Why oil prices will keep rising
By John Stepak
There are plenty of short-term factors affecting the oil price: tensions over Iran's nuclear ambitions; rising militant activity in Nigeria; and worries over suicide bomb attacks in Saudi Arabia. Some analysts argue that if it wasn't for these factors, oil prices would slip back towards the $40 a barrel mark.
But geopolitical tension has always been a feature affecting the oil market. The basic reason why we are pretty sure oil has entered a long-term bull market is much more straightforward: demand is high and supply is constricted. Simple as that.
As John Kelly of Abbey points out in "oil prices where now?" http://www.moneyweek.com/file/4581, the last time the world was threatened with a major energy crisis it was rescued by the discovery of two new oil-producing regions, the North Sea and Alaska. These were both huge finds and, better still, were in politically stable regions.
So production from them was fast built up and Opec consequently cut back its own production until it was only running at about 60% of capacity. With excess supply knocking around (Opec couldn't cut back too much - its member countries all needed the money), prices then fell in real terms. Problem solved.
But we'll have no such luck this time round. Production in Alaska and in the North Sea has peaked and production in the rest of the world may well have done the same. Back in 1956, American geophysicist M King Hubbert created a model of all known oil reserves and their lifespans. From this he developed his theory of 'Peak Oil'.
The idea is that when oil reserves are discovered, production amounts are initially small. Then, as the wells become more efficient, oil production increases. But at some point, a peak output level is reached that cannot be exceeded, even with improved technology. Then, the production slowly decreases as the oil gets harder and harder to extract. Finally, it becomes uneconomic to continue drilling at all.
In 1956, Hubbert predicted that oil production in the US would peak between 1965 and 1970 and world production would peak in 2000. US oil production did indeed peak in 1971, and has been decreasing ever since. And a number of oil-industry experts have calculated that the global production of conventional oil actually peaked in the spring of 2004.
Frightening stuff, but is it really true? We think it might be. Although the Saudis claim to have endless reserves, we have only their word for it, as Matt Simmons, author of Twilight in the Desert, points out.
Saudi reserves haven't been audited by anyone other than themselves since the late 1970s and the same can be said of almost all the Opec countries. After Hurricane Katrina, Saudi Arabia admitted that it was not able to increase production to make up for the loss of Gulf of Mexico oil rigs. That doesn't sound like the kind of thing a nation with an unlimited supply of oil to hand would say, does it?
Unfortunately, unlimited supply is rather what the world needs. Scores of developing economies - China, India, Russia, and so on - are in growth phases at the same time, and if they want to end up with the same kind of lifestyles as the Americans (which they do), they need oil. Right now, emerging markets use up tiny amounts of oil. China is consuming only 1.5 barrels per person per year and the Indians use less than one barrel a year each. That figure is 10.4 in the UK and in the US, each rampantly consuming resident gets through 26 barrels a year.
What happens when the Chinese all have enough money to own four cars per household, when the Indians decide that they - like the Americans - cannot manage without either air conditioning or heating on all the time, when the residents of all these countries have fully emerged as gas guzzlers and electricity wasters in their own right?
At the moment, the world uses up 85 million barrels a day, but according to the International Energy Agency (IEA), demand is going to leap 50% over the next 25 years, to 127.5 million barrels a day. Right now, the world produces a mere 1.5 million barrels a day more than it consumes, so to meet that demand without the price going sky high, the world is going to need to discover a lot more easily accessible oil than anyone thinks likely today.
None of this is to suggest that the world is actually running out of oil. It isn't. If we've just passed peak production, that means we've got the same amount left to use up as we have already used up - and we've used a lot.
But the world has run out of cheap oil. We can extract oil from the shale around the coast of Scotland and we can squeeze it out of the Canadian oil sands, but we can't do that for $20 a barrel.
And getting oil out of conventional wells is getting pricier too: according to Goldman Sachs, the price of pumping a barrel of oil out of the ground has increased by $4 a barrel in the last few years, thanks to the fact that in many of the world's wells the oil that can easily be pumped up has already been pumped up. This is one of the reasons the broker gave for suggesting earlier this year that the oil price could hit $100. That price seemed silly to many when Goldman Sachs first published it (its competitors had a field day taking pot shots at its analysis), but it doesn't seem so silly anymore. Demand is high, supply is tight, and that means that the only way for the oil price to go is up.