The recent decision by OPEC to reduce oil production has crystallized the growing influence of geopolitics on crude oil supplies. Despite strong pressure from the Bush administration on OPEC to delay its planned production cut, the position of Saudi Arabia, to reduce supplies, prevailed.
More important than the immediate impact on oil prices, OPEC's action signals the depth to which US foreign relations with Persian Gulf countries have plunged in the year since the US invasion of Iraq. US foreign relations with other key oil producing countries, including Russia and Venezuela, have also weakened considerably over the past year. Increasing antagonism between the world's largest oil producers and the Bush administration will keep world oil supply lean through at least the end of 2004. With supply diminished, oil demand, particularly in Asia, will remain strong, pushing international oil prices above $40 per barrel.
Saudi Arabia holds the world's largest petroleum reserves and accounts for over one-third and one-half of total OPEC oil production and spare production capacity, respectively. Its dominant position in OPEC and importance to world oil supply has made strong relations with Saudi Arabia a priority for the United States government over many administrations. In the past, strong relations with Saudi Arabia gave the US considerable influence over OPEC, helping to ensure that international oil prices remained at levels acceptable to consuming countries.
But over the past three years, relations between the Bush administration and Saudi Arabia have deteriorated substantially. The role of Saudi nationals in the terrorist attacks against the US in September 2001 instigated this deterioration. The deterioration in relations advanced with the US invasion of Iraq, which Saudi Arabia, along with many other Gulf countries, opposed. These countries opposed the War in Iraq specifically because they feared it would strongly destabilize the entire region - a fear that has been realized.
In addition to the chaotic conditions accompanying the US occupation of Iraq and growing instability there, terrorist attacks have occurred in Saudi Arabia, Morocco and Turkey. The conflict in the Palestinian Territories has escalated to heights unimaginable two years ago and the Bush administration continues to threaten Syria and Iran. Washington has succeeded in alienating almost every country in the Middle East.
Against this background, it's no great leap to infer that many of the region's governments would be happy to see President Bush defeated in this year's presidential elections, potentially heralding a change in US foreign policy and the return of stability in the Middle East. While the Gulf countries have no influence over US foreign policy, they do have modest leverage over the US economy via their ability to control oil supply and therefore international oil prices. High oil prices will undermine the US economy, threatening President Bush's re-election.
Russia is the world's largest crude oil producer and its second largest oil exporter. Like Saudi Arabia, Russia has strong influence over world oil supply and international oil prices. Relations between the US and Russia, though seemingly strong following the terrorist attacks in the US, have deteriorated sharply over the last year. Russia also strongly opposed the US invasion of Iraq. While Moscow was loathe to see the Middle East destabilize, it was even more concerned with the potential of increased instability in Central Asia and in Russia as a result of the war in Iraq.
As in the Middle East, an upsurge of terrorism has swept through Central Asia and Russia over the last year. In addition to increasing instability, the Putin government is also very concerned about US plans for permanent military bases in Uzbekistan and Kyrgyzstan, and Washington's influence over Georgia, a key transit point in the Caspian oil pipeline.
Though Presidents Putin and Bush may be "friends," its unlikely that Putin would be thrilled about a second term for Bush and the implications this would have for instability around and within Russia. Over the past year, the Putin government has consolidated its command over the country's oil companies, giving Moscow effective control over oil production and exports.
Like the Gulf countries, Russia can also have modest influence over the US economy and the outcome of the US presidential elections via its ability to withhold oil supply, pushing international oil prices higher.
President Hugo Chavez of Venezuela is definitely not a friend of President Bush. Venezuela's government remains adamant that the Bush administration covertly supported the coup which attempted to topple Chavez in April 2002.
Chavez has suggested that the Bush administration also supported the oil sector strike in late 2002, as well as the recent recall referendum in Venezuela. Chavez even threatened to stop Venezuela's oil exports to the United States if Washington continued to interfere in Venezuela's highly fractured political morass. Venezuela accounts for 14% of total US oil imports and 8% of OPEC oil production. Chavez would probably relish the opportunity to undermine President Bush's re-election chances by restricting oil imports or oil production, or both.
Even a minor decline of oil production, of a further 1 million barrels per day, in Saudi Arabia, Russia and Venezuela would push international oil prices well above $40 per barrel. Reduced oil production in these countries cannot be offset by increased production in other countries.
World spare oil production capacity is estimated to be only about 2.5 million barrels per day. Nearly one-half of this spare capacity is held by Saudi Arabia, Russia and Venezuela. Because only a small decline in production would have an inordinately large impact on oil prices, these countries would all benefit more from withholding production than increasing it. Against the backdrop of tightening oil supply, demand is expected to remain quite firm.
World oil demand is expected to increase by about 2% in 2004. Demand in both North America and Europe is expected to increase by only about 1%. In contrast, oil demand in Asia is expected to grow by 4% this year, led by nearly 11% growth of oil demand in China.
This is very significant because China is the world's second largest consumer of crude oil after the United States. China's crude oil consumption was equivalent to nearly 70% of the combined crude oil consumption of France, Germany, Italy and the UK last year. Though economic growth is expected to slow marginally in China this year, oil demand growth is expected to remain underpinned by the country's insatiable energy demand.
The high degree of energy price subsidization in China suggests that higher international oil prices will not significantly impact economic growth there. The main impact of continued high international oil prices will be on China's fiscal accounts. In the rest of Asia, the sustained strength of international oil prices will restrain economic growth by an average of about 0.5% this year.
Tightening world oil supplies and continued strong demand for oil will push oil prices above $40 per barrel (WTI basis) this year. However, in the short-term, oil prices could slide. In addition to building oil stocks in the US, which recently reached a 19-month high, speculative long positions in oil derivatives are very large.
At some point these speculative positions will shake out, pushing prices lower. Nonetheless, any downward correction in prices will probably be short-lived. Only significantly weaker than projected oil demand growth in China could lead international oil prices on a sustained downtrend this year.
Jephraim P. Gundzik is President of Condor Advisers, Inc. Condor Advisers provides emerging markets investment risk analysis to individuals and institutions globally. Please visit www.condoradvisers.com for further information.
