The Daily Reckoning PRESENTS: It seems as though the unthinkable...

The Daily Reckoning PRESENTS: It seems as though the unthinkable is happening - the world's supply of oil is rapidly decreasing. John Myers takes a look at the world's escalating demand for oil...and wonders where we'll get the supply. Read on...

THANKS FOR THE OIL BOOM
By John Myers

As America has entered an age of extreme dependence on oil, the appetite in the rest of the world is growing each and every year.

China is burning oil at a record rate, much of it from the Middle East. This year, China will import as much as 120 million tonnes of crude. That is up from 2003, when China imported 91 million tonnes.

Chinese crude buyers have been scouring the world for new sources of oil to fuel the country's runaway economy, buying from nontraditional suppliers such as Canada and Australia.

Operating from offices in major oil trading centers like London, New York, Hong Kong, Singapore, and Beijing, Chinese oil companies are using a wide range of mechanisms to secure supplies from the international markets. These include spot purchases, term contracts, and even barter deals.

At the same time, Chinese companies have been eager to invest in existing and new oil fields to ensure future supplies.

"We need to power the fast-growing economy," said a trading official with China's second-largest oil-importing company, China National United Oil Co., the trading arm of PetroChina Co.

A major driving force for higher oil demand has been a sharp increase in the number of private cars used in China. In the two-month period of June-July 2003, the number of private cars in Beijing alone rose by 200,000 units.

The Middle East continued to be China's largest crude supplier, importer, followed by Africa. Currently, the Middle East supplies 50% of China's crude oil imports.

Chinese oil demand has been soaring since 2000. But it is still only a fraction of the size that it will eventually reach.

Currently, all of Asia consumes just less than 20 million barrels of oil per day. Not much when you consider that Asia has a population of 3 billion people. Meanwhile, the United States, with a population of less than 300 million people, consumes 22 million barrels of oil per day. U.S. per capita consumption of oil is 10 times greater than Asia's. But as China and its neighbors continue to industrialize, that consumption gap will close. Just how far it can tighten before incredible price resistance happens is difficult to say, but consider this - if Asia's per capita consumption of oil were one-fifth of America's, the region would consume 40 billion barrels of oil, or more than 50% of the world's total production.

Meanwhile, Chinese petroleum reserves currently provide only a seven-day supply, compared with 60 days for the United States. There is a growing gap between Chinese crude production and supply. More and more, Beijing will rely on Middle East imports to make up this difference.

According to Dr. Marc Faber, "Asia will revolutionize the geopolitics surrounding the oil-producing regions of the world."

Again, the focus comes back to the Middle East. And a picture of that region is downright ugly. Iraq is a mess, Iran is an avowed enemy of the United States and Saudi Arabia? Nobody knows for sure where on the fence Saudi Arabia sits, but one thing is for sure - it isn't on Washington's side.

On the Canadian Broadcasting Co. documentary TV show, The Passionate Eye, noted historian Joseph Trento, said: "We invaded the wrong country. If we wanted to stop terrorism, we should have invaded Saudi Arabia."

The fact is that Saudi Arabia and its 8,000 princes have been playing both sides against the middle. The Saudi government has one of the largest foreign lobbies in Washington and spends tens of millions of dollars a year to influence the federal government. It even went so far as to bail out President George W. Bush's Texas oil company before he was president. Yet at the same time, the Saudis have paid hundreds of billions of dollars in protection money to al Qaeda.

But let's put all the politics aside and look just at the economics. Even if the royal family turns out to be a bunch of nice people who want peace and democracy in the Middle East, the question remains - does the kingdom have the oil necessary to supply the world's burgeoning demand for crude? The answer: probably not.

"We don't see us as the ones making sure the oil is there for the rest of the world," one senior executive told The New York Times. The newspaper reported that an official of state-owned Saudi Aramco cautioned that even the attempt to get up to 12 million barrels a day would "wreak havoc within a decade" by causing permanent damage to the oil fields.

Meanwhile, Sadad al-Husseini, Saudi Aramco's second-ranking executive and the company's No. 1 geologist, has warned that global "natural declines in existing capacity are real and must be replaced."

In other words, the once unthinkable is happening - even the rich oceans of oil in Saudi Arabia are being severely taxed by surging global demand.

Saudi Arabia's reported proven reserves, more than 250 billion barrels, are one-fourth of the world's total. The Big Daddy field in that equation is Ghawar. Discovered in 1948, the 300-mile-long sliver near the Persian Gulf is the world's largest oil field. In fact, it accounts for half of the nation's 9.8 million-barrel-per-day production.

According to Aramco, production practices at Ghawar and other giant fields are sustainable. But some North American oil insiders wonder if Ghawar hasn't been worked over.

As one Canadian oil executive said to me, "The Saudis have done to Ghawar just what was done in East Texas - they drilled it too hard, too fast."

That is a frightening thought when you consider that today some of the pump jacks in East Texas manage to harvest just five barrels per day.

So the truth of the matter, oil rose to $55 per barrel because of one fundamental fact - it is becoming a scarce resource. This fundamental may be ignored for a while. But as oil supplies are taxed more and more each year, and new demand rises out of Asia, you have to wonder not if oil will reach $100 a barrel, but when.

Regards,

John Myers
for the Daily Reckoning