Ever since oil lifted over $50 I’ve been saying that speculation is the cause. Actually, the lower dollar (caused by speculation) is a good part of the cause and inflation speculation is the rest. What is not driving oil up, it seems, is actual supply and demand. That’s the assumption in the market, anyway, and it’s probably correct.
But there are some fundamentals influencing oil to the upside that are worth noting. One is Nigeria and the other is Venezuela. Both have collapsing governments and economies that have been well noted in the press but I think the combination merit some consideration as a bit of fundamental winds to the upside for oil pricing.
In Nigeria, the government has started a new chapter in the MEND saga. That’s the group of guerrillas in the oil-rich southern Delta swamps that steals oil (reportedly in cahoots with elements of the national army), supposedly for the benefit of impoverished locals but also largely for their own coffers. The locals get all the pollution but few jobs and few benefits from the royalties which go to the central government in the north. Now the federal military is taking on MEND in direct combat for the first time, saying they want to eliminate them.
MEND is putting up a good fight against the military. In addition it has shut down a lot of Nigerian oil production, thus far having stopped about half of Nigeria’s 2.4 mb/d capacity. MEND is now vowing to shut down the entire Nigerian oil industry. That’s a lot of oil off the market and there could be a lot more. Nigeria’s oil is prized for it’s high quality and a lot of it goes to the U.S.
In Venezuela oil production has been falling over the past year as major contractors like Exxon-Mobil have had their production contracts canceled. Recently Chavez seems to have gone off the deep end, no doubt because reduced oil prices compared with last year and reduced oil production are combining to put a severe strain the on the supply of dollars flowing into Chavez’ treasury. He depends on federal bribes to keep him in power. As Mary Anastasia O’Grady, the Wall Street Journal’s expert on South America wrote today in a piece titled “Chavez’s Cash Crunch”, Chavez requires a generous helping of oil-generated dollars to keep his government alive.
Indeed, the Venezuelan economy itself, as well as the government, is starving for dollars because, as O’Grady writes, the country depends on imports for a great deal of its food and other living staples; imports must be purchased in dollars. Increasingly oil is the only viable Venezuelan export that produces dollars to pay for imports. Chevez has strangled a good deal of the free market and entrepreneurial spirit out of the Venezuelan economy.
Recently Chavez has sent his military to take over more oil production assets of foreign companies as Venezuela has struggled to pay their charges. One problem with this expropriation strategy is that the companies seized employ fairly sophisticated technologies for re-pressurizing old fields that would otherwise decline rapidly. O’Grady says that Venezuelan oil field personnel lack the sophisticated skills needed to keep this equipment operating. Without it, Venezuelan oil production could decline much more rapidly than it already has done over the past year.
In addition to falling production, Venezuela has made deals with China to ship increasing amounts of Venezuelan crude to them instead of to their traditional market, the U.S. Thus there are several forces working against the ability of the U.S. to access two of its primary suppliers, Nigeria and Venezuela. This adds to the oil import problem America already faces with its two largest suppliers, Canada and Mexico. Canadian production is flat. Anticipated growth in oil sands production has been put on hold. In fact, environmentalists are trying to prohibit the importation of oil from the oil sands. Meanwhile Mexican exports are falling rapidly as their fields decline, as has been frequently discussed in the press lately.
To some extent these impediments to oil imports from Nigeria, Venezuela, Canada, and Mexico may help account for the recent fall in U.S. oil inventories. Or perhaps not. I’m not sure anyone knows that definitively. It’s hard to believe that there is actually any real shortage of oil supplies, given the substantial recession-induced drop in demand: probably 3 - 4 mb/d globally and 1 - 1.5 in the U.S. Nonetheless, these forces for lower oil supplies are worth bearing in mind as we see the oil price climb once again.
I’m not suggesting that speculation and the lower dollar aren’t the main cause of oil rising. They are, and because they are, there could be a substantial pull back in the oil price because there is still very likely a substantial glut in the short term oil supply. But there are a few elements of fundamental supply shortage starting to creep in to the market.
