Global Story

Addicted to Oil

by Peter Gunning, Chief Investment Officer, Asia Pacific, Russell Investment Group.

Oil prices dominate headlines. The fractured political landscape of the oil-rich Middle East generates endless debate. People are kidnapped, countries invaded and wars fought. Why is oil such a big deal?

Today’s modern lifestyle would be impossible without oil. It’s the world’s single largest source of fuel, supplying 41% of global needs.[1]

Apart from fuelling our cars, refined crude oil is used to produce liquefied petroleum gas, kerosene and fuel oil. Other by-products include lubricants, bitumen, and petrochemicals. Petrochemicals are used to make plastics, synthetic fibres, synthetic rubbers, detergents and chemical fertilisers. Many household items originate from oil: ink, crayons, bubble gum, dishwashing liquid, deodorant, cosmetics, spectacles, and tyres.

George W. Bush sparked much comment with his statement “America is addicted to oil”[2]. He’s right. America is the world’s largest oil consumer, consuming a quarter of global annual oil production[3]. The USA is one of the world’s largest oil producers, yet to satisfy the needs of its gas-guzzling population it’s also the world’s largest oil importer – making it vulnerable to supply squeezes.

Why is the oil price so high?

Unlike previous oil price hikes, caused by supply constraints, current high prices are being caused by increased global demand. China has been the main driver, its booming economy single-handedly accounting for one-third of the growth in global oil demand since 2000.[3] India’s consumption is expected to rise dramatically – by nearly 30% in the next five years.[5] It seems likely that high prices will be with us for some time.

Where does oil come from?[4]

Oil is composed of compressed hydrocarbons formed when aquatic plant and animal remains were covered by layers of sediment. Extreme pressure and high temperatures over millions of years transformed these particles into the liquid we know today as oil.

Oil is found in reservoirs in sedimentary rock. In some reservoirs, the oil is concentrated in pools, making it easy to extract, such as in the Middle East. Other types of reservoirs also contain large oil deposits, but the oil is diffused throughout the rock, making it harder to identify and more expensive to extract, such as in the USA.

OPEC

The Organization of Petroleum Exporting Countries (OPEC) is a permanent inter-governmental organisation with a stated aim of coordinating and unifying the petroleum policies of its eleven member countries and helping ensure stable oil prices.[6] OPEC’s member countries are Algeria, Indonesia, Iran, Iraq, Kuwait, the Socialist People’s Libyan Arab Jamahiriya (Africa), Nigeria, Qatar, Saudi Arabia, United Arab Emirates and Venezuela.

The Arab Oil Embargo of the early 1970s illustrated the power OPEC has to influence world oil prices, although today OPEC says such a crisis would be “unlikely”.[6] Nevertheless, high oil-consuming countries, keen to reduce their reliance on OPEC, are pursuing a variety of policies, from stockpiling supplies to encouraging energy conservation. Given that about two-thirds of known oil reserves are in OPEC countries, finding an alternative to oil is probably the only way they’ll reduce their reliance on OPEC.

The future of oil

The rise in oil prices has focused attention on the security and longevity of global oil supplies. According to a 2004 report prepared by the US office of petroleum reserves: “World oil reserves are being depleted three times as fast as they are being discovered.”[7] For governments and financial markets though, perhaps the more pressing issue is not when oil will run out, but when ‘peak production’ will be reached (the point when half the total oil known to have existed has been consumed, beyond which extraction goes into irreversible decline). Estimates on the likely peak production date range from 2007 to the mid-2030s.

Once peak production has passed, global oil production is expected to decline at about 2–3% a year. For a world ‘addicted to oil’, the withdrawal symptoms could be exceedingly uncomfortable.

The scramble to control oil resources seems set to intensify.[5]

1. Source: Organization of Petroleum Exporting Countries (OPEC); www.opec.org [back to article]
2. 31 January 2006, State of the Union address. See www.whitehouse.gov/stateoftheunion/2006/ [back to article]
3. ‘The oiloholics’, The Economist, 25 August 2005. [back to article]
4. Source: US Energy Information Authority (www.eia.doe.gov) [back to article]
5. ‘The end of oil is closer than you think’, The Guardian, 21 April 2005. [back to article]
6. Source: OPEC Web site www.opec.org [back to article]
7. Quoted in ‘The end of oil is closer than you think’, The Guardian, 21 April 2005[back to article]

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