x Abu Dhabi, UAETuesday 23 January 2018

Have we entered an era of oil incapacity?

World energy consumers must come to terms with the fact that they are one major crisis away from a shortage in supply.

This week, what might be called the energy industrial complex - the world's investment banks, consultants, government agencies, sovereign wealth funds, cartels and think tanks - will all be putting the finishing touches to reports to help shareholders, policy makers and consumers understand what to expect of global energy markets next year.

The best thing that can be said for these efforts probably is that 100 per cent of these reports have a 100 per cent chance of being wrong. Some specialists who concentrate on a particular country or region may nail their dismount, but prices look increasingly detached from what used to be called fundamentals.

More than ever, energy analysts must concede that they cannot possibly discount enormous upside and downside risks to their forecasts, brought on by the combination of factors completely out of the control of producing or consuming nations. And let's face it, if a spike to US$150 per barrel is almost as likely as a collapse to $65 a barrel, of what use are forecasts?

Pity these prognosticators for a moment. Just a short list of the intangibles hovering over their work would include, on the demand side: slowing growth in China; continued anaemic growth in the United States, Japan and Europe; increasing energy efficiency in the developed world; the threat of a break-up of the heavily indebted euro zone; and the increasing effectiveness of sanctions on Iran.

On the supply side there are similar variables: a steady drumbeat of new gas and oil discoveries in Africa and South America; the entry in earnest of Brazilian oil onto markets; the US-led revolution in shale gas; and tight oil technology that has turned the assumptions of just five years ago on their heads.

All this uncertainty - even the somewhat overblown risk of an Israeli strike on Iran's nuclear programme - might be manageable if not for one inconvenient fact: for the first time since the late 1960s, no government, corporation or cartel can realistically claim to have the spare capacity to backstop global demand in a sustained crisis.

Opec, which held a key meeting in Vienna last week, says there is no crisis in capacity. Its 2012 World Oil Outlook insists that it has the ability to provide a comfortable cushion of spare capacity in case some crisis should occur.

When the US Energy Information Agency earlier this year downgraded its estimates of Saudi excess capacity to barely 2 million barrels per day (bpd), the Saudi oil minister Ali Al Naimi insisted the number is 2.5 million bpd - even with the kingdom already replacing Iran's lost market share. And Opec projects its total spare capacity at 5 million bpd. It would be fair to say no one believes either figure.

Even if the higher figures were accurate, however, they still pale when compared to the size of the potential problem. Global oil demand, even in a lagging global economy, is 88 million bpd and has risen steadily, right through the global downturn, since 2000.

Analysts generally believe that to hold a credible ability to affect markets, producers must be able to increase supplies by 5 per cent of global demand (or 4.4 million bpd) within 30 days and sustain it for 90 days. Simple maths has led an increasing number of analysts to understand that this is beyond any one producer's ability.

Many came to this realisation over the past five years after running scenario analyses on the market impact of an Israeli-Iran war, which in extreme cases could include retaliatory Iranian strikes on regional oil and gas fields.

Robert McNally, the president of the Rapidan Group consultancy in Washington and a former White House international energy official, says that even if the US and European Union unleashed their full strategic petroleum reserves, the Saudis could not hold the line in such radical scenarios.

But it would not take disruptions as dramatic as war to create serious gyrations in global energy markets over the next decade or so. A major hurricane in the Gulf of Mexico, unrest in Angola, Mexico, Venezuela or Nigeria are just a few of the not-so-unlikely scenarios that could play havoc with prices. At the same time, raising non-Opec oil sources suggest that Opec may also lose its grip on the ability to support prices in slack times - and given the unpredictable performance of the world economy since 2007, this cannot be ruled out either.

"We're in a period today that has almost no parallel in living memory, where no cartel can cap the price of oil," Mr McNally says.

The last time this was true, he says, was in the first decades of the 20th century, when the US progressive movement had forced the break up John D Rockefeller's oil trust. Not surprisingly, oil prices gyrated wildly for a decade, when the then-US president Franklin Roosevelt empowered the Texas Railroad Commission (TRC) to have a hand in setting prices.

In collusion with the major US, British and Dutch companies, the TRC held sway over oil markets until the end of the 1960s. At that point it became clear that US consumption would outstrip output. In 1972, the TRC ordered full production, opening the door for Opec and ultimately Saudi oil hegemony.

Mr McNally and others now argue that this period, too, has come to an end. "In 2008, for the first time, Saudi effectively ran out of spare capacity during peacetime," he says. "This is a watershed - it ushered in a new period of very low spare capacity that will mean markets range widely with very little ability by producers or suppliers to affect price levels."

All of which means the business of energy prediction - in 2013 and beyond - is in for quite a ride.


Michael Moran is the chief editor and geostrategy analyst at the investment bank Renaissance Capital and author of The Reckoning: Debt, Democracy and the Future of American Power