OPEC- The Cartel (OIL part 3)

Today, we conclude our discussion on oil. Having covered the micro angle and what affects demand for oil on the global stage, it is important to mention the oil supply side and how it affects global oil prices.

As mentioned in the previous blog, oil is a commodity whose price is determined by how much people need to use it. Increased demand leads to increased prices subject to its availability (supply) staying constant. The reverse is also true. If fewer people demand oil, then its price will drop. This was a phenomenon witnessed in 2020 when the largest oil consuming industries were grounded to a halt. These included the air travel, manufacturing, and general energy consumption industries.

What Affects The Supply Of Oil?

The supply of oil on the global market is affected by various factors which include but are not limited to:

  1. Technological advancement in the extraction process
  2. Cost of extraction
  3. The Oil Cartel
  4. Supply chain from extraction to pump

Extraction

According to BP’s Statistical Review of World Energy, the globe has about 1.73 trillion barrels in economically recoverable oil as of 2020. This is oil that has not been extracted. The world consumes roughly 100 million barrels of oil per day or 3 billion barrels per month. There is clearly enough oil to go around for awhile as the global economy continues to grow at its current average rate of 3%.

If oil supply is then roughly known, why doesn’t the price of oil remain constant for as long as the reserves are not being depleted fast enough to distort its supply-demand equilibrium? Well, this brings us to the first two points; how much oil is being extracted, and how much it costs to extract the oil.

The cost of extracting oil increases with the age of an oil well. Older wells have reduced oil production which leads to an increase in price. New wells drilled into the earth have high levels of pressure which force the oil up without the need for sophisticated machinery. However, as the well ages, artificial pressure through water injection or gas lift is used to push the oil up to the surface. This increases the cost of extraction, therefore increasing the price of oil.

The average age of an oil rig from discovery to abandonment is estimated at 15-30 years for land drilling and 5-10 years for offshore drilling due to its high costs. According to Planete-Energies, after the third year of production, an oil well’s productivity reduces by between 1% and 10% per annum. It is therefore important to understand the age of the world’s largest oil rigs as a guide for the direction of the cost of extraction.  Understanding technological advancements in the extraction process is also important in determining whether supply will increase or decline, as this will in turn affect the global cost of oil.

The Oil Cartel

The factor with the biggest supply impact on oil prices is the cartel called OPEC. OPEC is a grouping of oil-producing countries that determine how much they will produce, in essence, directly affecting supply by the stroke of a pen. The top 10 oil producing countries account for 94% of the 1.7 trillion barrels of oil reserves and 40% of daily production.

Therefore, if any of these 10 countries decides to reduce supply, they will create an artificial shortage in the global market. For example, in the Saudi Arabia chart below, a drop in production led to a spike in global prices and vice versa.

It is therefore important to follow the outcomes of OPEC meetings for the set production levels for a period of time. This, together with global demand trends, would enable one to analyze and forecast if oil prices are likely to increase or decrease.

Supply Chain from Rig to Pump

Finally, the last factor impacting oil supply is the supply chain. The supply chain involves several factors but for the purpose of this blog, we will look at transporting oil from the refinery to the pump. As we have seen, the top 10 oil-producing countries are responsible for upwards of 40% of daily oil production. This means that any disruption in their ability to deliver oil would cause a huge supply shortage leading to prices skyrocketing.

For example, Venezuela went into a civil crisis in 2019 with the US imposing sanctions against Iran at the same time. These two events meant that the world’s largest and fourth largest oil suppliers could not deliver oil at their usual levels. This led to oil prices rising fast due to a supply shortage caused by interruptions in the supply chain. It is therefore important to follow events in the 10-largest oil-producing countries to determine their effects on the supply of oil.

This brings us to a close on why and how your pump prices change and what it means for you. Feel free to refer to part 1 and part 2 if you need to.

Published by kadzutu

passionate about the communitys financial prosperity

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