Are We Headed for Another 2008 Crisis?

Jim Brown
 
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With Brent crude nearing $120 and a price the majority of analysts did not expect until 2012 are we headed for another oil crisis like we saw in 2008?

The problem in 2008 was a shortage of light sweet crude. It was not a shortage of oil. The amount of excess capacity in sweet crude had declined to the point where oil buyers were essentially having to outbid each other for each tanker of available oil.

OPEC continually lamented that there was plenty of oil in the market and they could produce more if needed. Obviously, if you have been reading these pages long you have seen me explain this many times. Oil is not generic. There are hundreds of grades of oil. Refineries are setup to process a range of oil that fits within a certain weight and sweetness. They cannot process oil that is heavier or more sour than their equipment permits. If there is no oil available that falls within their requirement window they are out of luck. It can cost over a billion dollars and take three years to upgrade a refinery to process heavier grades of crude. That assumes you can get the environmental permits for the added emissions your plant will excrete.

We are not out of light crude today. However, the outage in Libya has put oil buyers on notice that we are close. There are several exporting countries that produce light sweet crude and could escalate production over the next several months by a few extra barrels. We are not talking a million barrels but something in the range 50,000 to 75,000. That won't ease the pain completely for buyers with no other option but those refiners can always run at a slightly lower run rate. Instead of processing 250,000 bpd maybe they drop back to 200,000 bpd and let the market absorb some of the shortage.

Obviously adding a few thousand barrels of sweet and cutting back on refinery output is a stop gap measure for a month or two until Libya restarts production.

What happens when the MEND rebels in Nigeria blow up the pipeline again? This is a quarterly occurrence and Shell has to claim force majeure for a couple weeks until it can be repaired. If that happened today with half of Libyan production offline it would be a disaster. Nigeria is a key supplier of light crude.

Algeria has also been mentioned as a problem child. Algeria produces 1.8 mbpd of crude with most of it light crude. If the current protests in Algeria were to increase to the same point as those in Libya and they lost half of their production we would have $150 oil in a matter of days.

The problem here is not the political instability causing disruptions in oil flows. The problem is the lack of any excess capacity in light sweet crude. Could we see a 2008 spike again in 2011? Absolutely! All we need is one more domino to fall and reduce light crude production by another large chunk and we would be right back in the $140 or higher range and the global economic recovery would fall flat on its face.

Fortunately this time around we don't have the equivalent demand for oil. The current economy is struggling to find traction and that will actually work in our favor to keep oil prices reasonable. Governments around the world are laying off workers and cutting salaries as stimulus programs come to an end. These layoffs will keep gasoline demand lower than what we saw in 2008.

The world is a different place today in terms of employment. Unfortunately we have had two years of depletion impacting light crude production so our excess capacity has declined as well. When the recovery kicks into high gear is when we will have to worry about prices spiking again on other than geopolitical problems.

Just because light crude is scarce it does not mean there is not a problem with heavy sour crude. If Saudi Arabia implodes on March 11th when the day of rage protest occurs then prices could rocket higher. That would be a speculation event rather than a drop in production. Everyone worries that Saudi could see a production drop in the event of political unrest but Saudi is not like these other countries. They are very disciplined and their facilities are very well protected. Initially I don't think political unrest would be an actual problem but it depends on the length and severity. Political protests are illegal in Saudi Arabia. How they react to the sudden appearance of tens of thousands of demonstrators will be a key detail.

Can we see 2008 prices in 2011? Yes, very easily, but it will only be temporary. The type of supply outage is not permanent and demand is well below 2008 levels. However, we will probably see those same prices in 2012 and it won't be because of a civil war in Libya.

Be prepared for higher prices. These events of the last couple weeks are a clear warning of the crisis we will be facing in the years ahead. Don't let anyone try and convince you that peak oil is a myth. If there were plenty of oil would we be having this price spike today?

Jim Brown

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