Kiran Stacey Amrita Sen answers your questions – Part one

In this week’s readers’ Q&A session, Amrita Sen, oil analyst at Barclays Capital, answers your questions.

In the first of two posts, she discusses whether speculation is driving up the oil price, whether such an increase could trigger another recession and when “peak oil” might occur.

Later, she will discuss drilling in the US, national oil subsidies and growing demand from the Middle East.

(NB – Because of a very high volume of questions, we were not able to tackle every question submitted. Apologies if yours was not answered.)

Next week, Michael Bromwich, director of the US oceans regulator, will be answering your offshore-drilling queries. Email questions to by the end of Sunday, April 10th.

But for now, over to Amrita:

Oil speculation

Are current high oil prices due to market fundamentals (high demand from China/India and stagnating production…) or is speculation the cause?
Lionel Badal

Very clearly, the former. More than anything, the growth in oil demand has been the single most dominant factor over the past 18 months.

Global oil demand is now 4.5m barrels/day higher since the bottom of the economic cycle. The scale of the 2010 demand shock was highly significant, witnessing the strongest growth in 30 years. It has surpassed the previous peak in 2007 by 1.4m b/d, a year after the worst recession in living memory, when consensus expectations expected that zenith to be reached at the earliest in 2013 – such has been the dominance of emerging market nations at the margin of the oil market.

These countries have a far higher threshold for higher prices (ie low price elasticity) and are geared towards rising income (ie high income elasticity) with the quest for urbanisation and industrialisation dominating. Moreover, as a whole, oil has moved to sectors that are significantly less price sensitive (for example transport), primarily due to the lack of substitutes.

That said, the strength in demand has been broad-based, with OECD oil demand also showing its first year of growth in five years. Since the start of last year, consensus estimates of the annual demand growth have been revised higher to the tune of almost 1.5m b/d on average across the IEA, EIA, Opec and Barclays Capital balances.

In a world where demand has resulted in the steady erosion of spare capacity, the loss of Libyan output and general unrest in the Middle East has added further volatility and anxiety in the market, putting further upward pressure on prices.

The loss of Libyan output and general unrest in the Middle East has added further volatility and anxiety in the market

A level of sustainable spare capacity below 4 per cent (which it is currently) does not constitute an entirely comfortable level for the physical market to operate under. In our view, a large proportion of Libyan exports can be reckoned to be out of the market for an extended period, and unless demand growth starts to show a fairly severe and rapid tailing away, we would expect the cushion of spare capacity to erode further.

Saudi capacity

Saudi spare capacity is usually quoted in the 3m b/d range. Do you think this is an accurate sum or has it been inflated to assuage Opec and world oil market watchers?
Benjamin Dow

It would be fair to say that the current Saudi spare capacity is in the range of 3m b/d. We currently peg it at around 2.6m b/d. Of course, increasingly, with the global oil markets becoming reliant upon Saudi Arabia for supply-side balancing, questions about the sustainability of production and its ability to invest in new capacity have been raised regularly.

Sceptics have argued that Saudi Arabia has very high rates of decline in existing fields, particularly given its historical reliance on the enormous and unparalleled Ghawar field. But thus far, Saudi Arabia has been able to continue to provide the main shock absorber with the global oil system.

A Saudi oil workerOver the years, Saudi Aramco has successfully replaced annual depletion in production with new reserves, and the kingdom has strived to keep 2m b/d as the optimal buffer in spare capacity for the oil market. A raft of new projects have been brought on stream between 2008-2010 to ensure enough flexibility in the Saudi production system to manage any undesired price rise, and the level of market confidence surrounding the actual existence of that flexibility is higher.

But the question of Saudi Arabia’s position with reference to the maintenance of its output profile has come into the limelight in recent weeks as the result of two related events.

Firstly, there have been reports that Saudi Arabia has detailed to oil services companies a plan to boost the rig count within the Kingdom by 28 per cent over the next two years. Secondly, there have also been reports that a decision has been made to speed up the start date of the 0.9m b/d Manifa oil field.

We view these reports as being indicative of the initiation by Saudi Arabia of actions to speed up the availability of current production and maintain current capacity, in order to ensure the continuation of flexibility in production volumes.

