Changing market dynamics and the near term outlook for oil prices: whither geopolitics?

DATAMONITOR VIEW 1
CATALYST 1
SUMMARY 1
ANALYSIS 2
The high oil prices witnessed in 2008 were the result of the OPEC capacity cushion reaching historically tight levels 2
By any measure, price movements between 2007 - 2008 qualify as one of the biggest oil price shocks in history 2
In the past, price shocks have arisen as a result of supply disruptions 3
There were no major supply shocks between 2005 - 2008; rather, output stagnated whilst demand continued to grow 4
Demand is a function of income - not price; as countries became richer, they consumed more oil thereby increasing demand 5
The growth in oil demand is a function of spectacular economic growth across the world but especially in China, India, Brazil and partly Russia 6
Much of the new demand came from China which nearly doubled its share of global oil consumption between 2000 - 2008, encouraged by subsidy 7
Global output stagnated because certain fields' production went into decline but Saudi Arabia - OPEC's swing producer - did not increase supply commensurately 9
The practical upshot of increased global demand alongside static output from Saudi Arabia was a gradual erosion of the OPEC capacity cushion 10
Non-OPEC supply growth had come from the Russian Federation but under-investment in pipelines and E&P began to make itself felt in 2005 12
In addition to demand and supply fundamentals, financial markets also exaggerated oil price movements although it is hard to quantify the impact 13
The tight capacity margin amplified otherwise insignificant external factors, resulting in higher, more volatile price patterns 15
How can we explain the sudden return to high prices in 2009? 16
Oil prices in 2009 have been erratic and volatile, and are already up to $70/bbl despite the still-fragile state of the global economy 16
Buoyancy in oil futures can be partly explained by slowing rates of economic decline in the West, and an astonishing return to growth in Asia 17
Others point to fundamentals remaining tight; strong long term growth in China & India against a backdrop of hard-to-retrieve supplies 19
Khurais will massively increase OPEC's spare capacity, reducing the impact of supply disruptions elsewhere - whither geopolitics? 20
APPENDIX 22
Further reading 22
Ask the analyst 22
Datamonitor consulting 22
Disclaimer 22
List of Figures
Figure 1: Real and Nominal year-average crude oil prices 1965 - 2009 2
Figure 2: Year on year change in global oil supply and year-average price 3
Figure 3: Year on year change in global oil supply and demand 4
Figure 4: A two-fold increase in a state's income more-than doubles its oil consumption 5
Figure 5: Global economic growth has been unusually high for 8 years, driven by non-OECD states 6
Figure 6: From 1993, Chinese oil demand begins to outstrip domestic production 7
Figure 7: Government subsidy kept retail prices artificially low, spurring demand 8
Figure 8: Output of key non-OPEC fields declined whilst Saudi Arabia stagnated (bpd) 9
Figure 9: The OPEC Capacity cushion declined significantly to 2005 and even in 2008 was low by historical standards 10
Figure 10: Similarly, spare refining capacity had been in decline since 1980 11
Figure 11: Annual change in Russian crude oil output 1996 - 2008 12
Figure 12: Correlation between volume of NYMEX contracts and the price of oil 13
Figure 13: The Value of the Green-bank declined significantly during the oil price spike 14
Figure 14: Sequence leading to high and volatile prices 15
Figure 15: Oil prices in H2'08 collapsed as dramatically as they increased in H1 but are already rebounding at an alarming rate 16
Figure 16: Brent and WTI moving average prices December 2008 to August 2009 17
Figure 17: Global Industrial Production Index (2007 = 100) 18
Figure 18: Brazil, Russia, China and India's economic growth will spur oil demand 19
Figure 19: It is unclear where the new reserves will come from 19
Figure 20: OPEC surplus crude oil production capacity 20