The Great Oil Bubble?

Supply and geopolitical issues will not go away in global recession
BY TONY ALLISON

The markets are rejoicing as the “great oil bubble” loses air and rapidly heads back to its proper double-digit price. The rejoicing may be a bit premature as the underlying supply and demand fundamentals do not appear to support “proper” prices for oil.

Between 2004 and 2007, global oil consumption grew by 3.9%, driven by emerging giants China and India (40% of the world’s population) and other rapidly growing emerging economies. While consumption has exploded, production has not kept pace. Non-OPEC production growth has slowed well below historical averages. And the only country with significant spare production capacity is Saudi Arabia. Unfortunately, Saudi spare capacity is not independently verified, and the vast majority of their current production is from the giant Ghawar oil field, a dowager now 57 years old which still produces nearly 5 million barrels a day.

“Saudi Aramco is injecting a staggering 7 million barrels of sea water per day back into Ghawar, the world's largest oilfield, in order to prop up pressure. It accounts for 30% of Saudi oil reserves and up to 70% of daily output. Doubts grow about Saudi as Global Swing Producer," Aberdeen Press & Journal Energy

It is interesting to note that the above article appeared in April 2004. Time is not on the side of Saudi Arabian spare productive capacity.

Surplus Capacity Remains Low

World surplus production capacity remains low. The estimated 1.35 million barrels per day in June 2008 is equivalent to less than 2 percent of consumption, an amount well below the 1996-2003 annual average of 3.9 million barrels per day. This puts upward pressure on prices and leaves world oil markets vulnerable to supply disruptions.

Even if world GDP were to slow significantly, oil consumption may not fall off the table. Per capita oil consumption is growing in the Middle East, China and India. If these areas continue to subsidize the price of gasoline, then demand may stay strong, even in a slowing global economy.

Disturbing Findings

The historically conservative International Energy Agency (IEA) ha

s issued some disturbing findings in its latest report. It notes that global production cannot keep up with demand, and the trend is getting worse. It predicts global oil depletion at 5.2% this year, versus 4% last year. Over 3.5 million barrels per day of new production will be needed each year just to hold global production steady. With Ghawar, the world’s largest and one of the oldest fields now producing less than 5 million barrels per day

(approximately 6% of global daily production), where will this new production come from this year, and in every succeeding year? What if the global depletion rate is over 6% next year, equivalent to Ghawar? This is the crux of the issue. Finite supplies will never be able to meet infinite future demand.

Increasing Reliance on OPEC Production

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