Wanted: New Sources of Crude Oil
by Tony D'Altorio, Investment U Research
Wednesday, March 2, 2011
Oil prices appear to be following the turmoil in Libya. Increased violence in the North African nation has cut at least half of its daily production of 1.6 million barrels of oil.
This comes at an extremely inconvenient time for global economies...
Globally, diesel and other distillates are in especially hot demand. JPMorgan (NYSE: JPM) projects they will account for over half the world's demand growth in oil this year.
It takes more heavier oils to produce diesel than it does Libyan light crude. And environmental rules everywhere are reducing the use of fuels with high sulfur content.
Europe, for one, limited sulfur content in fuels on inland waterways and for some machinery this year. It plans to expand the restrictions to trains in 2012.
Meanwhile, the U.S. Department of Energy just sold 2 million barrels of high-sulfur heating oil from a strategic reserve. Come summer, it will bid for the same amount of low-sulfur oil, further stoking demand for sweet crude.
Stock Markets Rally Over Saudi Arabian Announcement
Stock markets rallied after Saudi Arabia announced it would make up for any shortfall in Libyan oil production. But it's not that easy...
Libya's 1.6 million barrels might look small against global production of 87 million barrels a day. But the country produces some of the most-coveted and highest-quality, light sweet crude on the planet.
It is easily refined into gasoline and diesel, and has less sulfur, making it cleaner to burn. Libya's crude oil stream includes Es Sider, with its light density and low sulfur content.
Even more desirable is its huge El Sharara oil field, run by Spain's Repsol ADR (NYSE: REP). El Sharara's oil contains a mere 0.07% sulfur!
Saudi Arabia may supply the most of OPEC's 4.7 billion daily barrels of effective spare capacity. But Libya's quality is simply much better.
Arab Light, Saudi's leading oil by volume, is a relatively high 1.8% sulfur and heavier. This makes it more difficult to refine the oil into light products such as diesel and other fuels.
Quantity Is Not the Same as Quality
So while the Saudis have the quantity needed to replace Libya's lost production, their quality is lacking. You just can't substitute one for the other; it takes three barrels of Saudi oil to make as much diesel as one barrel of Libyan oil.
This means oil companies can't just replace lost production barrel for barrel. Ideally, they also need to find new sources of light, sweet crude.
Nigeria, Angola, Algeria, the North Sea and the region surrounding the Caspian Sea all provide just that. But most of those regions aren't exactly politically stable.
In other words, prices for the kinds of high-quality crudes that underpin benchmark oil futures contracts are headed up for a while. And refineries will likely have to cut output on those costs.
A Repeat of 2008?
As mentioned before, demand for low-sulfur oil is increasing amid all of this tightening. That bad combination has raised fears of repeating 2008, when oil prices hit over $145 a barrel.
Fortunately, this time is different, at least for the time being...
- After 2008, refiners now invest heavily in turning heavy oil into light products. Global refinery distillation capacity is up 3.3 million barrels per day since then, to 92.5 million.
- Oil inventories in developed countries are also higher than they were in December 2007. In the U.S., the 727 million barrel strategic oil reserve contains 293 million barrels that are low in sulfur.
On the downside, unrest in North Africa and the Middle East mean that oil prices remain above $75 a barrel for sometime. The turmoil in Bahrain is particularly unsettling, due to its proximity to Saudi Arabia and the near-by Bahrain.
With all of that in mind, investors should continue to hold and accumulate the ETF that holds Brent oil futures: the United States Brent Oil Fund LP (NYSE: BNO).
As discussed last month, Brent crude futures more closely track movements in the global oil markets than does the U.S.-based WTI oil futures.