Global context of today’s oil business

Leading energy analyst Daniel Yergin last month presented to the US House of Representatives Committee on Energy and Commerce a tour de force analysis of the current perplexing world of oil – its price, supply and demand, and security. Not everyone will agree with his conclusions, especially on ‘peak oil’, but we reproduce the text here (in slightly abbreviated form) in the belief that it truly manages to capture the global context of the oil business and as such provides a valuable insight into the energy challenges ahead. We are at a historic juncture. After a quarter century, the great cushion of surplus oil production capacity that was created by the energy turbulence of the 1970s and early 1980s has been largely spent - at least for the time being. It is on that relatively narrow band of ‘spare capacity’ that so much of the drama in world oil markets is playing out. Today, the balance between supply and demand in the world oil market is very tight. Part of the reason is the surge in economic growth in both developed and developing countries - of which the growth of China and, to a lesser regard, India provide the most noteworthy examples. But the demand surge turned into slower growth in 2005 and the data is still preliminary for 2006. Meanwhile, the focus of the market has shifted from demand to supply. We are currently experiencing that slow motion supply shock, the aggregate disruption of more than two million barrels per day. What explains the sharp rise in oil prices over the past eight weeks? The first is the real disruption of a significant part of Nigeria’s oil production owing to an insurgency in Nigeria’s Delta region. Workers have been evacuated, and the local insurgents are threatening further attacks. This means the loss of a high quality light sweet oil particularly wellsuited for making gasoline. The second is the ratcheting up of tensions over Iran’s nuclear programme with a fear of a disruption of Iran’s 2.5 million b/d of exports. Some Iranian spokesmen threaten to unleash an ‘oil crisis’ while others seek to separate oil from atoms. But in a market this tight, the risk of escalation is enough to send crude oil prices up. The third factor is at home (United States) - the rapid switch over from MTBE to ethanol on the East Coast and in Texas has added pressure to what has been for a number of years the most difficult period in the gasoline market - the spring makeover of gasoline from winter to summer blends. We would expect that the transition will be complete by the time most Americans begin their serious summer driving. But there is little reason to think that the tension over Iran’s nuclear program will abate, and much uncertainty remains over what will happen in Nigeria. So we must look to the impact of fundamentals for price moderation - in the build-up of supplies from elsewhere, the relatively high level of crude oil inventories, and the demand response to higher prices.