Oil price outlook

What is the impact on the global oil price in the next couple of years, given the conflict in Libya and the stretched Opec supplies?
Abhijit Sen, Abu Dhabi Oil Refining Company

Even before the upsurge in geopolitical risks, we had expected global oil spare capacity to decline steadily out to 2015, putting upward pressure on prices.

The large inventory overhang that kept a comfortable cushion at the margin of the market has disappeared, too, with OECD inventories now below the five-year average. Not surprisingly. against this fundamental backdrop, the current plethora of geopolitical events is adding a further layer of instability and volatility to the oil market.

Stretched Opec spare capacity is key. Once that buffer starts eroding, the ability of the oil market to absorb supply shocks can reduce sharply, with the opposite effect on price volatility and market sentiment. As soon as perceptions of global spare capacity become the key driver of price levels and volatility, the fear of unlikely but extreme outcomes among Gulf producers takes on a role that can transcend the oil market and spread into other assets.

In short, we should expect a longer-term increase in prices unless a new technology comes along to change the way we use energy.

Demand collapse

Will high oil prices break the back of demand? Can the market only rationalise through demand as IOCs suggest? If so, which plays do you see as the most risky?
Lorne Stockman, research director, Oil Change International

With oil prices pushing back beyond the $100 per barrel level in a volatile environment, the once dominant view that oil price spikes will swiftly derail the economic recovery is on the march again, with the key conundrum in the market underlined by whether this is a repeat of 2008.

In my view, the relationship between oil and the global economy has changed significantly. This is because oil demand has moved towards less price-sensitive sectors (transport) and less price-sensitive regions (the non-OECD). Transportation is now the single largest user of oil (accounting for 50 per cent of global oil demand) and the largest source of incremental demand (accounting for more than 90 per cent of consumption growth over the next 20 years). In my view, part of OECD oil demand has been in effect exported to non-OECD countries, together with the economic activities that shifted towards emerging markets.

Even at current price levels of $120/bbl, there does not appear to have been any significant permanent change in consumers’ consumption patterns, at least not yet. Of course that is not to say higher oil prices have no impact on demand whatsoever. Higher price averages can start reducing demand growth at the margin, while price spikes can instrument a harsh monetary policy reaction that can, in turn, have a long-lasting effect on economic activity.

Even at current price levels of $120/bbl, there does not appear to have been any significant permanent change in consumers’ consumption patterns

A customer at a gas pumpClearly, a $4 gasoline price in the US has a psychological effect, but it would be fair to say that the feedback from price to slowdown has been largely absent in the last decade, with the roots of the 2008 recession ultimately lying elsewhere than in oil prices alone.

Indeed it appears that households and firms are much more prepared to smooth their expenditures (letting savings take the strain). Moreover, as emerging market economies play catch up to the OECD, and as their GDP continues to turn more commodity intensive, oil demand is seeing little respite.

At a higher price level, supply may very well respond through greater incentives for drilling and exploration and by making high cost projects more viable, but the time lags are likely to be significantly higher and the size of the response may vary significantly.


What stance should the world community take towards Libya in your opinion: refuse to work with the rebels or help them fulfil previously-agreed oil contracts?
Natalia Konoshenko, Industry Portals

While some Western governments have recognised the Benghazi council as the legitimate Libyan government, there are various issues that remain unresolved in terms of potential oil contracts.

A Libyan man in BenghaziWhile financing rebels through oil purchases poses serious legal and ethical challenges, these statements simply highlight the issue about the structure and legality of the post-Gaddafi regime, should there be one.

Eastern activists have long maintained that the region has been deliberately impoverished by the Gaddafi government and that it has received few economic benefits from petroleum production. These grievances could complicate efforts to build a post-Gaddafi national unity government as regional leaders may demand a major redistribution of the energy revenues, as well as a weaker central government, as the price for their participation.

There also may also be some adjustment of the contract terms. Clearly, there will be a demand for the light sweet crude from Libya but the terms and conditions to get that crude may differ significantly if the rebels were to come to own the entire oil industry of the country.