The Economic Situation (9) - Bad News about Oil

1. Although Americans have cut back on their gasoline consumption, it is not clear that this can be sustained. The American suburban lifestyle cannot function without cheap gasoline. Americans may not be able to change their lifestyles sufficiently to bring about a permanent drop in dependence on oil. If gasoline prices drop a little, they will probably hit the hammer again.
2. The weakening of the American economy is reducing demand for oil. The problem is that this could be temporary. When the economy returns to full health, most of this demand for oil will be restored, putting upward pressure on prices. If the recession is short, the demand for oil will recover quickly.
3. Oil production has slowed over the past few years. I am not sure if we are anywhere near peak oil, but there is no doubt that the easy oil has already been pumped.
4. A serious problem is that no one knows the size of Saudi Arabian oil reserves. When the Americans were kicked out of Aramco in 1979, the Saudis had proven oil reserves of 50 billion barrels. Since then the Saudis have increased their reserves to 260 billion, despite not find a single new oil field. In the past ten years, they have pumped at least 50 billion barrels of oil, but their reserves are never adjusted down. The problem is that the Saudis do not allow any outsider to monitor their production or authenticate their reserves. Their reserves may be much smaller than they claim. When the truth emerges, the world might be oil shocked.
5. Nigeria has become an important oil producer, but the political situation in the oil producing areas is increasingly unstable. Oil workers have been kidnapped and oil pipelines have been destroyed.
6. Iran is an important oil and gas producer. Any military action against Iran would disrupt Iranian oil production. Iran might retaliate by closing the Straits of Hormuz through which half of OPEC oil must pass. This would blow out the price of oil.
   
   The problem is that Prime Minister Ehud Olmert of Israel, President George W Bush of the United States and President Mahmoud Ahmadinejad of Iran are all weak political leaders with declining domestic political support. They are all shoring up their weak political positions by pointing to foreign enemies. Despite the current posturing by the leaders of Israel, the United States and Iran, I expect wiser heads to prevail. I do not believe military action against Iran is likely in the next decade, but every time that war is threatened the price of oil will go up.
7. The United States has already pumped all the easy oil. Even if the law is changed to off-shore drilling, the new oil will be more expensive to extract.
8. The North Sea fields operated by Norway and the UK are being depleted quickly.
9. Russia has immense reserves of oil in Siberia, but they may not have the technical capability to extract and deliver this oil to market.
10. Central Asia has large reserves of oil and gas, but transport is difficult.
11. The big unknown is Asia. Will the Chinese economy turn down? This is the key question, but no one knows the answer. The developed world will certainly import fewer goods from Asia. However the new Chinese middle class are starting to spend and consume in a serious way. The growing demand from Asia may compensate for the declining demand from the west.
12. In the long term, demand for oil from China and India will be huge, if they continue to develop at current rates.