The formation of crude oil prices on the market:
For decades, until the mid-1980s, the international price of crude was not regulated by the free play of demand and supply, but determined or strongly conditioned by two distinct oligopolies: that of the "Seven Sisters", which essentially lasted until the end of the 1960s (although it was rapidly eroded in the course of that decade), and that of the Organization of Petroleum Exporting Countries (Opec), which held sway throughout the 1970s and until the early years of the next decade.
Opec's loss of its ability to control prices in the early 1980s and the beginning of crude oil price listing on the New York Mercantile Exchange (Nymex-1983) began a new phase in the formation of oil prices, which are still linked to world demand and supply. Nevertheless, as the oil supply is the result of the political and economic policies of the main producer countries, prices on the oil market are anomalous.
In order to understand the market, it is therefore more important - as well as more correct - to note that the price of oil (due to an anomaly which we explain below) derives from what in economic terms is called "the marginal barrel": the last barrel put into production to satisfy demand is the one that makes the price of the whole market.
The general concept is simple, as is evinced by Ricardo's explanation of the declining revenues of the agricultural sector: to satisfy a nation's grain demand, the best fields, those that produce most at the lowest cost, are put into production first.
As demand rises, however, new land is required; the best land is fully used and poorer land, with higher production costs, has to be cultivated. The price of grain goes up, to keep pace with the production costs of the last fields put into production (the "marginal costs"): obviously, at that price, the most efficient producers will have a rent.
This is what has happened in the oil sector, with one difference. Since the early 1970s the countries that have the lowest production costs in the world - the countries of the Arabian Gulf and of Opec generally - have constantly striven to limit their production to boost the price of crude oil.
This has enabled less efficient producers, like those operating in the North Sea, to fill the production gap artificially created by Opec.
In the oil market, therefore, we are witnessing a reversal of the economic theory that the most efficient producer enters the market first: in order to keep the price high, the producers have to act as swing producers, i.e. adjust their production to achieve the price they have agreed upon.
In this situation, the "marginal barrel" is not the one that is determined by the free play of demand and supply, but the one that is determined in a context of imperfect supply.
The sensitivity of the oil price to political factors and the existence of a producers' cartel (Opec) that has difficulty in getting its members to tailor their production to attain the agreed price targets, create discontinuities and volatility on the oil market, so that it is hard to make any realistic price forecasts.
One thing, however, can be safely said. Since the end of the Second World War (we might even say since the beginning of the twentieth century), the long-term trend of crude oil prices in real terms has been downward, except during periods of political crisis (the Iranian crisis of 1951-53; the Suez crisis of 1956; the Arab-Israeli crisis and the rise of Opec, from 1973 to 1985; and the Kuwaiti crisis of 1990-91).
When the crises subsided, the structural downward trend was resumed, albeit with intervals due to changing market conditions. In the last decade the sensitivity of oil prices to political crises has been different from that of the past: the existence of the substantial unused production capacity of Saudi Arabia - the great market stabilizer of past years - has introduced a powerful buffer into the world oil system. In these conditions, the immediate reaction of the price to political crises persists, but tends to be reabsorbed quite rapidly.
Proven reserves quantities of oil found for which it is possible reasonably to estimate the cost of recovery in the economic conditions existing at the time of the estimate.
Probable reserves
quantities of oil that can probably, but not certainly, be extracted.
Possible reserves
quantities of oil that are less certain than probable reserves and are estimated with a low level of reliability, insufficient to indicate whether they can be produced.
The question of the reserves:
There are three categories of oil reserves: proven, probable and possible. The ones of economic interest are the proven reserves that can be produced in the economic and technological conditions in force when their size is estimated.
In other words, a country may have abundant reserves of crude, but because of the geological conditions of the subsoil, the costs of extracting it may be too high, and it would be destined to remain in the ground until a new technological development lowered its production costs.
Similarly, a sudden fall in the price of crude on international markets may force the oil companies to downscale their reserves, eliminating those whose costs are no longer compatible with the crude oil price obtaining at the time (of course, the reverse is also true).
