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Crude Oil: More than demand and supply... - Views on News from Equitymaster
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  • Jan 8, 2007

    Crude Oil: More than demand and supply...

    Crude oil is one of the most volatile commodities in the world. Continuing with its basic traits, it was highly volatile in 2006, with fluctuations of almost US $20 per barrel. Market participants focused attention on bullish non-fundamental signals and downstream bottlenecks, after which bearish factors in the form of crude oversupply and easing geopolitical tensions shifted attention to market fundamentals, leading to a sharp correction in prices of 27%. While prices have recently regained some of the lost ground, the question of whether prices will stabilize remains far from settled.

    Crude oil is the engine that propels the world economy, thus economists and analysts track its movements in order to arrive at a correct picture of the growth in economy and the corporate sector. There are a whole host of factors that affect crude oil prices, apart from demand and supply. Conflicting political, geographical and economic factors are also key determinants of the crude oil prices. Geopolitical risk premium, which was as high as US$ 20 to 25 per barrel at the peak price of US$ 75 per barrel, has recently eased to US$ 10 to 15 per barrel at the current price. This non-fundamental component has a sizeable impact on crude oil prices and while it is extremely difficult to quantify the same, it is largely dependent certain geopolitical factors like insurgencies, terrorist activities and hostile conflicts. Against this backdrop, we have made an attempt to outline the distribution of the world proven oil reserves and our interpretation of the same.

    Composition of the world proven reserves
    Proved reserves At end 1985 At end 1995 At end 2004 At end 2005    
    Particulars barrels (Bn) barrels (Bn) barrels (Bn) barrels Share of total R/P ratio
    USA 36.4 29.8 29.3 29.3 2.4% 11.8
    Total North America 101.5 89.0 60.6 59.5 5.0% 11.9
    Venezuela 54.5 66.3 79.7 79.7 6.6% 72.6
    Total S. & Cent. America 62.9 83.8 103.0 103.5 8.6% 40.7
    Russian Federation NA NA 72.4 74.4 6.2% 21.4
    Total Europe & Eurasia 78.6 81.5 138.7 140.5 11.7% 22.0
    Iran 59.0 93.7 132.7 137.5 11.5% 93.0
    Iraq 65.0 100.0 115.0 115.0 9.6% *
    Kuwait 92.5 96.5 101.5 101.5 8.5% *
    Oman 4.1 5.2 5.6 5.6 0.5% 19.6
    Qatar 4.5 3.7 15.2 15.2 1.3% 38.0
    Saudi Arabia 171.5 261.5 264.3 264.2 22.0% 65.6
    Syria 1.5 2.6 3.2 3.0 0.2% 17.5
    United Arab Emirates 33.0 98.1 97.8 97.8 8.1% 97.4
    Yemen 0.1 0.1 2.9 2.9 0.2% 18.3
    Total Middle East 431.3 661.5 738.2 742.7 61.9% 81.0
    Algeria 8.8 10.0 11.8 12.2 1.0% 16.6
    Angola 2.0 3.1 9.0 9.0 0.8% 19.9
    Libya 21.3 29.5 39.1 39.1 3.3% 63.0
    Nigeria 16.6 20.8 35.9 35.9 3.0% 38.1
    Total Africa 57.0 72.0 113.8 114.3 9.5% 31.8
    China 17.1 16.3 16.0 16.0 1.3% 12.1
    India 3.8 5.5 5.6 5.9 0.5% 20.7
    Total Asia Pacific 39.1 39.2 39.8 40.2 3.4% 13.8
    TOTAL WORLD 770.4 1027.0 1194.1 1200.7 100.0% 40.6
    OPEC 535.8 785.1 897.4 902.4 75.2% 73.1
    Non-OPEC 172.0 179.8 175.8 175.4 14.6% 13.6
    * More than 100 years.

    The above table reveals that Middle East has the largest proven crude oil reserves in the world (62% of the total reserves) followed by the African continent that accounts for as much as 9.5% of the world proven reserves. The level of political risk in some of these countries is significantly higher, thus any political unrest puts crude oil prices under significant pressure. With oil companies in these regions mostly government owned, the process of the exploration and development of the reserves also tends to be on the slower side.

    If we further analyse the proven reserves on a country basis, Saudi Arabia accounts for a huge 22% of the world proven crude oil reserves, followed by Iran (11.5%), UAE (8.1%), Kuwait (8.5%), and Venezuela (6.6%). Iraq, one of the most volatile regions in recent history, accounts for 9.6% of proven oil reserves.

    What has kept the risk premium higher?
    Iran along with Iraq accounts for 18% of the world's proven oil reserves. Both these countries are currently in the center of a huge political storm, thus jeopardizing their oil development plans. In a strong reaction to these events, oil prices had run up from US$ 65 per barrel to as much as US$ 78 per barrel. More importantly, the above numbers are proven reserves, which still need to be developed to a significant extent, thus warranting a stable political environment. While spare production capacity has declined considerably on the back of increased demand from developing countries, heightened political activities have not allowed production to keep pace with demand, thus putting further pressure on prices. Such is the concern that our interaction with one of India's biggest shipping companies, revealed the fact that roughly 10% of the global crude oil requirement is being kept on board in floating vessels in the sea to ensure supplies in case of any conflict escalation.

    While we are not experts of the world political affairs, we do not foresee any significant easing of the current political scenario. Thus, in order to counter risk associated with crude supply, short-term solutions, like the strategic oil reserves (SOR) have been resorted to by the major consuming countries. After the terrorist attacks in the US in 2001, it resorted to strategic oil reserves. The same is being implementing by India as well, with strategic oil reserves expected to be in place upto 2010.

    To conclude, we believe, crude oil prices are expected to scale-up from the current levels due to fundamental factors in the long run, while in the short run, non-fundamental factors will keep the volatility levels higher.



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