At the moment, when I post and talk about the incremental bbl, I do try to show that my 90.00 level is something that I have cobbled together, and that it's not a hard target. I don't know how Goldman gets their 105.00 level for oil, or their 9.00 level for NG. The incremental bbl is therefore an ongoing work in progress for me.

My thesis is as follows: it doesn't matter that many OPEC producers are still pumping bbls from legacy fields where the cost has fallen towards zero. Or, even, that some of these can bring on new supply at levels that are still pretty cheap. Let's say KSA is bringing on new supply at a marginal cost of 40.00, or even 25.00, or even 15.00. None of that applies to my view of the incremental bbl.

My view is: what is the highest price level needed to bring on the actual bbl that allows the world to obtain a net increase in supply? As we are not currently obtaining a net increase in crude oil supply,(or let's say we are but only in slight upticks that are in the margin of error), then we are currently very much in the zone of the incremental bbl right now. This 100-120 level.

When I try to explain the concept to people in a more general sense, I ask the following question: what happens to the price of oil if we take off all the unconventional bbls, from the Alberta Oil Sands? Then I go on to explain the cost inflation in the Oil Sands to bring on new supply currently, and in the future. Then I go back to the first question: can the world obtain higher levels of oil production if the Oil Sands producers do not increase production?

So this is how I think about the issue in a conceptual sense.

BTW, when TAQA the Abu Dhabi Oil Company invested in the oil sands in the last 18 months, one of the explanations that was given by the investment managers, was that TAQA wanted exposure to the incremental bbl, which they saw as being set at a new high level by oil sands production. In other words, low cost GCC producers with their legacy fields of easy to extract conventional oil need to re-frame the pricing environment, such that while they can enjoy the spread between their cost and the marginal bbl, that is a profit phenomenon now, only. TAQA was looking forward to the re-pricing of oil.

In a specific sense, however, were labor and metals to drop significantly in price, then I think Goldman and others might have have to start lowering their incremental level from 105.00. On the downside, therefore, my view is that labor, materials, and environment are playing an equal role to geology right now, in the mark-up to the new high level of the marginal bbl(this may be stating the obvious). And then of course there is the matter of EROEI, which as others are pointing out, is probably at a rate of decline that probably outpaces our ability to analyze it in real time.

The bottom line is that this is a very tricky thing to quantify.

In terms of market prices and the near term, my view is that if oil can hold above 100.00 to 110.00 in the next 6 months, then the chances of a new spike are reduced. However, if oil goes below 100.00 to 90.00 soon, then I think we could spike to a new high pretty easily before May of 2009, as the lagged negative effects on new supply would kick in starting in late Winter, early Spring next year.

For now, I am sticking with 90.00 as my marginal level, and have new comfort that Goldman is higher and that OPEC is obviously eyeing 100.00. (I also think Petrobras is thinking about 100.00 too).

Cheers,
Gregor