Oil prices have rocketed about 70 per cent in three months. With demand still declining, that owes much to a revival of financial market spirits. But there's something else: supply capacity, especially from the Organisation of the Petroleum Exporting Countries, is shrinking. With demand recovery in mind, that's a reason to bid up the price.
Opec on May 13 projected global demand this year at 1.83 per cent below 2008 levels. Oil inventories are also running well above historic norms — 60 days' supply at present — in the wake of weak first-quarter demand. However, appetite for oil is expected to pick up later in the year, with fourth quarter demand less than 1 per cent below 2008’s level.
As for supply, the Energy Information Administration forecasts Opec’s 2009 supplies at 33.5m barrels/day, down 2m barrels/day from 2008. But supplies from Opec members were unexpectedly low in the first quarter at 28.7m barrels/day, and dropped further in April. Such a large supply shortfall, if ongoing, would tend to push the oil price higher.
There is some potential for countries like Saudi Arabia to increase production if demand — and prices — take off again. But that fliexibility is less obvious elsewhere in Opec. For example, the Venezuelan government has nationalised oil output, giving control to the state oil company Petroleos de Venezuela. Pdvsa’s crude oil output declined by 12 per cent in 2008, in spite of high prices, suggesting Venezuelan production is likely to continue below its potential.
In Nigeria too, unilateral changes to oil royalty contracts and continued unrest in the Niger Delta have caused a substantial and apparently worsening production shortfall. Iraq, for its part, has failed to pass legislation allowing rapid development of its huge reserves.
Non-Opec oil supplies should increase over time, particularly from Brazil. But that increase may be slower than expected, because recent price declines led to the cancellation of several huge Canadian tar sands projects.
Governments have massively expanded the money supply to fight recession. Those policies could also be boosting oil demand. While supply runs below forecast, that ought to add to the upward pressure on prices. That suggests higher prices could prove somewhat sticky, even if investors lose some of their recently rediscovered appetite for risk.