The answer is pretty simple, really– demand keeps going up but supply doesn’t.
The above graph plots global production of crude petroleum. Historically, the long-run upward trend was interrupted only by recessions (bringing down demand) or temporary supply disruptions arising from geopolitical disturbances. But even in the absence of such events, world production failed to increase during 2006 and is down slightly so far in the first 7 months of 2007 compared with the first 7 months of 2006.
One can look in more detail at the contributions of individual oil-producing countries to this stagnation in global production. Within the OECD, Canada was able to increase oil production by 0.2 million barrels per day in 2006 compared with 2005, thanks to booming production from its oil sands. But this was not enough to offset declining production from the North Sea, which is in a chronic downward trend due to depletion:
Comparing the first six months of 2006 with 2007:H1 one sees a similar story. U.S. production gains this year were added to those from Canada, but both were more than offset by an acceleration of the decline in Norway and the clear depletion now setting in for Cantarell, the main Mexican field.
Within OPEC, there has been good news from Angola and Iraq, which would have been enough to compensate for the turmoil in Nigeria. But all this was swamped by the 400,000 b/d cut in Saudi production during 2006, on which we’ve commented at length here, noting that it coincided with a big increase in their drilling efforts and circumstantial indications that production from northern Ghawar (by far the most important historical source of Saudi production) is declining due to depletion.
The same trends continue through the first half of 2007:
If production is down overall within both the OECD and OPEC, how did we manage to keep global production from actually falling? The answer has been solid production gains from the former Soviet Union areas, whose production increased 400,000 b/d in 2006 and almost an additional 700,000 b/d in 2007:H1.
Total global production may have stagnated, but demand has not. Demand for oil from China has continued on its exponential trend, growing more than 8% in 2006. Whereas Chinese consumption accounted for 3.4% of world demand in 1990, it now represents 8.6%. And if Chinese consumption has increased with global production constant, that means oil use by all the rest of us must decrease. For example, U.S. petroleum consumption fell 200,000 b/d during 2006. And what persuaded Americans to do that? Higher oil prices.
You mean it’s as simple as supply and demand? Yes, I do.
But what’s going to change the situation? Unfortunately, that’s a harder question.