Demand and Supply Crude Oil

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Application of Demand

& SupplyCrude Oil

Arvind S-01; Dhawal G-08; Rupesh S-26; SamayL-29

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Introduction

Crude oil is a naturally occurring substance (i.e., Fossil Fuel, formed fromorganic remains over a period of millions of years) found in certain rockformations in the earth. It is a dark, sticky liquid which, scientifically speaking,

is classified as a hydrocarbon. This means, it is a compound containingcarbon and hydrogen, with or without non-metallic elements such as oxygenand sulfur. Crude oil is highly flammable and can be burned to create energy.Derivatives from crude oil make an excellent fuel.

Uses

Different types of oil that are obtained from crude oil are as mentioned below:

1. Ethane and other short-chain alkanes

2. Diesel fuel (petro diesel)3. Fuel oils

4. Gasoline (Petrol)

5. Jet fuel

6. Kerosene

7. Liquefied petroleum gas (LPG)

8. Natural gas

Certain types of resultant hydrocarbons when mixed with other non-hydrocarbons, create other products like:

1. Alkenes (olefins), which can be manufactured into plasticsor othercompounds.

2. Lubricants (produces light machine oils, motor oils, and greases, addingviscosity stabilizers as required).

3. Wax, used in the packaging offrozen foods, among others.

4. SulfurorSulfuric acid. These are useful industrial materials. Sulfuric acid isusually prepared as the acid precursoroleum, a byproduct ofsulfurremoval from fuels.

5. Bulk tar.6. Asphalt

7. Petroleum coke, used in speciality carbon products or as solid fuel.

8. Paraffin wax

9. Aromatic petrochemicals to be used as precursors in otherchemicalproduction.

Measuring Crude Oil

Crude oil is measured in barrels. When crude oil first came into large-scalecommercial use in the United States in the 19th century, it was stored in

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wooden barrels. One barrel equals 42 US gallons, or 159 litres. In somecases crude oil is also measured in tons. The number of barrels contained ineach ton varies depending on the type and specific gravity of each crude,however the average number considered would be around 7.33 barrels pereach ton.

Population

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The world population is the total number of living humans onEarth at a giventime. As of November 2008, the world's population is estimated to be about6.7 billion (6,700,000,000). In line with population projections, this figurecontinues to grow at rates that were unprecedented before the 20th century,although the rate of growth has almost halved since its peak of 2.2% per year,which was reached in 1963. The world's population, on its current growthtrajectory, is expected to reach nearly 9 billion by the year 2042.

The growth in population of the different regions from 2000 to 2005 was:

237.771 million in Asia92.293 million in Africa38.052 million in Latin America

16.241 million in Northern America1.955 million in Oceania

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-3.264 million in Europe383.047million inthe

wholeworld

A significant factor on petroleum demand has been human population growth.Oil production per capita peaked in the 1970s. The worlds population in 2030is expected to be double that of 1980. There are speculation or predictionsthat oil production in 2030 will have declined back to 1980 levels as worldwidedemand for oil significantly out-paces production. There are claims that therate of oil production per capita is falling, and that the decline has gone

undisguised because a politically incorrect form ofpopulation control may beimplied by mitigation. Oil production per capita has declined from 5.26 barrelsper year (0.836 m/a) in 1980 to 4.44 barrels per year (0.706 m/a) in 1993,but then increased to 4.79 barrels per year (0.762 m/a) in 2005. In 2006, theworld oil production took a downturn from 84.631 to 84.597 million barrels perday (13.4553106 to 13.4498106 m3/d) although population has continued toincrease. This has caused the oil production per capita to drop again to4.73 barrels per year (0.752 m/a).

One factor that has so far helped ameliorate the effect of population growth ondemand is the decline of population growth rate since the 1970s, although this

is offset to a degree by increasing average longevity in developed nations. In1970, the population grew at 2.1%. By 2007, the growth rate had declined to1.167%. However, oil production is still outpacing population growth to meetdemand. World population grew by 6.2% from 6.07 billion in 2000 to 6.45billion in 2005, whereas, global oil production during that same periodincreased from 74.9 to 81.1 million barrels (11.91106 to 12.89106 m3), or by8.2%.

Agricultural effects of peak oil, Food vs. fuel and 20072008 world food

price crisis

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Because supplies of oil and gas are essential to modern agriculturetechniques, a fall in global oil supplies could cause spiking food prices andunprecedented famine in the coming decades. Geologist Dale Allen Pfeiffercontends that current population levels are unsustainable, and that to achievea sustainable economy and avert disasterthe United States population would

have to be reduced by at least one-third, and world population by two-thirds.The largest consumer of fossil fuels in modern agriculture is fertilizerproduction via the Haber process, which is essential to high perennial cornyields. If a sustainable non-petroleum source of electricity is developed, thisprocess can be accomplished without fossil fuels using methods such aselectrolysis.

