Sometimes it’s hard to see the forest for the trees or, in the case of our expectations for oil prices, the message of a city burning halfway across the globe for all the oil derricks spreading across the plains of North America.

Shale drilling and the dramatic lift it’s given to domestic energy production have fostered the impression of a growing glut, often extrapolated from the swollen commercial crude inventories in the US. But energy markets are global in scope and degree of interconnection, and in the global scheme of things there is no glut.

In fact, the wonder at the moment is not so much that crude is above $100 a barrel but that so few  people expect it to head higher in the near term. Overseas supply disruptions that might have seemed critical before Arab Spring and the fracking revolution in the US now get shrugged off as routine.

Source: International Energy Agency, May Oil Market Report

That burning city I mentioned is Mosul, Iraq’s second-largest. It was seized Tuesday by fighters affiliated  with the hardline Sunni fundamentalist Islamic State of Iraq and al-Sham (ISIS), who routed government forces nominally loyal to the Shia-dominated government in Baghdad, 220 miles to the south.

This shocker didn’t directly threaten the bulk of Iraq’s recently growing crude output, which is concentrated in the Shia heartland in the country’s south. But the Sunni rebels’ subsequent drive toward Baghdad certainly has, propelling oil prices higher Thursday.

At this point the survival of the current Iraqi regime is far from  assured, as underscored by its requests for US air strikes on its foes.

The thing to remember is that, in terms of its recent contributions to the global supply of crude, Iraq is a success story rather than a failure.


Source: International Energy Agency

The big failure in terms of crude production has been Libya, which was producing just 235,000 barrels per day (b/d) last month, down from at least 1.5 million b/d a year earlier, according to the International Energy Agency (IEA).

Port blockades and oilfield closures by regional militias opposed to the weak central government in Tripoli are to blame, and given that Libya is losing more than $100 million in oil revenue a day you’d think one of the many deals to break the political deadlock would have stuck by now. Only it hasn’t. 

Source: International Energy Agency

Fundamentalist Salafist militias ideologically and perhaps financially linked to Saudi Arabia’s regime have been a major source of the instability.

Their aims (a fundamentalist Islamic state) and means (car bombings) are very similar to those of the ISIS group in Iraq and Syria. And in fact Iraq’s prime minister in March accused Saudi Arabia and Qatar of openly financing ISIS and other Sunni groups fighting against his government.

His charges, and suspicions of a Saudi role in Libyan unrest, sound credible because it is very much in Saudi rulers’ financial interest to keep Libyan crude off the market and dampen the growth of Iraqi output. Right now, Saudi Arabia is the only member of the Organization of Petroleum Exporting States with meaningful spare production capacity. Which means it gets to reap the benefit of high oil price without worrying about having to cut production to offset the traditional cheating on their quotas by other members of the exporters’ cartel. In fact the Saudis are noncommittally fielding calls from groups like the IEA to boost output in order to meet rising global demand in the second half of the year.

And that demand is rising despite the growth slowdown dampening the demand for fuel in several large emerging economies. It’s rising in part because China is now buying much more crude than current needs warrant in order to build up a strategic reserve. The Middle East’s own considerable demand for crude is also up as high energy prices stoke consumption in the producing economies.


Source: International Energy Agency

But most importantly, demand is starting to recover in the developed world. I discussed revived US demand for fuel in a recent Energy Letter, and Canada is on much the same trajectory. European demand has also turned positive, helped by growth in Germany and the UK, even as European commercial stocks remain well below their recent five-year average.

Japan’s economy is also performing better, and only the expected restart of some of the country’s nuclear plants, offline since the Fukushima accident three years ago, is still leading the EIA to forecast a modest drop in demand year-over-year.

Since the 34 developed-country members of the Organisation for Economic Co-operation and Development (OECD) account for half the current global fuel demand, an end to years of erosion in their fuel consumption, if confirmed, would be big news for the energy markets. It certainly figures to make traders more nervous about the OPEC’s reduced production slack, all of it concentrated in Saudi Arabia. 

Of course there can be no guarantees that developed-country demand will continue to grow. But at this point the near-term odds of further recovery look better than those for peace in Libya or Iraq, a quick end to the trade sanctions on Iran or regime change in decaying Venezuela.

That leaves Saudi Arabia as the supplier of last resort and US shale drillers able to pump as much as they can without pressuring global energy prices.

Nothing in commodity markets can be assured and one day crude will certainly go through a correction.  But given the market power currently wielded by the world’s biggest exporter and its incentives for keeping rivals weak, it would be foolhardy to expect a big discount anytime soon.