Here’s an understatement: the news in the oil markets has been troublesome lately. Although the relatively peaceful transition to sovereignty in Iraq is a bright spot, there are many darker ones. Some of these have been with us for years; others are more recent in vintage.
For months, I’ve watched the news coming out of Iran with concern. Iraq, of course, remains vulnerable to car bombs, sabotage, and other foul play from insurgents and terrorists. These situations have grabbed headlines and caused the price of oil to jump, although they are unlikely to significantly disrupt oil supplies.
Adding further fuel to the fire, crude oil demand is on an upswing spurred by economic growth. With resurgence in business activity in many countries—the US, Germany, Japan, and others—comes an increased need for oil. In China, manufacturing sector growth and a virtual explosion in the number of cars and trucks on the road have boosted demand by some 20% over last year. There’s not a lot of excess capacity at the moment in several links in the oil production and supply chain to deal with this jump in oil requirements. Many producers are pumping all they can, refineries are at 97% capacity, and demand just keeps growing.
And now the latest news, a rumored, forced shutdown of Russia’s largest oil company, Yukos, sent oil futures to a 21-year high. Yukos accounts for some 2% of oil production, and is a monstrous company by any standard. When a huge overdue back taxes bill led to a threat by Russian authorities to stop most of its production, it was like the proverbial straw on the camel’s back. Markets went wild, up to levels not seen since 1983.
What are the chances of gloom and doom continuing on all of these fronts? Virtually nil. We’re in a strange period of time now, with many causes for uncertainty, but it’s not likely to last. Russia can ill afford to shut down one of the country’s largest sources of economic activity, and the powers that be know that. The stability of the entire nation would be jeopardized if a prolonged closure led to an economic crisis. There are also investors waiting in the wings with funds ready to bail out the struggling Yukos. Even if the company did cease production for a period of time, there are other producers who could take up some of the slack.
Crude inventories are up about 23 million barrels over a year ago, and the current threats to supplies are not as real as they have been at points in the past. When Iraq invaded Kuwait in 1990, prices jumped (though not this high) in response to the very possible idea that Saddam Hussein could disrupt supplies in Iraq, Kuwait, Saudi Arabia, and beyond. For the market to react with such fervor to the very low probability that Russian authorities will actually shut down Yukos for an extended period of time would only happen when things are already skittish. Otherwise it is simply not rational.
Projects are underway around the globe which will augment the capacity to supply oil. Construction in Mexico is nearing completion on projects which could raise production levels by up to 4%. Several other oil-rich nations (Venezuela, Saudi Arabia, Nigeria, and elsewhere) have intentions of increasing supplies, but face political, workforce, or other problems that are constraining their ability to expand immediately.
The oil market is likely to be under pressure for months to come. Rising demand and supply issues will leave the market vulnerable to unanticipated shocks. An early cold snap could see prices spiking, for example. Even so, the US economy is far more able to deal with higher oil prices than in the past. Expensive oil is certainly not good for economic growth (unless you live where it is extracted), but it’s not likely to derail the ongoing recovery.