World Oil Market Oversupplied?

posted by Nicholas Cunningham on June 15, 2012 at 9:06 am

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The three most recent price spikes in the oil markets (2008, 2011 and 2012) sparked concerns that the global oil markets would not be able to satisfy the world’s insatiable appetite for oil. But, high prices typically do not last long, and prices dropped in all three cases almost as fast as they rose.

In all three situations, price spikes caused some demand destruction as consumers reached the limits on which they were willing to pay for gasoline without changing behavior. Clearly, a cratering global economy also contributed to a decline in oil demand including the ongoing Eurozone crisis.

However, many analysts believe that oil oversupply is also a major factor in driving down prices.

Global oil production has surged in the last two years, reaching an all-time high of 88.9 million barrels per day this year (see graph below).

Oil production is booming in the Bakken in North Dakota, allowing it to surpass Alaska as the U.S.’s second largest oil producing state. As Daniel Yergin recently noted, “[I]n 2011, the United States registered the largest increase in oil production of any country outside of OPEC.” With surging U.S. oil production, analysts and policymakers have U.S. energy independence in their sites.

But, perhaps most importantly, Saudi Arabia has rapidly ramped up production. It produced a record amount of oil in the past year to offset lost production from Libya. Even though oil production in Libya has recovered, Saudi Arabia has kept output up to offset a potential decline in Iranian production from western sanctions. An oil embargo of Iranian oil by the European Union is set to take effect on July 1.

Higher oil production over the last few months has resulted in world oil production exceeding demand for the first time since 2005 (see graph below).

In addition to Saudi output, geopolitical tensions between the U.S. and Iran have eased, causing prices to plunge from $128 per barrel of Brent crude just a few months ago down to its current level of about $96 per barrel.

Therefore, analysts were closely watching the latest meeting of OPEC, which met Thursday in Vienna.  OPEC is a collection of 12 major oil producers, mostly in the Middle East, and they make collective decisions on output in order to reach their price targets. Saudi Arabia acts as the “swing” producer, essentially the central bank of oil, ramping up or cutting back on production to maintain price levels.

OPEC agreed at Thursday’s meeting to keep its production ceiling at 30 million barrels per day due to ongoing economic weakness in the global economy, despite calls from some members to cut production.

Although OPEC attempts to speak with one voice, it is not a monolith, and members often disagree. Several countries, including Iraq, Venezuela, and Iran were calling for a cut in output to boost prices. For these nations, oil represents the vast majority of their export revenue. Venezuela has called for oil to stay above $100 per barrel and it is believed that Iran needs oil prices to stay above $100 in order for it to balance its budget. Iraq has also said that prices between $100 and $120 per barrel are “reasonable and acceptable.” However, enough members resisted a production cut.

The latest decision will ensure that oil markets are oversupplied, at least in the short-term.

 

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