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As the autocratic rule that has dominated the Middle East for decades continues to unravel, volatility in the global oil markets points toward one overriding concern: How can we maintain an oil-flow balance in the face of this escalating uncertainty?
Global oil prices are posting their highest levels since the speculative frenzy of 2008 drove them to $147 a barrel. And it's all because of worries that the unrest and resulting production curbs in Libya would spread to other oil-exporting countries.
Oil prices retreated recently based on several developments that investors perceived as positive. First, reports said that Libyan protesters were allowing oil shipments to resume from certain parts of the country. Second, Khalid Al-Falih, the head of state-owned Saudi Aramco, said that "all incremental needs" for extra oil have been met.
Of course, even with the Saudi oil supply pledge, these developments offer only a momentary respite in the Mideast crisis. Almost two-thirds of the world's known conventional oil supplies are located in the Middle East region. And the question that isn't being answered – or even asked – right now is this:
If there's an extended crisis, like the civil war that's brewing in Libya, are oil supplies going to last through a long-term disruption?
The answer to that question will leave you feeling less than confident.
Crude oil prices have already eclipsed the $100-a-barrel level in New York and $120 a barrel in London. And civil unrest is still an issue in Algeria, Syria, Yemen and Saudi Arabia. Risks of tension and out-right rebellion – that could further interrupt oil supplies in the region – are still high.
And that doesn'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.
Oman Sultan Qaboos bin Said has ordered the hiring of 50,000 people in the wake of 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).
And more important than Oman's oil production, 25% of the world's oil supply moves through a narrow strait around the Omani coast each day to exit the Persian Gulf. A revolt in Oman could be a global disaster.
In the face of this kind of widespread uncertainty, when you ask analysts like me 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 – ahead of the mainstream news reports – the Saudis have agreed to replace the volume from Libya that had been lost to the market.
And we're ahead of the mainstream news reports again with a backdoor way to profit from the Middle East crisis. You can do well investing directly in oil. But you could do better – much better – by putting your money elsewhere. Indeed, while the whole world watches oil, I'm keeping an eye on the other explosive market. And today, I'll show you how to make a flat-out killing in it. Full story.
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, an increase in export flow can be done in a matter of hours from Saudi fields – which, when you factor in the transit time required, translates into a few days.
But even this is merely a momentary reprieve. We still need a long-term solution.
With Libya Oil Clogged, We Need A Reliable Surplus
Right now, about 80% of the Libyan supply is off-line. Forces opposed to strongman Col. MoammarGadhafi are in control of several pivotal export terminals and port facilities. But Libyan protesters are permitting crude shipments to resume from certain parts of the country.
Libya is descending into a civil war. That is the next stage in the current political situation – a new dimension guaranteed to prolong the crisis period and provide numerous opportunities for the effect to ignite other countries. Already, we are concerned about 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 quotas. And with these OPEC countries already selling at full capacity, the apparent surplus available there is on paper only.
When it comes to any reliable surplus of crude within OPEC, Saudi Arabia is it.
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.
The second option is Canada. And here time is 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, even outside of OPEC, 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.
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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. And a threat to Hormuz could quickly turn oil into a rare commodity.
But let's say that does not happen and Saudi Arabia is able to send its increased oil production through Hormuz. 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 country's 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 means at least two things:
- Field engineers have immediate pressure problems.
- 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 that are now more than 12 months old. Those rates are increasing faster than expected.
OPEC itself quietly raised its worldwide demand estimate three times since then.
That's the first time in history OPEC has raised estimates three times in one year.
By 2012, soaring international requirements for oil may effectively reduce the Saudi surplus to about 2 million barrels a day. And after replacing Libya's production, that reduces Saudi Arabia's surplus 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 a single new hotspot to emerge in the already-troubled Middle East to exhaust the Saudi solution.
Currently, protests and new governments have popped up in 14 Middle East countries. The likelihood of one or more of those oil producers descending into a civil war or rebellion like the one we're watching unfold in Libya is almost certain at this point.
As stunning as it may seem to investors, Saudi Arabia might not have enough oil to go around.
As demand increases in coming months, we will see oil prices overrun their 2008 all-time high of $147. Oil prices will reach $150. And if demand growth and regional unrest continue, we could be looking at $300 a barrel by the end of the year.
That will mean increased costs for consumers across the board. But it will also provide a golden opportunity for investors. And if you're paying for it at the pump, shouldn't you be profiting from it in your portfolio?
Both of the options below offer excellent ways to take advantage of the current oil market unrest. Chose one, or try out both for an upside to rising oil prices:
- One of the simplest ways to profit from surging oil prices – outside of investing in futures on the NYMEX exchange – would be to invest in an exchange-traded fund (ETF) that tracks the commodity's movement.
The iPath S&P GSCI Crude Oil Total Return ETF (NYSE: OIL) and the PowerShares DB Oil Fund (NYSE: DBO) are two options.
- If you're looking for specific companies, it may be best to look in China, where the most oil consumption growth is occurring. To that end, China National Offshore Oil Corp. (CNOOC) (NYSE ADR: CEO) is one option.
- CNOOC is often referred to as the most "Western" of China's oil majors because it was founded with a mandate to form joint ventures with foreign companies. CNOOC is the vessel through which China is acquiring foreign expertise in the energy sector.
Now is not the time to invest in a Western oil company. ExxonMobil (NYSE: XOM), Royal Dutch Shell (NYSE: RDS.A), BP (NYSE: BP) and their pals are too wrapped up in the region to make good Mid-East crisis investments.
These companies have already begun ramping up existing production outside the Middle East and searching for new resources in other regions. But until they come online, traditional Big Oil will suffer as the crisis in the Middle East continues.
Along with big oil, you should also shield your portfolio from those sectors that will receive the most damage as oil hits new highs. Avoid any transportation-heavy industry, like manufacturing, and look to companies that provide vital services and products, like healthcare. We've uncovered just such a stock. It's an investment that could thrive with high oil prices. Click here for our research report: New "Smart Drug" Unleashes Holy Hell on Nature's Deadliest Disease.
Worries about oil supplies sent global oil prices to 2½-year highs at the start of the Libyan civil war. As you can see below, the "supply shock" of losing Libya's oil production was the eighth-worst oil-supply shortage since 1950. .
About the Author
Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk assessment, and emerging market economic development. He serves as an advisor to many U.S. governors and foreign governments. Kent details his latest global travels in his free Oil & Energy Investor e-letter. He makes specific investment recommendations in his newsletter, the Energy Advantage. For more active investors, he issues shorter-term trades in his Energy Inner Circle.