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IHS™ CERA Alert - Oil Disruption: This time it really is different—
To an extent

(03/02/2011)

by Bhushan Bahree

Key implicaTions

The loss of significant volumes of oil supply from Libya, a major energy exporter, has caused anxiety but not alarm and dread. This contrasts with the response to oil supply disruptions in the 1970s, when consumers became fearful of actual shortages and panicked. The disruptions of the 1970s were much larger than today’s Libyan outage. But credit for relative calm now is also due to the development of institutions and international cooperative efforts, and to more information. This IHS CERA Alert defines what’s different this time.

GeopoliTical anxieTy

The loss of significant volumes of oil supply from Libya, a major energy exporter, has caused anxiety but not alarm and dread. This contrasts with the response to oil supply disruptions in the 1970s, when consumers became fearful of actual shortages and panicked. The disruptions of the 1970s were much larger than today’s Libyan outage. But credit for relative calm now is also due to the development of institutions and international cooperative efforts, and to more information. These include clear operational understandings between members of the International Energy Agency (IEA) and the Organization of Petroleum Exporting Countries (OPEC). These channels of communication have been built and road-tested over more than three decades. This time, it really is different—to an extent. Consider the following:

• Consuming countries have built up strategic oil inventories. Members of the IEA and other major consumers such as China have built up large inventories of oil that can be released to markets in the event of a supply disruption. The United States alone has more than 700 million barrels in storage. Altogether IEA members have more than 4 billion barrels of public and industry stocks.

• Saudi Arabia maintains strategic spare capacity. The kingdom has a stated policy of maintaining 1.5–2 million barrels a day of spare crude output capacity that can be quickly brought into use to offset a disruption elsewhere. It has even greater spare capacity currently because of an expansion program undertaken when demand was soaring in the past decade.

• The IEA and OPEC have an understanding on sequential intervention. Both organizations have matured since the 1970s, when the IEA was a fledgling meant to counter OPEC, and OPEC was full of nationalist fervor at a time of “North-South” confrontation. A thaw that started after the first Gulf War resulted in increasing dialogue between the two culminating in the establishment of the International Energy Forum. This finally led to a gentleman’s agreement on supply intervention which was tested out when the United States and its allies invaded Iraq in 2003. OPEC moves first to offset a supply shortage. The IEA follows up with a release of strategic stocks held by its members only if necessary, that is if OPEC is unable to fill a supply gap.

• Oil futures markets are a critical balancing factor. Oil was not traded on futures exchanges during the crises of the 1970s. As trading and liquidity built up during the 1980s and 1990s, futures markets have come to play a critical role in instantly pricing risk. A run-up in prices can quickly dampen demand to align it with available supply, though price volatility during adjustment phases can be unnerving.

a sTeaDier horizon

None of the above means that the world is protected against every oil supply threat. A disruption in excess of the ability of the mechanisms in place to cope with a physical disruption could still occur. But the defense mechanisms have worked during Venezuelan strikes in 2002 and 2003, the Iraq war in 2003, and Nigerian supply woes related to political troubles. Now Saudi Arabia has stepped in smoothly to offset supply losses resulting from the violence and political upheaval in Libya. Others in OPEC, notably in the Gulf, may also help. The IEA is standing by to assist, if needed, with more oil. This is not 1979.

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