Fear factor inflating oil prices

Don Stowers, Editor-OGFJ

Oil markets are running scared. That seems to be the consensus of a number of industry observers, including the US Energy Information Administration. Why else are prices so high when there are no real shortages?

The EIA recently reported that US commercial inventories of crude oil totaled more than 332 million barrels - more than the average inventory for the comparable period (first week in August) from 1983 through 2005, which was 326 million barrels.

Several analysts that I respect have told me recently that when oil reaches $70 a barrel, as much as $20 of that price can be attributed directly to geopolitical concerns. In other words, if the global situation were more stable - especially in the Middle East - oil futures would be trading at closer to $50/bbl.

Here are a few of the reasons oil buyers are afraid:

• Iran - OPEC’s second-largest oil exporter could choose to withhold supplies or close the Strait of Hormuz, disrupting the flow of oil from the Persian Gulf.
• Iraq - Continued attacks by insurgents are preventing an estimated 1.4 million barrels per day of oil from reaching world markets.
• Nigeria - Attacks by rebels and criminals have taken at least half a million barrels per day off the world market.
• Venezuela - Production in this largest oil exporter in South America is still rebounding from a strike in 2002. In addition, President Hugo Chavez is throwing out bids from many US and European countries in exploration agreements in favor of China and Russia. Although 60% of Venezuelan heavy crude currently is shipped to the US, Chavez is looking for new customers and may have found them in China.

Speaking before a group of oil and gas industry executives during Summer NAPE in Houston on Aug. 24, Tom Petrie noted, “Geopolitics has come back to the fore in a way we haven’t seen since the 1970s.” He added, “We have entered a period where rotating chaos seems to be the norm.”

Petrie, chairman and CEO of Denver-based Petrie Parkman & Co., told the crowd at the company’s twice-annual A&D breakfast that the Middle East remains the focal point of geopolitical instability, but he cited Nigeria and Venezuela as other oil-producing countries whose political actions and commercial alliances can impact world oil prices.

The growth in energy demand, driven by China, India, and the rest of Asia, has cut into spare capacity, said Petrie. He pointed to a graph that showed the huge difference between world oil production, which is at an all-time high, and spare capacity, which is at or near an all-time low.

Plenty of oil buyers are stockpiling and paying premium prices for future delivery because they believe oil prices will rise even higher. This kind of “defensive buying” contributes to the spare capacity problem and boosts prices artificially.

Rebuilding spare capacity is critical, Petrie concluded. “We can’t do much about geopolitical issues, but we can work to rebuild that cushion,” he said.