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So why wouldn't oil prices rocket?

A few oily thoughts.

The last "super giant" oilfield (more than 10 billion barrels) was discovered 40 years ago; the last American refinery was built 25 years ago; each successive American "driving season" guzzles more gas than the last.

The average oil discovery these days is small - 50 million barrels - and the average net present value of each reservoir is below the cost of exploration. Drilling for oil has not paid off for a long time.

Meanwhile, in America, rapacious consolidation and a clamp on new capacity has led to a shortage of gasoline, separate to the demand/supply picture for oil.

And then there's this driving season, a uniquely American event. It starts on the Memorial Day long weekend, or the last Monday in May, and ends on Labor Day, the first Monday in September. These two long weekends are the bookends of summer: in between, millions of yank- tanks and SUV gas guzzlers jam the highways, filled with Griswolds heading off to Wallyworld.

As this year's Memorial Day approaches, a shortage of refining capacity is pushing the price of petrol above a horrifying (to Americans) $US2 a gallon - equivalent to 77.7c Australian a litre. For some reason this has also pushed the Australian unleaded petrol price above $1 a litre ($US2.57 per US gallon).

Why a refining-capacity-driven rise in the end price should result in a sharp rise in the raw material input price (crude oil) is hard to fathom but, then, the oil market is not the most rational of markets.

The oil price, like the price of most commodities, is set according to both long-term and short-term factors, with an emphasis on how the traders feel that day (or sometimes that minute).

The short-term factors du jour are the impending US driving season combined with a shortage of refining capacity, instability in the Middle East and rapidly growing demand from China.

The latest escalation in the oil price - that is, when oil decoupled decisively from other commodities which it had been tracking for about 12 months - began on April 5 with the uprising in Iraq led by Moqtada al-Sadr.

But underlying these factors is a persistent prediction that global oil production will peak around 2008-10 and then begin an unstoppable decline.

The patron saint of the oil production doomsayers is M. King Hubbert. In 1956 he correctly predicted that US production would peak in 1970; he later predicted that global production would peak in 1995 but he got that wrong.

Nevertheless the debate goes on. One of those keeping the Hubbert flame alive is Colin J. Campbell. This passage from a July 2002 paper by him sums up the (still) current thinking: "Oil discovery in the United States peaked in 1930 with the discovery of the East Texas field. Peak production inexorably followed 40 years later but no one particularly noticed as cheap imports made up the difference.

"Since then, the same pattern of peak and decline has been repeated from one country to another, save for the Middle East, and the time lag from peak discovery to peak production is falling, thanks to modern technology.

"Given that peak world discovery was passed in 1964, the corresponding peak of global production is now getting close. Exactly when it will come depends on many short-term factors, not least of which would be military intervention in the Middle East. The base- case scenario points to 2010 but it could come sooner if economic recovery should drive up the demand for oil. The question is not whether but when oil production will peak."

Note that these forecasts are about oil production peaking, not "oil reserves running out". Note also that military intervention in the Middle East has now occurred and that another factor has since emerged to drive up demand for oil: the explosive growth of China.

It turns out, in fact, that Chinese demand and military intervention in the Middle East are the two most important short-term factors behind this year's oil shock. But whether they bring forward the long- term oil peak is impossible to say.

That's because there is no reliable information about Saudi Arabian reserves and production, and no one has any real idea whether there is more oil to be found on the Arabian Peninsula, if they actually look.

One of the most important assumptions underlying the oil market is that the Saudis can act as almost swing producers in the event of a supply disruption. That is far from clear.

But as Americans prepare their SUVs for the driving season, OPEC is running at full capacity and the non-OPEC producers are in decline.

There may well be a short-term correction back to below $US40 a barrel if OPEC quotas are raised and Saudi Arabia maintains its over- production but it is far from clear that the successors of M. King Hubbert are wrong about the big picture.

No one's making oil any more.

mail@alankohler.com

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