Global Oil Outlook: A Crude Reality

May 28, 2008

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Consumers and businesses alike are suffering from higher energy costs. How did we get here? There is no short answer, as a number of factors together have led to today's prices.

Research from the International Energy Agency (IEA) has determined that primary energy demands will more than double by 2030.

Manufacturers are disproportionately affected by energy price instability, according to the National Association of Manufacturers. In the United States, the world's biggest energy consumer, industry accounts for more than one-third of the country's consumed energy. Usage is even greater when factoring in product transportation. In fact, the U.S. and the booming economies of China and India account for nearly half of the projected growth in world liquids use, according to the Energy Information Administration (EIA)'s latest international numbers.

The EIA projects that world oil consumption will grow by 1.2 million barrels per day this year alone, and that the average real price of crude oil will be $70 per barrel in 2006 dollars, or about $113 per barrel in nominal dollars, in 2030.

Of course, many reasons have been cited:

OPEC Organization of the Petroleum Exporting Countries (OPEC) crude oil production averaged about 32.2 million barrels per day during the first quarter of 2008, the EIA reported this month: "Only Saudi Arabia has significant surplus production capacity, currently estimated to be about 1.9 million barrels per day."

Analysts say OPEC, which holds two-thirds of the world's oil reserves and insists it is pumping enough oil into the market, has little incentive to increase production.

Instead, the oil cartel blames the high price on financial speculators, geopolitical tensions in the Middle East and a lack of investment in the U.S. in oil refining capacity. OPEC predicts global oil demand in 2008 will average 87 million barrels per day — largely unchanged from its previous estimate. Demand from China, the Middle East, India and Latin America is forecast to be stronger, but the European Union and North America's demand will be lower.

Last November, global oil prices reacted strongly as OPEC members spoke openly about potentially converting their cash reserves to the euro and away from the U.S. dollar.

Global Supply and Demand One of the most common reasons cited for the price jump is supply and demand. The world is using more oil, which accounts for 70 percent of the price of gas, and finding less of it.

World oil markets are particularly tight during the first half of 2008, with year-over-year growth in world oil consumption outstripping growth in non-OPEC production by more than 1 million barrels per day, according to the EIA's latest Short-Term Energy Outlook.

In recent years, world oil prices have trended upward due to heavy demand for diesel fuel from developing countries such as China. As demand has grown and the supply of oil remained relatively flat, the difference between the amount of oil the world could produce and the amount it consumed narrowed. That meant a supply disruption from one place in the world could not be easily covered with spare oil from another part.

Yet, according to a recent Financial Sense editorial, a lack of crude oil supply is not the problem. "In fact, the world is in over-supply now."

Geopolitical Disruptions In September 2005, Hurricane Katrina knocked out a significant chunk of U.S. refining, and gasoline prices spiked above $3 a gallon for the first time.

New supplies of oil from non-OPEC countries were supposed to come online in 2007 and ease some of these supply bottlenecks. But problems in Kazakhstan and Russia, among others, mean global consumption is growing twice as fast as non-OPEC production.

What's more, analysts also say general resource nationalism since the mid-2000s is partly responsible for high oil prices. further notes on oil-impacting geopolitics:

Some say the Bush administration's provocation of Iran and Venezuela, coupled with a botched occupation of oil-exporting Iraq, has contributed to the geopolitical tension.

In addition, environmental concerns have contributed to fewer areas for drilling. Congress has forbidden drilling in the Arctic National Wildlife Reserve in Alaska as well as in the Gulf of Mexico and elsewhere due to possible threats to the environment.

Speculators Speculators, who buy and sell commodities futures to take advantage of price changes, are betting the price of oil will increase due to regional instability in the Middle East, on which the U.S. depends for large quantities of oil. Instability causes uncertainty, which in turn causes increases in commodities futures like oil.

"In the most recent sustained run-up in energy prices, large financial institutions, hedge funds, pension funds and other investors have been pouring billions of dollars into the energy commodities markets to try to take advantage of price changes or hedge against them," explains another recent Financial Sense editorial

From CNNMoney this month:

Strong demand, tight supplies and a volatile marketplace have attracted the interest of investors... . Money flowing into oil — and commodities in general — has been especially sharp over the last 6 months as investors look for good returns amid falling stock prices and an inflation hedge against a falling dollar.

"As much as 60 percent of today's crude oil price is pure speculation driven by large trader banks and hedge funds," explains Financial Sense.

Limited Refineries Finally, there is the issue of refining the crude oil into gasoline. In 1981, there were 324 refineries with a total capacity of 18.6 million barrels per day, according to the EIA. As of 2007, there were 149, with a capacity of 17.4 barrels per day. Moreover, all existing refineries last year were working at peak capacity and had been incapable of producing more gasoline, even if more cheap crude were readily available.

That's because a new refinery hasn't been built in the U.S. in three decades (when Jimmy Carter was president). In fact, from 1975 to 2000, the U.S. Environmental Protection Agency received only one permit request for a new refinery.

Interestingly, refineries in the U.S. are now running at below-normal levels for this time of year as high prices are putting a strain on oil refiners. In a time of record-high gas prices, profits for virtually all refiners are down sharply. Coming after last year's stellar profits, some American refiners actually lost money in the first quarter of 2008. In response to falling gasoline demand and rising costs, refiners have cut their production rates. Earlier this year, refineries were running at 85 percent of their capacity. (Source: The New York Times)

We've only scratched the surface here, but, like most things, the truth would appear to lie somewhere in the middle of all these causes. Let us know what you think the reason(s) for such high oil and gas prices is, and if these factors are leading you to change your preferences and actions.


World Energy Outlook International Energy Agency

Energy Security for American Competitiveness National Association of Manufacturers, Feb. 27, 2007

International Energy Outlook 2007 Energy Information Administration, May 2007

Short-Term Energy Outlook Energy Information Administration, May 6, 2008

Number and Capacity of Petroleum Refineries Energy Information Administration

Energy & Utilities Trends Plunkett Research, Ltd.

Renewable & Alternative Energy Trends Plunkett Research, Ltd.

Who's to Blame for $4 Gas by Steve Hargreaves CNNMoney, May 22, 2008

More on the Real Reason Behind High Oil Prices, Part II by F. William Engdahl Financial Sense, May 21, 2008

Perhaps 60% of Today's Oil Price is Pure Speculation by F. William Engdahl Financial Sense, May 2, 2008

Myths and Facts about Oil Refineries in the United States

Oil Refiners See Profits Sink as Consumption Falls by Jad Mouawad The New York Times, May 14, 2008

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