The real reason why oil is so expensive

Garry White looks at why OPEC has dropped production, and finds that the Middle East's energy crisis, combined with unsustainable government subsidies, is the real driver behind the high oil price.

OPEC pumped an average 32.35m barrels a day in March, down 85,000 barrels from February. Production by the 12 members with quotas (all except Iraq) fell 30,000 barrels to 29.97m barrels a day. This is the first time output has fallen in seven months.

On Saturday, OPEC's Secretary-General Abdullah al-Badri said during a trip to Iran:

'Oil supply to the market is enough and high oil prices are not due to a shortage of crude but rather it is because of the decrease in the dollar's value, shortage of refinery capacity and some political tensions in the world.'

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I believe that a significant amount of this is bravado: OPEC does not want to reduce output because member countries know their oil is in limited supply and they want to get the maximum price they can muster.

I reckon the main issue, however, is that their own energy crisis means they couldn't even if they wanted to. Peak Power problems are keeping the oil price high, not Peak Oil - but Peak Oil will have its day.

Middle Eastern power usage

According to the Lehman Brothers' chief energy economist, Edward Morse, world markets could have lost 1 million barrels per day (bpd) of oil in the summer of 2007, as Middle East power plants were forced to burn crude and natural gas redirected from enhanced oil recovery projects as summer demand for services for air conditioning rose. Morse believes that a combination of these "lost" Middle East exports and disruptions from Mexico, drove up oil prices in the latter part of 2007 by a greater amount than the flow of money from hedge funds.

It is important to note that the evils of subsidy have made Middle Eastern residents some of the largest energy users per capita in the entire world. Governments are having difficulty getting rid of these subsidies without causing civil unrest.

The latest data available on World Energy consumption is for 2003 from the World Resources Institute. The figures represent total energy consumption per capita in units of kilograms of oil equivalent (kgoe) per person.

US: 7,794.8

UK: 3,918.1

UAE: 10,538.7

Qatar: 21,395.8

Kuwait: 9,076.0

Bahrain: 10,250.5

The US is decried as the gas-guzzling capital of consumption: but this is only partly true. It is actually the residents of the Middle East who are the largest consumers of energy in the world. With a wealth and population explosion added to the mix, oil-rich countries are facing an unprecedented energy crunch.

Generous subsidies

According to the IMF, Middle Eastern governments were more generous in subsidising oil products than governments anywhere else in the world during 2007. While oil prices rose strongly throughout the year, governments in the Middle East passed on just 58% of the increase in the cost of importing petrol.

The region's governments also passed on an average of 67% of the increased cost of diesel to their consumers, a smaller amount than governments in any other part of the world. Yemen spent a staggering 9.3% of GDP on energy subsidies in 2006, the most of any country in the region.

This trend is, patently, unsustainable. However, governments are going to find it tricky to cut these subsidies and discourage consumption. In June last year, there were riots at petrol stations in Iran after the government tried to get its soaring fuel subsidy costs under control.

Iran's problem is that it lacks refining capacity so it has to import around 40% of its petrol at market rates. Some estimates have put the cost of Iran's fuel subsidy and import policy at more than £5bn a year.

All of this gives leverage to the region's future power consumption and none of the countries have the power infrastructure to cope. Peak Power has hit the region before Peak Oil, but the countries are failing to admit the depth of their crisis because it is really easy to blame all of the upside in oil prices on the dollar. OPEC has always played the game with smoke and mirrors it will never change.

This article is taken from Garry White's free daily email Garry Writes'.