Conventional oil market analysis is focused on traditional economic factors. The only intangible factors left to deal with is the sentiment of OPEC (to abide by quotas, increase/decrease quotas, etc.) and Saudi Arabia's maximum production capacity (a closely guarded secret). This type of analysis has worked fairly well in the past, but it has recently reached an impasse. It is no longer explanatory or predictive. This brief explains the problem, and what can be done to correct it.
A Window of Vulnerability at the Edge of Criticality
The oil market has reached an imbalance where disruptions in supply caused by terrorists can generate outsized increases in price. Here's why:- Demand growth has outstripped the growth in supply. China and India have become economic powerhouses with voracious and rapidly growing appetites for oil. As a result, the maximum supply of oil available (due to long lead times on new production capacity and fewer new high quality sources) is now barely able to meet current global demand. Excess production capacity has been estimated at less than 1 m barrels a day (a little more than 1% of global demand).
- Inelastic demand. The demand for oil is relatively unresponsive to price increases. In this market situation, large increases in price will not appreciably impact the quantity of demand in the short run. The net result is that the price of oil can fluctuate up and down wildly despite the best efforts of suppliers (due to their lack of excess supply capacity). In effect, OPEC has lost its pricing power.
The New Participants
The price of oil is now in the hands of small, violent groups (terrorists, guerrillas, gangs, tribes -- take your pick..) that can disrupt supply. They bomb pipelines, impair corporate operations, and interdict other mechanisms of production with increasing levels of effectiveness. Their activities are the primary reason oil is over $58 a barrel today. These groups include:- Iraq's guerrillas. These guerrillas have successfully kept Iraq's production, despite billions in investment, from reaching pre-war levels. This has kept the country with the world's second largest reserves from correcting the current imbalance.
- Others. New participants such as Nigerian tribes, Kurds in Turkey (PKK), Balochs in Pakistan, and Chechens in Russia (to name a few) have joined to disrupt oil production and transport globally.
- Global targets of potential disruption (now and future).
- Scale and frequency of disruptive events in target locations.
- Iraq's resumption of production.