Friday, 24 October 2008

The Supply-Demand Principle - Oil (I told you so)

Here is a statistic I like. Almost 60% of the world's oil is produced by non-OPEC members. Yes,
seven of the world’s fifteen largest oil producers, Russia, the United States, China, Mexico, Canada, Norway, and Brazil, are outside of OPEC. Although, production means nothing. The real statistic, is the exports by each country. This is actually where OPEC comes into play, and gets it's political sway. Here is a list of the top 14 oil exporters

Exporters2 Net oil
1. Saudi Arabia (OPEC)
2. Russia 6.57
3. Norway 2.54
4. Iran(OPEC) 2.52
5. United Arab Emirates (OPEC)
6. Venezuela (OPEC)
7. Kuwait (OPEC)
8. Nigeria (OPEC)
9. Algeria (OPEC)
10. Mexico 1.68
11. Libya (OPEC)
12. Iraq (OPEC)
13. Angola (OPEC)
14. Kazakhstan

Source: Energy Information Administration (EIA). .

So, there you go. OPEC dominates the list of exporters, which is what really controls the price of oil world wide, because it simply is the supply and demand basic law. If they control the supply, they control the price: increase supply, price drops, decrease supply, price goes up. Of course, I am making the assumption that demand is relatively constant, which it is, apart from minor fluctuations. Some countries are trying to reduce their oil-dependence (like the Western countries - Britain moving to nuclear like France already has- I talk about it here) yet, other emerging countries, make up for that drop in demand by increasing theirs.

Anyway, there are three core factors worth focusing on, and why I believe Oil is more often an effect rather than a cause.

1) Saudi Arabia: Saudi Arabia, in it's Najd desert, has the biggest oil reserve in the world, estimated at single handily supplying the world with oil for a couple years (of course, this is just an estimation, but is roughly around 30bn barrels ). The importance of Saudi Arabia, and why it has such power , whether in OPEC or on the world stage, is a major player, because it is the only country in the world with the ability to affect the price of oil by increasing its production, not to mention, that the cost of oil extration per barrel is the lowest in the world. (Saudi Aramco, although government owned, would be the largest oil company in the world, with an estimated size of somewhere around $750 billion. (I've seen there oil rigs and sites- massive!) Unfortunately, they are treated as the elephant in the room....

2) Russia : Russia is the second largest exporter, and it, like the third largest exporter Norway, are non-OPEC members. (I'll exclude Norway from the debate, its third on the list but it is much smaller compared to the other two, and it's political placing isn't of much significance- apologies to Scandinavians...) Although, Russia, unlike Saudi Arabia, has two fundamental problems: Size and Weather. Russia is by far the largest country in the world, with around 17 Million Square Kilometers, and well, we all known what Siberia's weather is like. Those two issues are of significant importance because digging for oil can be a very risky business, and oil rig engineers are highly skilled people that don't come cheap. Operating at below zero temperature doesn't make it ideal conditions, neither does middle-of-nowhere sites that, due to extreme whether conditions sometimes maybe shut down or suspended, in addition to the transporting oil and pipelines that can freeze up isn't great. That's one advantage Saudi has over them- heat, although can be scorching and uncomfortable, but operating in 50'C is better than operating at -30'C temperatures. Cost of extracting a barrel thus runs higher.

3) The United States : Surprisingly the USA, when it comes to the oil game, contrary to popular belief, it has no real say. It is by far the largest oil consumer, at around 20 million barrels/day, which in itself is a mind boggling number. So, when you are consuming more than what the 3 biggest exporters can send you, then you're kinda under the mercy of the oil barons. Well, we all think the mighty USA doesn't bow to them- no, of course not, but, it has to use its political and military sway to pressure these countries, as it cannot play the oil game alone. So, basically, besides ma man Obama making phone calls to Opec and Mr. Medvedev (or Putin hehe), he can't really do anything. Well, sure, the US oil companies have huge investments in Saudi and around the world, but well, that doesn't necessary translate into patriotism in a capitalist economy, does it? Now, back to the supply-demand game, the USA can reverse the game and drop its consumption and thus cause a drop in the oil prices , because well, if no one wants something, the price falls, but we all know that's difficult to achieve, not with uncle Joe, John McCain's midwest cousin driven his truck all around up and down Cleveland.

Again, I say it, oil is an effect, not a cause. So, now the credit crunch has hit the world, and the whole world economy is slowing down, surprise surprise, the oil prices, which hit a record high a while back, have began falling, because, well, production by industry world wide has slowed, and so has uncle Joe in the midwest, decided that ordering take-out maybe a cheaper option than driving to McDonalds.

So, to keep a bit of the supply-demand balance, OPEC decided to cut its production. (Although, i think, the hell with it, lower the prices back more, maybe the world economy moves again!)

And that's what happening. I didn't say it, Bloomberg did. see!

p.s.: In line with what I said, Saudi Arabia cut its production most :)

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