Inside oil

11 April, 2005

The overall global perception is that oil is a finite and diminishing resource - and it is in Opec's interests to maintain the perception to justify a high price.

In fact, there are huge potential reserves:

• Certainly in Iraq and in Russia, where legal uncertainties have discouraged foreign exploration
• Still, possibly, in Saudi Arabia
• Maybe in Iran and Kuwait
• Other reserves - such as the immense Orinoco tar basin - will become viable as the price rises.

Refining

The most immediate concern, however, is refining capacity.

Only a handful of countries have sufficient refineries to produce the light crude oil needed in the United States. Among them is Venezuela, with whom, however, Washington is engaged in a political tug-of war.

Expanding refinery capacity in America has been brought to a standstill by environmental considerations. In the Gulf, it is static.

Refining could be greatly expanded in Russia. So could it be in Iran - but this seems unlikely given the state of American relations.

It takes a couple of years to expand refining capacity significantly. So the shortage heralds the prospect of another price surge unless growth in world demand slows down appreciably.

Trade

The greatest underlying worry for the energy-dependent United States is the increasing tendency of oil producers to engage in direct trade with favoured consumers, bypassing world markets and the Opec price system.

Though binding on its members, this can easily be flouted and is not binding on non-members.

Thus Venezuela, traditional supplier of anything between a quarter and a half of American light crudes, is increasingly favouring other Latin American nations and potentially the Chinese (though transport costs to the Far East may be prohibitive).

The Russians are gearing up to supply the Japanese and Chinese markets preferentially.

Iran is also engaged in direct deals with both China and India, including a huge gas pipeline project to the latter which has raised American hackles.

Russia is also giving favoured treatment to Germany and parts of Western Europe.

US problems

All of which leaves the United States floundering to secure a stable source of supply from the Middle East.

While Saudi Arabia has long been a reliable provider, the kingdom is wobbling somewhat politically.

American planners are eager not to find themselves with too many eggs in this particular basket - a consideration which makes Iraq and its reserves particularly attractive since that country potentially houses the world's largest major reserves of light crudes.

Outlook

The long-term outlook is for a steady, inexorable rise in oil prices, hobbling world economic growth, followed by a falling demand which would eventually reduce oil prices.

This might just persuade producers to abandon their decades-old miserliness in exploration, outlined in our previous report - and embark on the development of new fields, production and refining capacity.

That would enable the world to escape from one of the most destabilising factors in the modern global economy.