As decades-long autocratic rule unravels in the Middle East, volatility in the global oil markets continues to point toward one overriding concern: Oil.
Almost two-thirds of the world's known conventional oil supplies are located in the region. How can we maintain an oil flow balance in the face of the rising uncertainty? Most analysts reduce it to a supply equation. If a certain amount of normal deliveries is suddenly withdrawn from the market – say, for example, the 1.6 million barrels a day produced by Libya – what is the remedy?
We look for other readily available sources to pick up the slack.
That's why, while Brent prices are still increasing in London – once again approaching $113 a barrel – the rate of that increase is beginning to level off. Meanwhile, West Texas Intermediate crude (the benchmark for settlement on the Nymex) could be down as much as $1 when the New York market opens this morning.
The Saudis have agreed to replace the volume from Libya lost to the market – actually, lost to Europe, since 80% of Libyan exports move there. Saudi Aramco, the state-owned national oil company, has pledged to move 700,000 barrels into the export flow immediately.
And, with the Saudis, "immediately" does mean just about what the word says. With roughly 2.5 million barrels per day excess capacity of physically available supply, that can be done in a matter of hours from Saudi fields -- translating into a few days or so, when you factor in the transit time required.
Of course, that's only a momentary respite. We still face the question of sustainability in a longer-term crisis. And that may be just what we are looking at here.
With Libya Oil Clogged, We Need a Reliable Surplus
As of this morning, about 80% of the Libyan supply is off-line. Forces opposed to strongman Colonel Muammar Gaddafi are now in control of some pivotal export terminals and port facilities.
Libya is descending into a civil war. That is the next stage in this unraveling – a new dimension guaranteed to prolong the crisis period and provide numerous opportunities for the effect to ignite other countries. Already, we are looking with concern on developments in neighboring Algeria.
Saudi oil cannot quell the disturbances in the streets. But at least it can calm down global oil trade.
Or can it?
Saudi Oil Minister Ali al-Naimi has said repeatedly over the past two years that Saudi Arabia has an upward capacity of 12+ million barrels a day it can move into the market -- and it could do so for the next 88 years.
His comment this week – that OPEC would also meet shortages as they appear – is reassuring but not particularly significant. Other OPEC members are regularly selling volumes in excess of their monthly quotas. The apparent surplus available there is on paper only.
When it comes to any reliable surplus of crude, Saudi Arabia is it.
Russia and Canada Aren't Up to the Task
There are possible non-OPEC sources, too. But they are problematic.
Russia, for example, is now the usual world leader in monthly exports, having displaced the Saudis last year. And the Canadian oil sands provide prospects for additional volume in the longer term.
Yet Russia is facing a rapid maturing of its traditional fields, and significant capex would be required to keep current volume from declining. There may be some marginal help from the Russians -- but not to the extent we may need if an entire region becomes unsettled.
As for Canada, the time element gravitates against a solution. The logistics simply are not there to crank up production rapidly; nor, for that matter, is there a transport network to move the oil where it needs to go. The crisis is erupting much faster than an oil sands solution can be put in place.
So it seems we are back to relying on Saudi Arabia.
Is Saudi Oil Enough?
Now, I am overlooking the Armageddon scenario in all of this. Should the unrest imperil (or even close) transit through the Straits of Hormuz – the primary oil chokepoint in the world – the globe would descend into a mega-economic contraction in short order. (On any given day, about 25% of the world's oil supply passes through the Straits. That includes all of the Saudi supply that cannot be moved by pipeline across the country to Jeddah on the Red Sea.)
But let's say that does not happen and the increased supply is available from Saudi. Is it enough?
Pumping upwards of 12 million barrels a day from Saudi fields is likely to do some serious damage to the reservoirs. And quickly.
Avoiding for the moment the question raised by the late Matt Simmons and others (including myself) as to whether the Aramco resource and field reserve figures are even accurate, the oil market needs assurance that flows are sustainable to avoid rapidly increasing prices.
Personally, what has disturbed me, on each of my visits to Aramco and its fields, is the use of secondary recovery techniques at the very start of field activity.
Put simply, Aramco is injecting water into wells almost as soon as they are open. That always means at least two things:
- Field engineers have immediate pressure problems, and
- The water flooding will damage the integrity of the deposit and lower overall production.
Putting maximum stress on the production network will only intensify this problem.
But there are two other even more pressing concerns right now.
Higher Refinery Costs, Soaring Demand
First, the Libyan exports are light sweet (low sulfur) crude. The Saudi (or OPEC, or Russian) is sour crude (with high sulfur content). It is more expensive to refine and process into products like gasoline, diesel, heating oil, and jet fuel.
So even if the volume concerns are met, the Saudi solution will still mean rising prices for the end user.
But the major problem remains the most basic. Assumptions about increasing Aramco flow to meet production declines elsewhere rally means that we have only about three million extra barrels a day available.
Libya, in full-blow conflict, takes up more than half that amount.
And that excess capacity figure was calculated last year, based on global demand rates. Those rates are now increasing faster than expected.
OPEC itself quietly raised its worldwide demand estimate three times in 2010 – the first time that has ever happened.
By 2012, soaring international requirements for oil may effectively reduce the Saudi surplus to about two million barrels a day. That reduces the effective Saudi surplus after Libyan replacement to about 400,000 barrels a day.
Oil traders make pricing determinations based on forward-looking perceptions, rather than current availability. If demand continues to rise (and it almost certainly will) and Libyan supply remains interrupted, we would need a single new hotspot to emerge in an already troubled Middle East to exhaust the Saudi solution.
Saudi Arabia just may not have enough oil to go around.