Oil Shock

Last week's oil surge saw crude oil prices eclipse the $100-a-barrel level in New York and $120 a barrel in London. In a brand-new research report - a Mideast crisis update - Bank of America Corp. (NYSE: BAC) analysts said last week's market reaction was the eighth-largest supply shock since 1980.

"More worryingly, with other countries like Algeria, Syria, Yemen or Saudi Arabia scoring highly on social discontent, the risk of continued tensions in the region remains high, in our view," the analysts wrote.

And those comments don't even include the Sultanate of Oman, the country located on the southeast coast of the Arabian Peninsula that last year exported about 860,000 barrels of oil per day - compared with about 1.6 million a day from Libya.

Oman Sultan Qaboos bin Said has ordered the hiring of 50,000 people in the wake of weekend protests that resulted in the death of one person and the injury of 11 others in that country, according to reports from Oman's state-run news media. Oman is the region's largest oil producer outside the Organization of Petroleum Exporting Countries (OPEC).

In the face of this kind of widespread uncertainty, when you ask analysts for their ideas on how we can maintain an oil-flow balance, most reduce it to a supply equation. If a certain amount of normal deliveries is suddenly withdrawn from the market - say, for example, the 1.6 million barrels a day produced by Libya - what is the remedy?

You have to look for other readily available sources to pick up the slack.

As we reported to our Oil & Energy Investor subscribers late last week - ahead of the mainstream news reports - the Saudis have agreed to replace the volume from Libya that had been lost to the market (actually, that had been lost to Europe, since 80% of Libyan exports move there). Saudi Aramco, the Saudi-operated venture that's the world's largest state-run oil company, pledged to move 700,000 barrels into the export flow immediately.

One thing about the Saudis: When they say "immediately," they are acting with the same urgency that the word is meant to convey.

With roughly 2.5 million barrels per day excess capacity of physically available supply, that can be done in a matter of hours from Saudi fields - which translates into a few days or so, when you factor in the transit time required.

But even this is merely a momentary reprieve. We still need a long-term solution.

With Libya Oil Clogged, We Need A Reliable Surplus

As of Friday about 80% of the Libyan supply was off-line. Forces opposed to strongman Col. Moammar Gadhafi had taken control of some pivotal export terminals and port facilities. Yesterday, as we noted earlier, Libyan protesters were permitting crude shipments to resume from certain parts of the country.

Libya is descending into a civil war. That is the next stage in this unraveling - a new dimension guaranteed to prolong the crisis period and provide numerous opportunities for the effect to ignite other countries. Already, we are looking with concern on developments in neighboring Algeria and nearby Oman.

Saudi oil cannot quell the disturbances in the streets. But at least it can calm down global oil trade.

Or can it?

Saudi Oil Minister Ali al-Naimi has said repeatedly over the past two years that Saudi Arabia has an upward capacity in excess of 12 million barrels a day that it can move into the market - and that the country could do so for the next 88 years.

His comment last week - that OPEC would also meet shortages as they appear - is reassuring. But it isn't particularly significant. Other OPEC members are regularly selling volumes in excess of their monthly quotasThe apparent surplus available there is on paper only.

When it comes to any reliable surplus of crude, Saudi Arabia is it.

And if that country isn't up to the task, who is?

Two Players Not Up to the Task

It goes without saying that there are possible sources that aren't part of OPEC.

But each of the main candidates is problematic.

Russia, for example, is now the usual world leader in monthly exports, having displaced the Saudis last year. And the Canadian oil sands provide prospects for additional volume in the longer term.

Yet Russia is facing a rapid maturing of its traditional fields, and significant capital expenditures would be required to keep current volume from declining. There may be some marginal help from the Russians - but not to the extent we may need if an entire region becomes unsettled.

As for Canada, the time element gravitates against a solution. The logistics simply are not there to crank up production rapidly; nor, for that matter, is there a transport network to move the oil where it needs to go. The crisis is erupting much faster than an oil-sands solution can be put in place.