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The world increased its daily oil consumption from 63 million barrels in 1980

to 85 million barrels in 2006The demand side of Peak oil is concerned with the consumption over time,and the growth of this demand. World crude oil demand grew an average of1.76% per year from 1994 to 2006, with a high of 3.4% in 2003-2004. Worlddemand for oil is projected to increase 37% over 2006 levels by 2030(118 million barrels per day (18.8106 m3/d) from 86 million barrels(13.7106 m3), due in large part to increases in demand from thetransportation sector.

Energy demand is distributed amongst four broad sectors: transportation,

residential, commercial, and industrial. In terms of oil use, transportation is thelargest sector and the one that has seen the largest growth in demand in

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recent decades. This growth has largely come from new demand for personal-use vehicles powered by internal combustion engines. This sector also hasthe highest consumption rates, accounting for approximately 68.9% of the oilused in the United States in 2006, and 55% of oil use worldwide.Transportation is therefore of particular interest to those seeking to mitigate

the effects of Peak oil.

Although demand growth is highest in the developing world, the United Statesis the world's largest consumer of petroleum. Between 1995 and 2005, USconsumption grew from 17.7 million barrels a day to 20.7 million barrels a day,a 3 million barrel a day increase. China, by comparison, increasedconsumption from 3.4 million barrels a day to 7 million barrels a day, anincrease of 3.6 million barrels a day, in the same time frame.

As countries develop, industry, rapid urbanization and higherliving standards

drive up energy use, most often of oil. Thriving economies such as China andIndia are quickly becoming large oil consumers. China has seen oilconsumption grow by 8% yearly since 2002, doubling from 1996-2006. In2008, auto sales in China were expected to grow by as much as 15-20percent, resulting in part from economic growth rates of over 10 percent for 5years in a row. Although swift continued growth in China is often predicted, itis predicted that China's export dominated economy will not continue suchgrowth trends due to wage and price inflation and reduced demand from theUS. India's oil imports are expected to be more than triple from 2005consumption levels by 2020, rising to 5 million barrels per day (790103 m3/d).

Production

The most common method of obtaining petroleum is extracting it from oil wellsfound in oil fields. With improved technologies and higher demand forhydrocarbons various methods are applied in petroleum exploration anddevelopment to optimize the recovery of oil and gas (Enhanced Oil Recovery,EOR). Primary recovery methods are used to extract oil that is brought to thesurface by underground pressure, and can generally recover about 20% ofthe oil present. The natural pressure can come from several different sources;where it is provided by an underlying water layer it is called a water drive

reservoir and where it is from the gas cap above it is called gas drive.

During the oil price increases since 2003, alternative methods of producing oilgained importance. The most widely known alternatives involve extracting oilfrom sources such as oil shale or tar sands. These resources exist in largequantities; however, extracting the oil at low cost without excessively harmingthe environment remains a challenge.

Chemically transforming methane orcoal into the various hydrocarbons foundin oil. The best-known such method is the Fischer-Tropsch process.

As crude oil prices increase, the cost of coal to oil conversion becomescomparatively cheaper. The method involves converting high ash coal into

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synthetic oil in a multi-stage process.

Currently, two companies have commercialised their Fischer-Tropschtechnology. Shell Oil in Bintulu, Malaysia, uses natural gas as a feedstock,and produces primarily low-sulfurdiesel fuels. Sasolin South Africa uses coal

as a feedstock, and produces a variety of synthetic petroleum products.The process is today used in South Africa to produce most of the country'sdiesel fuel from coal by the company Sasol. The process was used in SouthAfrica to meet its energy needs during its isolation underApartheid. Thisprocess produces low sulfurdiesel fuel but also produces large amounts ofgreenhouse gases.

An alternative method of converting coal into petroleum is the Karrick process,which was pioneered in the 1930s in the United States. It uses lowtemperatures in the absence of ambient air, to distill the short-chainhydrocarbons out of coal instead of petroleum.

Oil shale can also be used to produce oil, either through mining andprocessing, or in more modern methods, with in-situ thermal conversion.

Conventional crude can be extracted from unconventional reservoirs, such asthe Bakken Formation. The formation is about two miles (3 km) undergroundbut only a few meters thick, stretching across hundreds of thousands ofsquare miles. It further has very poor extraction characteristics. Recovery atElm Coulee has involved extensive use of horizontal drilling, solvents, andproppants.

More recently explored is thermal depolymerization (TDP), a process for thereduction of complex organic materials into light crude oil. Using pressure andheat, long chain polymers ofhydrogen, oxygen, and carbon decompose intoshort-chain hydrocarbons. This mimics the natural geological processesthought to be involved in the production offossil fuels. In theory, thermaldepolymerization can convert any organic waste into petroleum substitutes.

Production Challenges

Oil extraction is costly and sometimes environmentally damaging

Offshore exploration and extraction of oil disturbs the surrounding marineenvironment.

