how the companies themselves respond. Remember that Réal Cusson, Canadian Natural Resources's senior vice president of marketing, recently said that companies will flirt with trouble if crude drops to $85 (U.S.) per barrel.

However, Mr. Potter himself also acknowledges that any outlook, particularly in the shorter term, is hard to predict. "Should macro concerns ease as they did in [the first half of 2011], we could see WTI pricing back in the $100 (U.S.) per barrel range as supply/demand balances should tighten and spare capacity remains relatively low. On the flip side, oil could trade lower if some resolution is reached with Iran, particularly if Saudi Arabia does not curtail production quickly. Additionally, it is quite plausible that macro sentiment worsens, which would further pressure oil demand growth expectations."