As I write this, Brent crude is trading at about $130 per barrel. The price has doubled over the last year and quadrupled over the last three.
Millions of words have been written about the causes of the massive increases, and shortage of supply is usually given as the main one. The “peak oil” argument has been frequently discussed in Energy. I do not want to revisit that in this column, but concentrate on the short-term supply and demand issues.
Over time, oil supply and demand/consumption must balance. In any given period – a day, month or year – they can differ because of stocks, which can be built up or depleted, but in the long run, oil demand and supply must be the same. The US maintains strategic oil reserves, China is building one and EU policy is for each member state to have stocks equivalent to 90 days’ consumption. In 2007, world oil consumption was just over 3.9billion tonnes, equivalent to 85million barrels per day. World oil production was slightly higher, so there was a tiny increase in stocks.
There is a common misperception that world oil demand has been increasing rapidly, partly because of growth in China and India. In reality, the recent average annual growth has been less than 1% because consumption has been falling in some countries, including the UK.
There is little reason to expect a significant increase in the growth rate because demand will eventually fall if prices remain high. Consumers, particularly the large electricity generators, will switch to cheaper alternatives, albeit after time lags.
The main causes of the price increases should therefore be supply-related. It seems that any time there is a minor disruption to supplies – a pipeline explosion in Iraq, rebel troubles in Nigeria, a tanker running aground, and so on – there is a disproportionate jump in the price. Further, the price rarely returns to its previous level when the supply is restored.
Any objective analysis of the supply situation should conclude that the problems are being exaggerated and that speculation is a much larger cause of the high prices. Unfortunately, I have seen little objective analysis in recent weeks.
Current spare capacity is equivalent to about 4million barrels per day. That could be increased to about 10million bpd within six months.
Most of the spare capacity is in Saudi Arabia. It is heavy oil and the Saudis took a decision last year not to sell their heavy crudes at large discounts. There is undoubtedly a shortage of refining capacity for such crudes.
I have written in this column in the past that Saudi Arabia can easily and quickly increase output, as requested by the US and others, but that King Abdullah has linked that to evidence of real commitment by the Americans to a resolution of the Palestine conflict. President Bush met the king some days ago and, subsequently, Aramco announced a 300,000bpd increase in production.
There will also be significant increases in oil production later this year from the Caspian Sea and offshore Africa. There have been many delays in these regions, as exemplified by the Kashagan field in the Caspian, but real progress is being made now.
The US Energy Information Agency (EIA) recently forecast that non-OPEC output at the end of 2008 will be 600,000b/d higher than at the start. That figure takes account of continuing declines in the UK, Norway, Mexico and elsewhere.
The EIA forecasts show relatively large increases in Brazil, Azerbaijan, the US itself and Russia, with smaller rises in Kazakhstan, Sudan, Vietnam and other countries. I cannot comment on the likely accuracy of all these forecasts but those for the Caspian Sea countries, where I have been working recently, seem reasonable to me.
If the EIA is correct and the Saudis meet their promise there will be a 1 million bpd rise in production. A basic economic principle if that if the supply of a product rises, the price will fall, other things being equal. Unfortunately, in this instance, the other things include the financial speculators. The Peak Oil proponents may be correct in the long run but at the present time the supply shortfalls are being wildly exaggerated. And who is benefiting, apart from the speculators? Saudi Arabia, Russia and the other exporters.
Tony Mackay is MD of Mackay Consultants