To avoid oil spills

Global warming on account of carbon-di-oxide emission resulting from burningoil

Identification of correct oil well

Infrastructure setup for extracting oil

Government policies & approvals

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Locations

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OPEC

The Organization of the Petroleum Exporting Countries (OPEC) is apermanent, intergovernmental Organization (cartel), created at the BaghdadConference on September 1014, 1960, by Iran, Iraq, Kuwait, Saudi Arabiaand Venezuela. The five Founding Members were later joined by nine otherMembers: Qatar (1961); Indonesia (1962); Socialist Peoples Libyan Arab

Jamahiriya (1962); United Arab Emirates (1967); Algeria (1969); Nigeria(1971); Ecuador (1973) suspended its membership from December 1992-

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October 2007; Angola (2007) and Gabon (19751994). OPEC had itsheadquarters in Geneva, Switzerland, in the first five years of its existence.This was moved to Vienna, Austria, on September 1, 1965.

OPEC's objective is to co-ordinate and unify petroleum policies amongMember Countries, in order to secure fair and stable prices for petroleumproducers; an efficient, economic and regular supply of petroleum toconsuming nations; and a fair return on capital to those investing in theindustry.

They have quotas for each member of OPEC and in relation to this the priceof oil is set. Price setting is such that it effects the entire industry prices.

Cost & Investment

Oil exploration can cost tens or hundreds of billions of dollars.

The actual costs depend on such factors as the location of possible oilreserves (i.e. on land or in deep water), how large the oil field is expected tobe, how detailed the exploration information must be, and the type andstructure of the rock below the ground. Exploration requires careful mappingof the surface in order to locate suitable sites (ie, types of geologicalstructures), deep formation surveys (eg, with two and three-dimensionalseismic techniques), and test-drilling. It is not easy to determine a typical cost

of such activities.

OPEC has the lowest average production costs in the oil industry. This ispartly because some OPEC Member Countries have large amounts of oil inreasonably accessible locations. Yet OPEC Members will still need to spendtens of billions of dollars in future to meet the growing need for oil.

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Oil price

Medium-Term Oil Prices, 1994-2008 (not adjusted for inflation).

In terms of 2007 inflation adjusted dollars, the price of oil peaked on 30 June2008 at over $143 a barrel. Before this period, the maximum inflation adjusted

price was the equivalent of $95-100, in 1980. Crude oil prices in the lastseveral years have steadily risen from about $25 a barrel in August 2003 toover $130 a barrel in May 2008, with the most significant increases happeningwithin the last year. These prices are well above those which caused the 1973and 1979 energy crises. This has contributed to fears of an economicrecession similar to that of the early 1980s. One important indicator whichsupported the possibility that the price of oil had begun to have an effect oneconomies was that in the United States, gasoline consumption dropped by .5% in the first two months of 2008, compared to a drop of .4% total in 2007.

However some claim the decline in the US dollar against other significantcurrencies from 2007 to 2008 is a significant part of oil's price increases from$66 to $130. The dollar lost approximately 14% of its value against the Eurofrom May 2007 to May 2008, and the price of oil rose 96% in the same timeperiod.

Helping to fuel these price increases were reports that petroleum production isat or near full capacity. In June 2005, OPEC admitted that they would'struggle' to pump enough oil to meet pricing pressures for the fourth quarterof that year.

Demand pressures on oil have been strong. Global consumption of oil rosefrom 30 billion barrels (4.8109 m3) in 2004 to 31 billion in 2005. These

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consumption rates are far above new discoveries for the period, which hadfallen to only eight billion barrels of new oil reserves in new accumulations in2004. In 2005, consumption was within 2 million barrels per day(320103 m3/d) of production, and at any one time there are about 54 days ofstock in the OECD system plus 37 days in emergency stockpiles.

Long-term oil prices, 1861-2007 (top line adjusted for inflation)

Besides supply and demand pressures, at times security related factors mayhave contributed to increases in prices, including the "War on Terror," missilelaunches in North Korea, the Crisis between Israel and Lebanon. nuclearbrinkmanship between the US and Iran, and reports from the U.S. Departmentof Energy and others showing a decline in petroleum reserves.

Another factor in oil price is the cost of extracting crude. As the extraction ofoil has become more difficult, oil's historically high ratio ofEnergy Returnedon Energy Invested has seen a significant decline. The increased price of oilmakes non-conventional sources of oil retrieval more attractive. For example,the so-called "tar sands" are actually a reserve ofbitumen, heavier, lowervalue oil compared to conventional crude. It only became attractive toproduction companies when oil prices exceeded about $25/bbl, high enough

to cover the costs of production and upgrading to synthetic crude.

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Effects of rising oil prices

World consumption of primary energy by energy type in terawatts(TW),

1965-2005.

In the past, the price of oil has led to economic recessions, such as the 1973and 1979 energy crises. The effect the price of oil has on an economy is

known as a price shock. In many European countries, which have high taxeson fuels, such price shocks could potentially be mitigated somewhat bytemporarily or permanently suspending the taxes as fuel costs rise. Thismethod of softening price shocks is less in countries with much lower gastaxes, such as the United States.

