Oil output and price rise

Oil prices soared to record levels in recent years, basic economics suggested that consumption would fall and supplies would rise as producers drilled for more oil. But as prices flirt with $120 a barrel, many energy experts are becoming worried that neither seems to be happening. Higher prices have done little to suppress global demand or attract new production, and the resulting mismatch has sent oil prices ever higher.

A central reason that oil supplies are not rising much is that major producers outside the OPEC cartel, like Russia, Mexico and Norway, are showing troubling signs of sluggishness. Unlike OPEC, whose explicit goal is to regulate the supply of oil to keep prices up, these countries are the free traders of the oil market, with every incentive to produce flat-out at a time of high prices.

But for a variety of reasons, including sharply higher drilling costs and a rise of nationalistic policies that restrict foreign investment, these countries are failing to increase their output. They seem stuck at about 50 million barrels of oil a day, or 60% of the world’s oil supplies, with few prospects for growth.

According to normal economic theory, and the history of oil, rising prices have two major effects. They reduce demand and they induce oil supplies. Not this time with global supplies tight, geopolitics continue to play a big role in pushing up oil prices. Oil futures closed at $118.75 a barrel, up 23 cents, on the New York Mercantile Exchange, after strikes by oil workers in Scotland and Nigeria that shut down nearly 1.7% of the world’s daily production.

Countries outside the organization of the Petroleum Exporting Countries have been the main source of production growth in the past three decades, as new fields were discovered in Alaska, the North Sea and the Caspian region.

At the same time, oil consumption keeps expanding. Global consumption is forecast to increase by 1.2 million barrels a day this year to 87.2 million barrels a day, with much of the growth in demand coming from China, India and the Middle East.

Higher oil prices mean record profits for oil companies that have, to some extent, masked the supply problems. Exxon Mobil and Chevron are both expected to deliver knockout performances when reporting quarterly earnings this week, even as they struggle to increase production.

What is disturbing here is that things seem to get worse, not better. These high prices are not attracting meaningful new supplies. The outlook for oil supplies signals a period of unprecedented scarcity. Oil prices might exceed $200 a barrel by 2012. Some regions are simply running out of reserves. Norway’s production has slumped by 25% since its peak in 2001, and in Britain, output has dropped 43% in eight years. Production from the giant Prudhoe Bay field in Alaska has dropped by 65% from its peak two decades ago.

In many other places, the problems are not below ground, as energy executives like to put it, but above ground. Higher petroleum taxes and more costly licensing agreements, a scarcity of workers and swelling costs, as well as political wrangling and violence, are making it harder to raise production. The world is not running out of oil, but rather it’s running out of oil production capacity.

Mexico, the second-biggest exporter to the United States, seems increasingly helpless to find new supplies to offset the collapse of its largest oil field, Cantarell. A combination of falling production and rising domestic consumption could wipe out Mexico’s exports within five years.

Foreign investment could help Mexico produce oil from deeper waters, but that is a controversial proposition in a country where oil has long been seen as part of the national patrimony. Another country, Russia, is also a focus of worries. Russia is not exactly running out of places to look for oil-a huge chunk of eastern Siberia remains unexplored and the country has been the biggest contributor to the growth in energy supplies in the last decade.

Russia as a country now focuses on stabilizing its output. Russia today produces about 10 million barrels of oil a day, up from a low of 6 million barrels in 1996.

As countries like Russia slow output, OPEC will have to pick up the slack. The oil cartel accounts for 40% of the world’s oil exports and owns more than 75% of global reserves. But there are serious concerns that OPEC will also find it tough to increase production.

Saudi Arabia, the world’s top oil exporter, is completing a $50 billion plan to increase capacity to 12.5 million barrels a day, but it signaled recently that it would not go beyond that. That means Saudi Arabia could fall short of the 15 million barrels a day that most experts had expected it to produce in the long run.

OPEC’s 13 members plan to spend $150 billion to expand their capacity by five million barrels a day by 2012. But OPEC will need to pump 60 million barrels a day by 2030, up from around 36 million barrels a day today, to meet the projected growth in demand.

Not everyone is pessimistic about energy supplies. To make up the shortfall, the world is also increasingly turning to fuels from unconventional sources, like biofuels or heavy oil Canadian tar sands, for example, has attracted large investments. But the estimates are that current investments will be insufficient to replace declining oil production. The energy agency said it would take $5.4 trillion by 2030 to raise global output.