Oil Price Rises
Oil Price Rises
Oil has recently (May 2009) reached a seven month high and has had its biggest monthly gain in a decade. Obviously it comes on the back of some sharp falls in the oil price from the middle of last year but nonetheless the present spike in prices is significant and has taken many commentators by surprise.
Why, in the midst of a global economic downturn, might the oil price rally? Some say the simple explanation is the world economy is showing some signs of recovery with China in particular increasing its demand for oil. However a more thoughtful explanation is that many of the problems in the oil industry that contributed to its boom in the “commodity supercycle” have not gone away and indeed are exacerbated by the global downturn:
· The oil industry is still affected by the lack of “easy oil” to extract in politically stable countries and oil companies are forced to rely on exploiting new reserves in inhospitable climates such as the Arctic. Due to the global downturn all but the biggest oil companies have cut back on exploration and development. For example, Shell, has delayed its Canadian tar sands oil expansion plans and the number of exploration wells in the North Sea has fallen by 78%. Thus there are few readily accessible new sources of supply available to the oil companies if they suddenly need to increase production. Even in the midst of the last oil price boom world oil production barely increased. Perhaps more significantly the lack of investment now should exacerbate the problem of supply once the world economy fully recovers.
· The world continues to face a long term oil “crunch” that fuels speculative interest and risk appetite. The US with a population a little over 300 million consumes 25 barrels of oil per person per year. Europe goes through 10 barrels of oil per person per year. Both these figures contrast starkly with China that consumes at present just 2 barrels per person per year. The oil imports of India are expected to triple by 2020. It is reasonable to suppose that the demand for oil from these developing countries will grow strongly.
· The role of Saudi Arabia cannot be overlooked. It claims it has the world’s largest reserves and it has previously ramped up production to help stabilise prices (for example after the first Gulf War of 1990). Saudi Arabia was projected in 2007 to produce 12 million barrels per day by 2010 but so far the latest figures show it is still stuck around 10 million barrels. Throughout the whole of the last oil price boom Saudi Arabia was unable to significantly increase production, indeed in 2007 it slipped back. Reasons may include for example the depletion of the biggest oil field in the world: the Ghawar. Whatever the reason the unwillingness or ability of Saudi Arabia to adjust production is a key dynamic in projecting future oil price growth.
Of course any future growth in the oil price relies on a recovery from the global downturn. Good economic news from China recently has helped but a sustained economic recovery would be the best guarantee of a sustained oil price hike. Precisely when that recovery will happen no person can guarantee.