Some economists predict that a substitution effect will spur demand foralternate energy sources, such as coal orliquefied natural gas. Thissubstitution can only be temporary, as coal and natural gas are finiteresources as well.

Prior to the run-up in fuel prices, many motorists opted for larger, less fuel-efficient sport utility vehicles and full-sized pickups in the United States,Canada and other countries. This trend has been reversing due to sustainedhigh prices of fuel. The September 2005 sales data for all vehicle vendorsindicated SUV sales dropped while small cars sales increased. Hybrid anddiesel vehicles are also gaining in popularity.

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Possible Causes For Rising Price of oil

Demand

World crude oil demand grew an average of 1.76% per year from 1994 to2006, with a high of 3.4% in 2003-2004. World demand for oil is projected toincrease 37% over 2006 levels by 2030, according to the 2007 U.S. EnergyInformation Administration's (EIA) annual report. Demand is projected toreach 118 million barrels per day (18.8106 m3/d) from 2006's 86 millionbarrels (13.7106 m3), driven in large part by the transportation sector. A 2008report from the International Energy Agency (IEA) predicted that althoughdrops in petroleum demand due to high prices have been observed indeveloped countries and are expected to continue, a 3.7 percent rise in

demand by 2013 is predicted in developing countries. This is projected tocause a net rise in global petroleum demand during that period.

The transportation sector is the largest energy sector, and the one that hasseen the largest growth in demand in recent decades. This growth has largelycome from new demand for personal-use vehicles powered by internalcombustion engines. This sector also has the highest consumption rates,accounting for approximately 68.9% of the oil used in the United States in2006 and 55% of oil use worldwide as documented in the Hirsch report. Carsand trucks are predicted to cause almost 75% of the increase in oilconsumption by India and China between 2001 and 2025. In 2008, auto sales

in China have been expected to grow by as much as 15-20 percent, resultingin part from economic growth rates of over 10 percent for 5 years in a row.

Demand growth is highest in the developing world, but the United States isthe world's largest consumer of petroleum. Between 1995 and 2005, USconsumption grew from 17.7 million barrels a day to 20.7 million barrels a day,a 3 million barrel a day increase. China, by comparison, increasedconsumption from 3.4 million barrels a day to 7 million barrels a day, anincrease of 3.6 million barrels a day, in the same time frame. Per capita,annual consumption by people in the US is 24.85 barrels, 1.79 barrels in

China, and .79 barrels in India.

As countries develop, industry, rapid urbanization and higherliving standardsdrive up energy use, most often of oil. Thriving economies such as China andIndia are quickly becoming large oil consumers.[China has seen oilconsumption grow by 8% yearly since 2002, doubling from 1996-2006. In2008, auto sales in China were expected to grow by as much as 15-20percent, resulting in part from economic growth rates of over 10 percent for 5years in a row.Although swift continued growth in China is often predicted,others predict that China's export dominated economy will not continue suchgrowth trends due to wage and price inflation and reduced demand from the

US.India's oil imports are expected to more than triple from 2005 levels by2020, rising to 5 million barrels per day (790103 m3/d).

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Another large factor on petroleum demand has been human populationgrowth. Because world population grew faster than oil production, productionper capita peaked in 1979 (preceded by a plateau during the period of 1973-1979). The worlds population in 2030 is expected to be double that of 1980.

The role of fuel subsidies

State fuel subsidies have shielded consumers in many nations from the pricerises, but many of these subsidies are being reduced or removed as the costto governments of subsidization increases.

In June 2008, AFP reported that "China became the latest Asian nation tocurb energy subsidies last week after hiking retail petrol and diesel prices asmuch as 18 percent... Elsewhere in Asia, Malaysia has hiked fuel prices by 41percent and Indonesia by around 29 percent, while Taiwan and India have

also raised their energy costs. In the same month, Reuters reported that

Countries like China and India, along with Gulf nations whose retail oil pricesare kept below global prices, contributed 61 percent of the increase in globalconsumption of crude oil from 2000 to 2006, according to JPMorgan. Otherthan Japan, Hong Kong, Singapore and South Korea, most Asian nationssubsidize domestic fuel prices. The more countries subsidize them, the lesslikely high oil prices will have any affect in reducing overall demand, forcinggovernments in weaker financial situations to surrender first and stop theirsubsidies. That is what happened over the past two weeks. Indonesia,Taiwan, Sri Lanka, Bangladesh, India, and Malaysia have either raised

regulated fuel prices or pledged that they will.

The Economistreported: "Half of the world's population enjoys fuel subsidies.This estimate, from Morgan Stanley, implies that almost a quarter of theworld's petrol is sold at less than the market price."U.S. Secretary of EnergySamuel Bodman stated that around 30 million barrels per day(4,800,000 m/d) of oil consumption (over a third of the global total) issubsidized But energy analyst Jeff Vail warned that cutting subsidies would dolittle to reduce global prices.