Another important point regarding reserves is the recoverability of the crude. A hydrocarbons deposit is not - as many people think - a sort of great lake or underground cavity which, once drilled, yields its entire contents. When we talk about a field we are referring to something much more complex, in which hundreds of billions of fractions of hydrocarbons are imprisoned in the pores of the rock and dispersed throughout the reservoir (which may extend for many kilometers).
This helps us to understand why not all the crude oil or gas in a field can be put into production. The recovery rate of a field indicates the percentage of hydrocarbons that can be effectively extracted from it in relation to the technology and price conditions applying at the time.
Today, the average recovery rate of the world's oilfields is nearly 35 percent. In 1970 it was about 22 percent. Every percentage point increase in the recovery rate of the world's oilfields represents a two-year increase in the useful life of global reserves. Hence the importance of the index and of the technological improvements that can help to raise it.
The proven reserves existing in the world at the beginning of the year 2000 amounted to about 1,050 billion barrels (bb) compared with annual consumption of just over 27 bb (i.e. about 75 million barrels per day) in 1999: they imply a useful life of slightly less than 40 years with respect to current crude oil consumption (in 1970 the reserves/production ratio was 30 years).
One of the established features of the proven reserves is their concentration in a few geographical areas. The five Gulf countries have 62 percent of the world's reserves.
Saudi Arabia alone, with more than 260 billion barrels, has 25 percent Next come Iraq (10.7 percent), the United Arab Emirates (9.3 percent), Kuwait (9.2 percent) and Iran (8.5 percent).
With the exception of Venezuela, which has reserves of over 70 bb (although the crude is heavier), the other big holders of the world's oil reserves are not comparable to the five mentioned above (see Table 1).
Tab. 1 The 20 countries with the largest oil reserves
(billion barrels – 1998)
Country Reserves Country Reserves
Saudi Arabia 261,5 China 24
Iraq 112,5 Nigeria 22,5
UAE 97,8 Norway 10,9
Kuwait 96,5 Algeria 9,2
Iran 89,7 Kazakhstan 8
Venezuela 72,6 Brazil 7,1
Russia 48,6 Azerbaijan 7
Mexico 47,8 Canada 6,8
USA 30,5 Angola 5,4
Libya 29,5 Oman 5,3
Some interesting points may be deduced from an analysis of the geographical location of the reserves.
The North Sea, though the scene of a remarkable production feat since the 1980s, has total reserves of just 16 bb (Britain and Norway), equivalent to 1.5 percent of global reserves.
The anomaly of the region is that, at current rates of production, its reserves have a useful life index (reserves/production ratio) of less than 10 years; for Saudi Arabia, the index is more than 80 years. However, up till now, continual revisions and discoveries resulting from technological developments have resulted in repeated postponements of the time when production in the area is expected to start to decline. The last frontier of oil exploration in the North Sea is the west Shetland region.
The situation of the Caspian region (Azerbaijan, Kazakhstan and Turkmenistan) is still uncertain. Rightly considered one of the new frontiers of oil exploration, it has an estimated potential of at least 40-50 bb, although much more optimistic assessments have also been made. However, so far the proven reserves are equivalent to those of the North Sea (about 16 bb).
The other frontier region, West Africa (Nigeria, Angola, Congo, Brazzaville and Gabon) has proven reserves of more than 30 bb and great potential in its deep offshore (depths exceeding 600 meters) and ultra-deep offshore (depths of more than 1,200 meters).
Exploration in these areas is even more recent than in the Caspian, and the potential estimated so far fluctuates between 20 and 30 bb. Moreover, the latest discoveries of giant fields (with reserves of more than 500 million barrels) were made in these areas.
The other African oil-rich region, North Africa (Libya, Algeria and Egypt) has reserves of more than 42 bb. Considering that Libya has so far been at the margins of the oil system for international political reasons and that Algeria started the systematic development of the oil sector only in the second half of the 1980s, the area may still hold some interesting surprises in store, even though it is considered fairly mature.
The consistency of US reserves is not remarkable. Taking into account high domestic consumption, the country's reserves have a useful life of slightly more than ten years. Latin America, with reserves of about 140 bb, concentrated mainly in Venezuela and Mexico, is today the prime source of US oil imports. In future, an important role in the Latin American continent may be played by Brazil, whose deep offshore is revealing interesting mineral prospects.
