The February oil futures price on NYMEX has jumped $8 a barrel in the last three weeks. It’s useful to try to put this into a broader view of what’s going on in the world oil market.
The immediate impetus for the recent oil price hikes seems to have been unfavorable news developments in three key global hot spots. Iraq’s unsteady oil production has been even less steady than usual. For neighboring Iran, bettors at Tradesports are now putting a 40% probability on tension escalating into a military conflict. A disruption in Iranian oil shipments for whatever reason would likely prove to be a very significant economic event. And turmoil in Nigeria is particularly unsettling given the critical importance of that country’s oil production in everybody’s scenarios for the next few years. Iraq, Iran, and Nigeria together account for about a third of the increase in oil production from OPEC that Cambridge Energy Research Associates is counting on over the next five years.
But it’s also important to try to maintain a longer term perspective. Oil prices have been on a broad and very impressive upswing over the last four years, though up until early 2004 this had only brought oil back up to where it had been in 2000. In accounting for the price surge in 2004, it seems clear that developments on the demand side rather than the supply side played the key role. Global oil production was up 3.3 million barrels per day in 2004 relative to 2003, the biggest annual increase of any year during the last quarter century. And production in the first six months of 2005 showed robust gains over the corresponding months in 2004.
I argued last August that one needs to amend this story to describe developments as 2005 progressed, as supply limitations rather than demand increases came to be the dominant story. Indeed, global production fell by 0.3 mbd in September and 1.1 mbd in October compared with the corresponding months in 2004. In an accounting sense one could attribute all of this to the hurricanes, which resulted in an average of 1.1 mbd of shut-in production from the Gulf of Mexico in September and October. The more complete part of the story, however, is that production increases in the rest of the world failed to materialize to compensate for the lost U.S. production. This fall we were thus seeing the confluence of two forces: demand was declining as consumers adjusted to the higher prices, and supply was declining as a direct result of the hurricanes.
But the need to keep global demand in check remains an ongoing reality. There remains the basic difficulty of reconciling surging demand from China and other developing countries with the practical geological challenges of continuing to increase global oil production. The bumps from each day’s news are important, and could ultimately prove to be events of quite profound impact. But those operate within, and in some ways are themselves manifestations of, a broader context that should not be overlooked. As I stated earlier, I don’t expect a collapse in oil prices even if peace settles like a dove on Iraq, Iran, and Nigeria.
And I’m not exactly counting on that to happen.