Supply

All the easy oil and gas in the world has pretty much been found. Nowcomes the harder work in finding and producing oil from morechallenging environments and work areas.

William J. Cummings, Exxon-Mobil company spokesman, December2005 ,

In order to pump oil, it first needs to be discovered. The peak of world oilfield

discoveries occurred in 1965 at around 55 billion barrels (GB)/year. The rateof oil barrels of oil discovered has been falling steadily since. Less than 10

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Gb/yr of oil were discovered every year between 2002-2007.

Reserves

Conventional crude oil reserves include all crude oil that is technically

possible to produce from reservoirs through a well bore, using primary,secondary, improved, enhanced, or tertiary methods. This does not includeliquids extracted from mined solids or gasses (tar sands, oil shales, gas-to-liquid processes, orcoal-to-liquid processes).

Oil reserves are classified as proven, probable and possible. Proven reservesare generally intended to have at least 90% or 95% certainty of containing theamount specified. Probable Reserves have an intended probability of 50%,and the Possible Reserves an intended probability of 5% or 10%.Currenttechnology is capable of extracting about 40% of the oil from most wells.

Some speculate that future technology will make further extractionpossible,but to some, this future technology is already considered in Provenand Probable reserve numbers.

In many major producing countries, the majority of reserves claims have notbeen subject to outside audit or examination. Most of the easy-to-extract oilhas been found.Recent price increases have led to oil exploration in areaswhere extraction is much more expensive, such as in extremely deep wells,extreme down whole temperatures, and environmentally sensitive areas orwhere high technology will be required to extract the oil. A lower rate ofdiscoveries per explorations has led to a shortage ofdrilling rigs, increases in

steel prices, and overall increases in costs due to complexity.

Concerns over stated reserves

World reserves are confused and in fact inflated. Many of the so-called reserves are in fact resources. Theyre not delineated, theyrenot accessible, theyre not available for production

Sadad I. Al Husseini, former VP ofAramco, October 2007.

By Al-Husseini's estimate, 300 billion (64109 m3) of the worlds 1,200 billionbarrels (190109 m3) of proved reserves should be recategorized asspeculative resources.

One difficulty in forecasting the date of peak oil is the opacity surrounding theoil reserves classified as 'proven'. Many worrying signs concerning thedepletion of 'proven reserves' have emerged in recent years. This was bestexemplified by the 2004 scandal surrounding the 'evaporation' of 20% ofShell's reserves.

For the most part, 'proven reserves' are stated by the oil companies, theproducer states and the consumer states. All three have reasons to overstate

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their proven reserves:

Oil companies may look to increase their potential worth.

Producer countries are bestowed a strongerinternational stature

Governments of consumer countries may seek a means to fostersentiments ofsecurity and stability within theireconomies and amongconsumers.

The Energy Watch Group (EWG) 2007 report shows total world Proved (P95)plus Probable (P50) reserves to be between 854 and 1,255 Gb (30 to 40years of supply if demand growth were to stop immediately). Majordiscrepancies arise from accuracy issues with OPEC's self-reported numbers.Besides the possibility that these nations have overstated their reserves for

political reasons (during periods of no substantial discoveries), over 70nations also follow a practice of not reducing their reserves to account foryearly production. 1,255 Gb is therefore a best-case scenario. Analysts havesuggested that OPEC member nations have economic incentives toexaggerate their reserves, as the OPEC quota system allows greater outputfor countries with greater reserves.

The following graph shows refutable jumps in stated reserves withoutassociated discoveries, as well as the lack of depletion despite yearly

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production:

Graph of OPEC reported reserves

Kuwait was reported to have only 48 Gb in reserve, of which only 24 were"fully proven." This report was based on "leaks of confidential documents"from Kuwait, and has not been formally denied by the Kuwaiti authorities. Thisleaked document dates back from 2001, so the figure includes oil that havebeen produced since 2001, roughly 5-6 billion barrels, but excludes revisionsor discoveries made since then. Additionally, the reported 1.5 Gb ofoil burnedoffby Iraqi soldiers in the first Gulf War are conspicuously missing fromKuwait's figures.

On the other hand investigative journalist Greg Palasthas argued that oilcompanies have an interest in making oil look more rare than it is in order tojustify higher prices. Other analysts in 2003 argued that oil producingcountries understated the extent of their reserves in order to drive up the priceof oil.

Unconventional sources

Non-conventional oil, Heavy crude oil, Tar sands, andOil shale

Raw bitumen is separated from the sand in giant separation cells.

