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Back to the new normal

Judging by history, and reflecting rampant supply, tepid demand and a passive Opec, $50 oil is about where the price belongs

It's time to stop muttering about the oil-price crash and time to stop talking about a recovery. The terms imply that oil prices should be higher. They shouldn't. A better term is the oil-price return or, to pluck from the economist's lexicon, the reversion to the mean.

An oil price at $45-50 a barrel-its level since the beginning of September-is neither high nor low. It's pretty much normal. Between the Second World War and the end of 2014, the mean price of oil, adjusted for inflation, has been $41/b. Between 1974, the first full year to feel the impact of Opec power, and 2014, when Opec power vanished, the real price of oil has averaged $54/b.

That historical range-$41-54/b-neatly coincides with the band Brent has traded in for the past six months. Oil hasn't so much crashed but found its old home. Theoretical economists must be delighted.

Companies that produce and sell oil obviously aren't. The pain is evident everywhere in the sector. But historical perspective is necessary. For some youngish executives in the industry, oil's retreat back to its $50/b level is their first taste of the market's ruthlessness and the brutal reality of commodity cycles. They enjoyed a decade of above-average prices. Now things are getting back to normal.

Companies had better get used to it. The International Energy Agency (IEA) has put to bed any hopes for a price surge later this year. Demand growth is now slowing and supply rising, it noted in its September market review. That's the opposite of what a cheapening of the price of something is supposed to do. So stocks are rising, as they must, postponing once again that staple jargon of industry conference-talk, the "rebalancing".

Opec could-and as we argued last month, should-change this, ripping up its market-share strategy by cutting hard to inflate prices. Its shock-and-awe move of 2008, when at a meeting in Algeria the group agreed to take 2.2m b/d of supply off the market (adding to the total in the months after), dragged oil off the floor.

Almost eight years on, again in Algeria, it might opt instead for an effete freeze. The producer meeting on 27 or 28 of September will have happened by the time you read this (Petroleum Economist will be there and our analysis published first online). The odds are against a cut. But bilateral talks between the Saudis and Iran in Vienna on 22 September at least hinted at a possible deal.

Unless it's a convincing agreement, the market will be left to find its own way-and that means more oil. Kazakhstan's Kashagan field will make its long-delayed entrance this autumn. Eni, leading the development, expects output to hit 360,000 b/d over the coming months. The capture by Khalifa Hafter's forces of Libya's Sirte basin export infrastructure-and, crucially, the state company's endorsement of this-is likely to add 200,000 b/d soon. Negotiations between the government and militants in Nigeria's Delta have progressed and ExxonMobil and Shell are both planning to resume some shuttered exports.

More to come

It's even plausible to think that trio of producers could between them add 1m b/d or more by the second quarter of 2017. They would only be adding to a market that has steadily grown more glutted thanks to rampant production from Opec.

In the US, an upstream turn is already visible. The bottom has either been hit or is nearing. Rig count numbers are rising in most of the big oil plays. The economics of drilling in the Permian shale remain remarkably robust. Unlike other plays that opened up when oil prices soared in recent years, the Permian looks solid now that oil has recovered its historical range. The price drop has just improved its efficiency. "Given the advancements in drilling and completion technology and cost reductions," write analysts from Citi, an investment bank, "most would concur that Permian returns are now better at $50/b than at $100/b just a few years ago."

The outlook for demand is equally troubling for bulls. The IEA reckons the surge in consumption that followed the plunge in oil prices has ended-China needs less and OECD consumption growth has "all but vanished".

Global demand rose by 1.37m b/d in the second quarter of this year compared with Q2 2015. In the third quarter, the IEA says growth will have come in at just 0.83m b/d. That's a heinous number, given where oil prices are. (By comparison, consumption in Q3 2015 was a whopping 1.93m b/d more than in Q3 2014.) The IEA has also now revised down its forecasts for 2016 and 2017 consumption, to 1.3m and 1.2m b/d, respectively.

And that's before we find out what the US Federal Reserve does with interest rates, or what the much-expected 25-basis-point increase-probably in December-will do to global equity markets, emerging economies or the dollar. The answers are probably: down, down and up. Each would hurt oil prices.

So $50/b oil looks about right, painful as it is for producers that want more and for projects that only ever made sense at twice that price. If Opec does cut production, it might, as Citi's Seth Kleinman argues, end up doing so just to "hold the bottom of the $40-50 range".

That would be something for the history books-Opec intervening just to make sure oil trades at its historical average. The new normal will take some getting used to.

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