Oil: It's All About Supply

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Includes: BNO, OIL, USO
by: Howard Gold

Since popular revolutions started breaking out across North Africa and the Middle East early this year, crude oil prices have taken off.

Entrenched despots in Tunisia and Egypt bit the dust. Libya faces civil war as madman Muammar al-Gaddafi clings to power, while regimes in Bahrain and Yemen feel the heat from populations demanding change.

And uneasy lies the head that wears a crown in the House of Saud, the biggest oil producer of all. Worries about Saudi Arabia’s stability have spilled over into the Saudi stock exchange, which lost almost 7% of its value Tuesday, and is off 16% for the year.

Meanwhile, Brent crude oil futures have soared from the mid-$70s a barrel in July to over $115 Wednesday—and they’ve risen sharply since the resignation of President Hosni Mubarak of Egypt last month.

Now, as unrest spreads, investors wonder how high oil prices can go and what impact they will have.

Tight as an Oil Drum
Federal Reserve chairman Ben Bernanke and Berkshire Hathaway (NYSE: BRK.A) chairman and CEO Warren Buffett think oil and gasoline prices will go a little higher, but not enough to choke off the economic recovery.

“Gasoline prices have remained relatively elevated for some time. As of yet, I don’t see they’ve had much of an impact,” said Elliott Gue, editor of Energy Strategist and Personal Finance.

“I think the US economy is going to be more resilient to oil prices than many people think.”

Mike Jackson, chief executive officer of AutoNation (NYSE: AN), the nation’s largest auto retailer, told CNBC Wednesday he’d seen “no impact as of yet” on consumers’ car buying from higher gasoline prices, now around $3.39 a gallon on average for regular unleaded.

He doesn’t think oil will go much beyond $125 a barrel, nor will gasoline go much higher than $4 a gallon.

“The world may have changed from a political point of view, but from a supply-demand balance around oil, I don’t see any fundamental change,” he said.

Not yet. But globally, supplies are as tight as an oil drum, and that’s what’s giving investors the jitters.

The chart below tells the story about the key producers in the region, almost all of them members of the Organization of Petroleum Exporting Countries (OPEC).

Middle East/North African Countries' Oil Production
(as of January 2011)
Country Production (millions of barrels per day) Spare Capacity (millions of barrels per day) % of Daily Global Oil Production
Algeria 1.27 0.03 1.4%
Iran 3.66 0.04 4.1%
Iraq 2.66 0.05 3.0%
Kuwait 2.32 0.23 2.16%
Libya 1.58 0.22 1.8%
Qatar 0.82 0.18 0.9%
Saudi Arabia 8.6 3.5 9.7%
UAE 2.37 0.33 2.7%
Source: International Energy Agency Oil Market Report
Click to enlarge

Libya, with a population of six million, produced about 1.6 million barrels of crude a day in January, according to the International Energy Agency. That’s less than 2% of total global daily production, which is an estimated 88.5 million barrels this year.

About half of Libya’s production has shut down as rebels have seized control of some oil-producing regions and civil war rages through the country.

Problem is, most major oil producing countries are going at full throttle—except for Saudi Arabia, which the IEA estimates has spare capacity of 3.5 million barrels a day. Saudi officials claim the kingdom is pumping 500,000 to 600,000 more barrels a day—9 million in all—to pick up the slack from Libya.

If the Libyan situation gets much worse or if turmoil spreads to neighboring Algeria, which itself produces 1.3 million barrels a day, the resulting fall-off in production could push Saudi Arabia to the limits of its capacity.

But what about Saudi Arabia itself?

The ability to meet the world’s growing demand for oil hinges on the survival of the House of Saud, the monarchy that has ruled since modern Saudi Arabia’s beginning in 1932.

Can the House of Saud Survive?
Here there’s strong disagreement. Some people who never questioned the regime’s stability before now aren’t so sure.

“Up until two weeks ago, I didn’t think the [monarchy] had a problem. Now, anything’s possible,” said Toby Jones, a historian at Rutgers University who specializes in Saudi Arabia and the Middle East.

“People in Saudi Arabia share a lot of the frustrations that other people in the region [have,]” he continued, “[and] the Libyan political order works much the same way [as the Saudi monarchy does].”

On the other hand, Robert Lacey, author of two books about Saudi Arabia, most recently Inside the Kingdom, doesn’t think the monarchy is in danger.

“The big difference between Egypt and Saudi Arabia is that the ruler is beloved,” he told me. He also said Saudi Arabia was a deeply conservative country where many citizens worry about the “rapid” pace of reform that the monarch, King Abdullah, has instituted in recent years.

A rare November 2009 survey of Saudi citizens showed overall satisfaction with the country’s direction—with surprising support among the young, where unemployment may reach as high as 40%. Saudi citizens share concerns about corruption and economic opportunity with Egyptians and Tunisians, but at least when the survey was taken, they didn’t seem primed for rebellion.

The leading members of the House of Saud are in their late seventies and eighties, and in questionable health. King Abdullah just returned after months of medical treatment in the US.

His anointed successor, Crown Prince Sultan, is also in his mid-eighties and reportedly has Alzheimer’s disease. Former Interior Secretary Prince Naif, in his late seventies, is technically next in line—but he has health problems, too.

And after this gerontocracy, the issue of succession looms large.

“There has to come a moment when there is a new generation of leadership,” said Jones. But, he stressed, “over the long term Saudi Arabia does not have a durable political system in place. It’s a house of cards that will eventually crumble.”

Lacey disagreed, saying the royal family has deep legitimacy because of its close ties with influential tribal leaders and its longstanding, often-controversial alliance with Wahhabism, a deeply conservative form of Islam.

And then, of course, there’s the money. Upon the king’s return, he announced $10.7 billion in social spending, including pay increases for public employees and aid for students and the unemployed in what may be a $35-billion package.

Foreign Policy magazine called it “preventive medicine to ensure that Saudi Arabia does not catch the revolutionary disease.”

We should get our first glimpse of whether it’s working on March 11th, the date a Facebook-based campaign has called for public protests. Don’t expect a repeat of Tahrir Square.

In fact, as an outsider with little knowledge of Saudi Arabia beyond what I’ve read and heard from people I’ve interviewed, my best guess is that we won’t see a popular uprising soon. All that oil money gives the House of Saud lots of “flexibility” Mubarak never had.

Crisis Probably Averted—For Now
That means once the crisis in Libya ends—and if uprisings don’t spread to other big oil producers—we could see the end of this oil-price spike pretty soon.

“I think if things settle down in the Middle East, we could certainly see a quick drop in Brent crude prices,” said Elliott Gue.

“I still think you’re going to have Brent crude oil prices average above $100, and it’s still possible you could see a spike towards $120 later this year,” he continued, while warning that “the risk to the forecast is probably to the upside.”

So, like the House of Saud, we could all buy some time. But the big issue of succession and questions about how much oil the kingdom really has mean that real worries about oil supply—and generally higher prices—may be with us for some time to come.