Unconventional sources, such as heavy crude oil, tar sands, and oil shale arenot counted as part of oil reserves. However, oil companies can book them asproven reserves after opening a strip mine or thermal facility forextraction. Oilindustry sources such as Rigzone have stated that these unconventionalsources are not as efficient to produce, however, requiring extra energy torefine, resulting in higher production costs and up to three times moregreenhouse gas emissions per barrel (or barrel equivalent). While the energy

used, resources needed, and environmental effects of extractingunconventional sources has traditionally been prohibitively high, the three

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major unconventional oil sources being considered for large scale productionare the extra heavy oil in the Orinoco Belt ofVenezuela the Athabasca oilsands in the Western Canadian Sedimentary Basin, and theoil shales of theGreen River Formation in Colorado, Utah and Wyoming in the United States.Chuck Masters of the USGS estimates that, "Taken together, these resource

occurrences, in the Western Hemisphere, are approximately equal to theIdentified Reserves of conventional crude oil accredited to the Middle East."Authorities familiar with the resources believe that the world's ultimatereserves of non-conventional oil are several times as large as those ofconventional oil and will be highly profitable for companies as a result ofhigher prices in the 21st century.

Control over supply

Entities such as governments or cartels can artificially reduce supply to theworld market by limiting access to the supply through nationalizing oil, cuttingback on production, limiting drilling rights, imposing taxes, etc. Internationalsanctions, corruption, and military conflicts can also reduce supply.

Nationalization of oil supplies

Factor affecting global oil supply is the nationalization of oil reserves byproducing nations. The nationalization of oil occurs as countries begin todeprivatize oil production and withhold exports. The point is while estimates of

oil reserves may vary, politics have now entered the equation of oil supply."Some countries are becoming off limits. Major oil companies operating inVenezuela find themselves in a difficult position because of the growingnationalization of that resource. These countries are now reluctant to sharetheir reserves."

Only 7% of the world's estimated oil and gas reserves are in countries thatallow companies like ExxonMobil free rein. Fully 65% are in the hands ofstate-owned companies such as Saudi Aramco, with the rest in countries such

as Russia and Venezuela, where access by Western companies is difficult.The PFC study implies political factors are limiting capacity increases inMexico, Venezuela, Iran, Iraq, Kuwait and Russia. Saudi Arabia is alsolimiting capacity expansion, but because of a self-imposed cap, unlike theother countries. As a result of not having access to countries amenable to oilexploration, ExxonMobil is not making nearly the investment in finding new oilthat it did in 1981.

Monopoly/Cartel influence on supply

OPEC is an alliance between 12 diverse oil producing countries (Iran, Iraq,Venezuela, Kuwait, Saudi Arabia, Algeria, Gabon, Indonesia, Libya, Nigeria,Qatar, and the United Arab Emirates) to control the supply of oil. OPEC's

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power was consolidated as various countries nationalized their oil holdings,and wrested decision-making away from the "Seven Sisters," (Anglo-Iranian,Socony-Vacuum, Royal Dutch Shell, Gulf, Esso, Texaco, and Calso.) andcreated their own oil companies to control the oil. OPEC tries to influenceprices by restricting production. It does this by allocating each member

country a quota for production. All 12 members agree to keep prices high byproducing at lower levels than they otherwise would. There is no way to verifyadherence to the quota, so every member faces the same incentive to cheatthe cartel. Washington kept the oil flowing and gained favorable OPECpolicies mainly by arming, and propping up Saudi regimes. According tosome, the purpose for the second Iraq war is to break the back of OPEC andreturn control of the oil fields to western oil companies.

OPEC being a cartel has a significant market compared to non-OPECplayers. Due to this, decisions taken by OPEC closely affects oil pricing &every industry across the globe. It is a form of monopoly which exercises itspower through its sheer size. By simply holding supply it increases its pricealong side increasing demand for crude oil.

Due to the above there are significantly less players in the market. Theequilibrium between demand & supply keeps shifting its origin.

An important contributor to price increases has been the slow down in oilsupply growth, which has continued since oil production surpassed newdiscoveries in 1980. The fact that global oil production will decline at somepoint, leading to lower supply is the main long-term prices. This is because

there is a limited amount offossil fuel, and the remaining accessible supply isconsumed more rapidly each year. Increasingly, remaining reserves becomemore technically difficult to extract and therefore more expensive. Eventually,reserves will only be economically feasible to extract at extremely high prices.It is thought by many, including energy economists such as MatthewSimmons, that prices could continue to rise indefinitely until a new marketequilibrium is reached at which point supply satisfies worldwide demand.

Although there is contention about the exact timing and form ofpeak oil, thereare now very few parties who do not acknowledge that the concept of aproduction peak is valid though before oil prices increased in 2008 to

energy crisis levels, some commentators argued that global warmingawareness and new energy sources means that demand may fall beforesupply, making reserve depletion a non-issue.

In addition, turbulence in the Middle East (the world's largest oil-producingregion) has led to decreased exports, especially civil unrest in Iraq after the2003 U.S. invasion. Outside the Middle East, Venezuela has experiencedstrikes and political turbulence, and there is growing instability in West Africa.

Alternatively, lower production rates may be due to the fact that oil'shistorically high ratio ofEnergy Returned on Energy Invested continues a

significant decline. The increased price of oil also makes other, non-conventional sources of oil attractive to businesses. The most prominent

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example of this is the massive reserves of the Canadian tar sands. They are afar less cost-efficient source of heavy, low-grade oil than conventional crude,but with oil trading above $60/bbl, the tar sands have become very attractiveto exploration and production companies. Recent months have seen billionsof dollars invested in the tar (bitumen) sands.