The crude oil market does not therefore appear to suffer from problems of scarcity, but is still conditioned by the strong geographical concentration of the reserves and by the political use that this concentration permits.
Demand and production
Oil occupies a prominent place in world demand for primary energy. It is a meager predominance compared with the past, when it covered more than 50 percent of world consumption: this is due partly to the strong growth of natural gas, which started in the 1970s, and partly to the continued popularity of coal, especially because of the confidence placed in this source by the poorer countries.
In the last decade, world demand has risen at an average annual rate of approximately 1.4 percent. Only in the period 1995-1997, i.e. before the Asian crisis, did demand experience a significant increase, surpassing 2.5 percent.
In those three years, two factors in particular helped to boost world consumption: strong growth in south-east Asia, where oil demand increased at an annual rate of 5%, and the robust US economy. In the other Oecd countries, the growth of demand remained fairly flat (nearly 1 percent).
Since 1990 the former Soviet Union has been a highly distorting factor in world demand and production. Following the collapse of the USSR, demand in the region was more than halved (falling from 8.4 mb/d in 1989 to 3.7 mb/d at the end of 1998). Production also declined, though at a lower rate, from more than 12 mb/d at the end of the 1980s to approximately 7.4 mb/d today.
Tab. 2 World oil production, consumption and unused capacity
(millions of barrels/day)
Production (*) Production (*) Oil products consumption Theoretical export availability (*) Production (*) Unused capacity** crude only
Year 1998 Year 1999 Year 1999 Year 1999 January 2000
1. Saudi Arabia 8.91 8.32 1.29 7.03 8.29 2.50
2. USA 8.37 7.99 19.45 - 8.04 -
3. Russia (1) 6.12 6.13 2.60 3.53 6.23 N.D.
4. Iran 3.71 3.58 1.15 2.43 3.53 0.15
5. Mexico 3.50 3.38 2.05 1.33 3.28 0.30
6. Norway 3.14 3.11 0.22 2.89 3.41 0.12
7. China 3.19 3.18 4.38 - 3.17 -
8. Venezuela 3.44 3.11 0.54 2.57 3.10 0.12
9. UK 2.84 2.95 1.75 1.20 3.03 -
10. Canada 2.67 2.54 1.97 0.57 2.68 -
11. UAE 2.67 2.43 0.32 2.11 2.46 0.30
12. Iraq 2.13 2.54 0.44 2.10 2.21 0.29
13. Nigeria 2.20 2.07 0.16 1.91 2.07 0.04
14. Kuwait 1.92 1.77 0.19 1.58 1.72 0.40
15. Indonesia 1.57 1.51 0.98 0.53 1.49 0.10
16. Libya 1.45 1.44 0.26 1.18 1.46 0.05
17. Brazil 1.28 1.40 1.96 - 1.40 -
18. Algeria 1.43 1.37 0.20 1.17 1.37 0.13
19. Oman 0.90 0.89 0.05 0.84 0.89 -
20. Argentina 0.90 0.86 0.47 0.39 0.83 -
Tot. 20 Countries 62.34 60.57 33.36 60.66 4.50
Egypt 0.88 0.85 0.59 0.26 0.84 0.04
Colombia 0.77 0.83 0.30 0.53 0.81 -
Qatar 0.75 0.74 0.02 0.72 0.76 0.12
Angola 0.73 0.76 0.04 0.72 0.81 0.05
Neutral Zone 0.56 0.59 - 0.59 0.61 N.D.
Rest of the world 7.77 7.98 8.36
Process. Gains 1.64 1.67 1.74
Total World (2) 75.44 73.99 75.23 74.59
OPEC 32.72 29.44 5.55 23.90 29.05 4.20
Non-OPEC 44.72 44.55 69.68 45.54
Sources: Eni Strategic Studies' processing of International Energy Agency (IEA), Petroleum Intelligence Weekly (PIW) and Energy Intelligence Group (EIG) data.
Notes: (*) Including NGLs and oil from non-conventional sources.
(**) Only for January 2000 crude oil production, usable within 30 days and sustainable for at least three months.
(1) The 1999 consumption data are independent estimates, similar to those of 1998.
(2) The slight differences in the totals are due to rounding.
Source: ENI.
© 2000 Mena Report (www.menareport.com)