So it seems we are back to relying on Saudi Arabia.

Is Saudi Oil Enough?

First of all, I think it's clear that I am overlooking the "Armageddon scenario" in the analysis that I'm presenting to you here.

Should the unrest imperil (or even close) transit through the Straits of Hormuz - the primary oil "chokepoint" in the world - the globe would descend into a mega-economic contraction in short order. (On any given day, about 25% of the world's oil supply passes through the Straits. That includes all of the Saudi supply that cannot be moved by pipeline across the country to Jeddah on the Red Sea.)

But let's say that does not happen and the increased supply is available from Saudi. Is the Saudi oil supply enough?

Any push that calls for the pumping of more than 12 million barrels a day from Saudi fields is likely to do some serious damage to the reservoirs. And quickly.

Avoiding for the moment the question raised by the late Matt Simmons and others (including myself) as to whether the Aramco resource and field reserve figures are even accurate, the oil market needs assurance that flows are sustainable to avoid rapidly increasing prices.

Personally, what has disturbed me - on each of my visits to Aramco and its fields - is the use of so-called "secondary recovery techniques" at the very start of field activity.

Put simply, Aramco is injecting water into wells almost as soon as they are open. That always means at least two things:

1. Field engineers have immediate pressure problems.
2. And the water flooding will damage the integrity of the deposit and lower overall production.

Putting maximum stress on the production network will only intensify this problem.

And there are two other concerns that are even more pressing.

Higher Refinery Costs, Soaring Demand

First, the Libyan exports are light sweet (low-sulfur) crude. The Saudi (or OPEC, or Russian) crude oil is sour crude (a high-sulfur content oil). High-sulfur crude is more expensive to refine and process into products like gasoline, diesel, heating oil, and jet fuel.

So even if the volume concerns are met, the Saudi solution will still bring about an increase in prices for the end user.

But the second problem - the major one - remains the most basic. Assumptions about Aramco increasing flow to meet production declines elsewhere really means that we have only about 3 million extra barrels a day available. Libya, in full-blow conflict, takes up more than half that amount.

And that excess capacity figure was calculated last year, based on global demand rates. Those rates are now increasing faster than expected.

OPEC itself quietly raised its worldwide demand estimate three times in 2010.

That's the first time in history that's ever happened.

By 2012, soaring international requirements for oil may effectively reduce the Saudi surplus to about 2 million barrels a day. That reduces the effective Saudi surplus after Libyan replacement to about 400,000 barrels a day. Period.

Oil traders make pricing determinations based on forward-looking perceptions - not on current availability. If demand continues to rise (and it almost certainly will) and Libyan supply remains interrupted, all we would need is to have a single new hotspot to emerge in the already-troubled Middle East to exhaust the Saudi solution.

As stunning as it may seem to investors, Saudi Arabia might not have enough oil to go around.



News and Related Story Links:

• Money Morning News Analysis:
  The Middle East Crisis: Egypt, Libya and Triple-Digit Oil Prices
• Saudi Aramco:
  Official Website.
• CNNMoney:
  Oil Prices Retreat After Spike.
• Bloomberg News:
  Aramco Ready to Make Up Any Shortfall as Libya Exports Cut
• Wikipedia:
  Oman.
• BookRags.com:
  Secondary Recovery Techniques.
• Bloomberg News:
  Oil Fluctuates as Saudis Offer Supplies, Unrest Spreads to Oman.
• U.S. Energy Information Administration:
  Global Oil "Choke Points" - The Straits of Hormuz.
• Money Morning Buy, Sell or Hold Feature:
  Buy, Sell or Hold: The Libya Crisis and Record Oil Prices Will Ground United Continental Holdings Inc. (Nasdaq: UAL).
• Money Morning News Archive:
  Articles by Dr. Kent Moors.
• The Energy Advantage:
  Official Website.