Invitation to An Energy Crisis

DALLAS – As rising consumption and nationalism in OPEC countries pushes down their crude-oil exports and forces international oil companies to invest in high-cost areas with small reserves as global demand continues to grow, oil prices might ultimately shatter the record set in 2008. In the short run, heightened volatility will be the rule, owing to economic, political, natural, and technical factors. One has only to examine the recent past to see why.

While speculators can affect prices in the short run and increase price volatility, market fundamentals and government actions explain the spectacular rise in oil prices between 2003 and mid-2008. During this period, world oil demand increased, mostly in developing countries, while production remained relatively flat from 2005 to 2008. The only way to meet growing demand was to use OPEC’s spare capacity and commercial inventories. Once spare capacity vanished and commercial inventories declined to critical levels relative to estimated future demand, oil prices started to break record after record.

Let us consider some details. First, world crude-oil production declined by 266,000 barrels per day in 2006 and 460,000 b/d in 2007. Meanwhile, world oil demand increased by 1.2 mb/d in 2006 and 937,000 b/d in 2007.

Second, the difference between actual output and what the markets expected magnified the impact of falling production. For example, forecasts at the end of 2006 predicted an increase in world oil production of 1.8 million b/d in 2007, but production actually decreased by 460,000 b/d. The market factored in the missing increase and thus reacted to a decline of 2.26 million b/d, not the actual decline of 460,000 b/d.