In view of tighter supplies worldwide, terrorist and insurgent groups haveincreasingly targeted oil and gas installations to maximize both mayhem andpolitical gains. Sometimes, such attacks are perpetrated by militias in regionswhere oil wealth has produced few tangible benefits for the local citizenry, asis the case in the Niger Delta. The terror factor adds an additional premium,including insurance costs, to the price of oil.

Even if total oil supply does not decline, increasing numbers of expertsbelieve the easily accessible sources oflight sweet crude are almost

exhausted and in the future the world will depend on more expensive sourcesof heavy oil and renewable energy sources. Until the rises of 2008, CERA (aconsulting company wholly owned by energy consultants IHS Energy) did notbelieve this would be such an immediate problem. However, in an interviewwith The Wall Street Journal, Daniel Yergin, best known for his quotes that theprice of oil would soon return down to "normal", publicly amended thecompany's position on May 7, 2008, and now expects oil to reach $150 during2008, due to tightness of supply This reversal of opinion is significant, asCERA, among other consultancies, provide price projections that are used bymany official bodies to plan long term strategy in respect of energy mix andprice, so the impact of a misprediction is far wider than might otherwise be

expected. In contrast, some other organisations, such as the InternationalEnergy Agency (IEA), had already been much less optimistic in theirassessments for some time.

While efforts are underway to increase supply, for example through a numberof new mines in Canada's tar sands region which is estimated to contain asmuch "heavy" oil as all the world's reserves of "conventional" oil, such effortslag behind the increasing demand of recent years. Regulation andenvironmental efforts have also increased the shortage and price of oil.

Other possible causes

Besides supply concerns, many other issues have also had some effect on oilprices. Labor strikes, hurricane threats to oil platforms, fires and terroristthreats at refineries, and other short-lived problems are not solely responsiblefor the higher prices. Such problems do push prices higher temporarily, buthave not historically been fundamental to long-term price increases.

Possible financial causes

Financial speculation

Financial speculation occurs when investors purchase futures contracts to buya commodity at a set price for future delivery. "Speculators are not buying any

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actual crude. ... When [the] contracts mature, they either settle them with acash payment or sell them on to genuine consumers."

Many prominent economists have argued that financial speculation is notacause of rising oil prices, however several claims have been made implicating

financial speculation as a major cause of the price increases. In May 2008 thetransport chief for Germany's Social Democrats estimated that 25 percent ofthe rise to $135 a barrel had nothing to do with underlying supply anddemand. Testimony was given to a U.S. Senate committee in May indicatingthat "demand shock" from "Institutional Investors" had increased by848 million barrels (134,800,000 m3) over the last five years, similar toincreases in demand from China (920 million barrels). The influence ofInstitutional Investors, such as sovereign-wealth funds, was also discussed inJune 2008, when Lehman Brothers suggested that price increases wererelated to increases in exposure to commodities by such investors. It claimedthat "for every $100 million in new inflows, the price ofWest TexasIntermediate, the U.S. benchmark, increased by 1.6%." Also in May 2008, anarticle in The Economistpointed out that oil futures transactions on the NewYork Mercantile Exchange (NYMEX), nearly mirrored the price of oil increasesfor a several year period, however the article conceded that the increasedinvestment might be following rising prices, rather than causing them, and thatthe nickel commodity market had halved in value between May 2007 and May2008 despite significant speculative interest. It also reminds readers"Investment can flood into the oil market without driving up prices becausespeculators are not buying any actual crude... no oil is hoarded or somehowkept off the market," and that prices of some commodities which are not

openly traded have actually risen faster than oil prices.In June 2008, OPEC'sSecretary General Abdullah al-Badri stated that current world consumption ofoil at 87 million bpd was far exceeded by the "paper market" for oil, whichequals about 1.36 billion bpd, or more than 15 times the actual marketdemand.

In response to the possibility that financial speculators artificially inflated theoil market, the U.S. Congress began hearings in June 2008 to discover ifactions to "tighten restrictions on pension funds, investment banks and otherinvestors that they say are driving up fuel prices" were necessary.

An interagency task force on commodities markets was formed in the U.S.government to investigate the claims of speculators influence on thepetroleum market concluded in July 2008 that "market fundamentals" such assupply and demand provide the best explanations for oil price increases, andthat increased speculation was not statistically correlated with the increases.The report also noted that increased prices with an elastic supply would causeincreases in petroleum inventories. As inventories have actually declined, thetask force concluded market pressures are most likely to blame. Similarly,other commodities which are not subject to market speculation (such as coal,steel, and onions) have seen similar price increases over the same timeperiod.

