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Editorial comment

Just in case anyone was in any doubt, recent events have once again provided a poignant illustration of the significance of crude oil and its indisputable position as the world’s most important traded commodity. The increasingly fine balance between supply and demand, driven by a number of rapidly expanding Asian economies, most notably China and India, coupled with a deep seated fear of supply disruption amongst energy traders, mean that any event that risks an outage, inevitably leads to a marked upswing in the price of crude. With much of the world still struggling to regain its feet after the recent global recession, an escalation in the price of crude oil has exerted considerable pressure on the fragile global economic recovery. Brent crude stood at US$ 122 at the time of writing, up from just below US$ 95 at the close of 2010.

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This pattern is of course not unfamiliar. Let’s not forget, crude prices rose rapidly over a very short timeframe on the back of increasing Asian demand in 2008 to a high of US$ 147. However, events of the past year have been akin to a ‘perfect storm’ for the energy industry. From the Deepwater Horizon drilling rig explosion on 20 April 2010, and the ensuing moratorium on drilling in the Gulf of Mexico, to the ongoing, and far from resolved, chaos in the Middle East, and finally the devastating earthquake, tsunami and nuclear catastrophe in Japan, the energy industry has been thrown into an acute state of uncertainty and governments are being forced to re-evaluate their energy policies.

Whilst Opec has been able to compensate for the 1.6 million bpd of lost crude production from Libya, its overall spare capacity is fast being eroded. It is also struggling to match the high quality light crude that Libya was producing causing more pain for refiners who are forced to compete for scarcer resources. If problems within the region persist and spread to other nations across the Middle East and North Africa, then Opec’s available reserves will quickly dwindle. Saudi Arabia, Opec’s largest producer and source of the majority of crude reserves, looks vulnerable at present with developing disturbances among many of its near neighbours including Bahrain, Jordan, Oman, Yemen, Syria and Jordan. So far, Saudi’s solution to internal strife has been the populist measure of providing hand outs to its citizens and boosting public spending. An action that will cost Saudi Arabia a total of US$ 129 billion or the equivalent of half of the country’s 2010 oil revenues. Whether this works remains to be seen, but without doubt it will lead to higher oil prices as Saudi seeks to finance this huge public expenditure, plus there is the danger of less investment in future production capacity, again leading to higher prices.

Price rises have not been limited solely to crude oil, with significant increases being seen in natural gas rates as Japan, the world’s largest buyer of LNG, has boosted imports following the damage to its Fukushima nuclear facility. With radiation still leaking from the plant, this crisis remains critical and has potentially set the nuclear industry back years. Germany, the US and even China have each put their nuclear programmes on hold which can only put more pressure on future oil and gas prices.

An end to the turmoil in the Middle East is vital to a stable oil price. Why? Because according to the IEA, the Middle East and north African region will contribute 90% of crude oil production growth over the course of the next 10 years, and if crude oil is the world’s most important traded commodity, then this region holds the key to crude production. For the first time, Opec, largely comprised of members from the region, will amass US$ 1000 billion this year in export revenues if the price of crude remains above US$ 100 a barrel. My guess is that it will achieve this milestone and more. Let’s just hope that the fledgling global economic recovery can withstand the pressure of an extended period of higher oil prices.

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