In June 2008 U.S. energy secretarySamuel Bodman had said that insufficient

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oil production, not financial speculation, was driving rising crude prices. Hesaid that oil production has not kept pace with growing demand. "In theabsence of any additional crude supply, for every 1% of crude demand, wewill expect a 20% increase in price in order to balance the market," Bodmansaid.This contradicts earlier statements by Iranian OPEC governor

Mohammad-Ali Khatibi indicating that the oil market is saturated and that anincrease in production announced by Saudi Arabia was "wrong". OPEC itselfhad also previously stated that the oil market was well supplied and that highprices were a result of speculation and a weak U.S. dollar.

Futures speculators related to major oil producers, such as Sultan HassanalBolkiah Muizzaddin of Brunei Shell Petroleum, Saudi Prince Alwaleed BinTalal Alsaud and Russian Vagit Alekperov of LUKoil, may have artificiallyboosted prices by speculating in the oil futures market.

In September 2008, a study of the oil market by Masters Capital Managementwas released which claimed that speculation did significantly impact themarket. The study stated that over $60 Billion was invested in oil during thefirst 6 months of 2008, helping drive the price per barrel from $95 to $147 perbarrel, and that by the beginning of September, $39 Billion had beenwithdrawn by speculators, causing prices to fall.

Monetary inflationThe Austrian School of economics holds that price inflation derives frommonetary inflation, and its advocates, such as the Ludwig von Mises Instituteand congressman Ron Paul, argue that loose monetary policy from theFederal Reserve and other central banks is a major contributor to the increasein oil prices, and the cause of both commodity speculation and dollardevaluation.

The price of oil is closely tied to the value of the U.S. dollar because oil istraded in dollars. This has led to concern among some economists that theprincipal earned from the sale of oil may lose value in the long run if the U.S.

dollar loses real value.

In discussing the effect of the changing value of the U.S. dollar on the realprice of oil, however, it is important to include a calculation ofeffectiveexchange rates of the currencies in question, to separate the real and nominalvalues of those currencies. This method accounts forthe amount that a dollarcan buy (of electronics or food for example) compared to the amount anothercurrency, such as a Euro orpound sterling, can purchase. While the U.S.dollar has lost nominal value to other major currencies from 2001 to 2007, itschange in real value has not differed significantly from other currencies.

In addition, by comparing the price of oil in various currencies to the

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fluctuations in the exchange rates of those currencies it is clear that oil price isno more significantly correlated to the value of the dollar than to any othercurrency. This also holds true in a comparison of oil price to gold price.Similarly, since the early 1970s, the price of oil has been negatively correlatedto the value of the dollar, suggesting that the price of oil has more of an effect

on the value of the dollar than vice versa. As developed economies dependheavily on oil for transportation, petrochemical feedstock, and industrialagriculture, this correlation would affect most currency values.

Some analysts believe that as much as $25 of the June 2008 prices around$140 are due to dollar devaluation.

Forecasted prices and trends

According to informed observers, OPEC, meeting in early December, 2007,seemed to desire a high but stable price that would deliver substantial neededincome to the oil producing states, but avoid prices so high that they wouldnegatively impact the economies of the oil consuming nations. A range of 7080 dollars a barrel was suggested by some analysts to be OPEC's goal.

Some analysts point out that major oil exporting countries are rapidlydeveloping; and because they are using more oil domestically, less oil may beavailable on the international market. This effect, outlined in the export landeconomic model, could significantly reduce the oil available for trade and

cause prices to continue to rise. Particularly significant are Indonesia (which isnow a net importer of oil), Mexico and Iran (where demand is projected toexceed production in about 5 years), and Russia (whose domestic petroleumdemand is growing rapidly).

In May 2008, T. Boone Pickens, the influential oil investor who believes theworlds oil output is about to peak, warned oil prices would hit $150 a barrelby the end of the year. Eighty-five million barrels of oil a day is all the worldcan produce, and the demand is 87 m, Mr Pickens said in an interview withCNBC. Its just that simple.

In June 2008, Alexei Miller, head of Russian energy giant Gazprom, warnedthat the price of oil is likely to hit $250 a barrel sometime in 2009. Miller saidthat while speculation had played a role in oil prices, "this influence was notdecisive.Bloomberg reported that, as of mid-June, "At least 3,008 optionscontracts have been purchased giving holders the right to buy oil at $250 abarrel in December".

Also in June 2008, Shukri Ghanem, head of Libya's National Oil Corporation,said: "I think it [the oil price] will go higher. That is a trend that will continue forsome time. The easy, cheap oil is over, peak oil is looming."

On June 26, 2008, OPEC President Chakib Khelil said in an interview: "Iforecast prices probably between $150-170 during this summer. That will

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perhaps ease towards the end of the year."Iran's OPEC governorMohammad-Ali Khatibi predicts that the price of oil would reach $150 a barrelby the end of this summer.

Near-term peak oil proponent Matthew Simmons predicts a rise to $300 a

barrel or higher by 2013 as sweet crude petroleum becomes more scarce andmajor producers begin failing to meet demand.