I started earlier today a big piece about what it means to "control" oil (see the link below) and will finish today with the fairly general and theoretical considerations by discussiing oil prices.
I hope to then move on to more practical questions, to better understand the diplomacy of various countries and the behaviour of oil companies.
Don't hesitate to bring up questions if there are topics that you'd like to see covered.
Previous installment: The global fight for the control of oil
The following themes are already under way:
- for an importing country (and its economy), the strategic risk of insufficient supply in times of crisis
- for a given oil asset, the repartition of the oil "rent" between all "stakeholders"
For many products, the buyer has some degree of control via the level of his demand and/or the price he is willing to pay for that good. Oil is quite unusual in that it is a vital commodity for everybody (economies would grind to a halt without it), with limited demand elasticity (i.e. demand will not vary much with price) and a very efficient worldwide market. There is a single worldwide price (or at least equivalent netbacks taking into account transportation costs) and a fully liquid and solvent market which ensures that if you have oil, you will find a buyer - with the money to pay for it. This means that no one (except for very specific cases, for instance a pipeline leading to a single refinery, which will have some buying power) can set its conditions on the buying side.
Market power becomes a macro-economic question: what are global production and demand, what are their main drivers. Each country may worry about its specific dependency to imported oil, but the worldwide supply and demand balance is the only determinant of whether such imports will be found, and their price. To avoid such uncertainty, local policies can be put in place to change the local oil balance (policies to encourage domestic production, or favoring a switch to other forms of energy - nuclear, renewables, etc..-, or energy savings), and these policies will in turn influence the worldwide balance depending on the size of the country.
On the supply side, the picture is quite similar: the liquid worldwide market with many suppliers is also there, there is also a lack of elasticity on the production side (most countries produce at their maximum capacities most of the time - with one big exception, Saudi Arabia, about which more later, and it takes time to invest in new production capacities if they are needed). However, production levels are not currently correlated to reserve levels, and likely future production levels are much different from today's. In fact, reserves are much more concentrated than production, giving a small number of countries the perspective of growing market power.
On the other hand, another factor constrains the market power of the sellers: their own dependence on oil export revenues for a large part of their exports, GDP, and budget revenues. This means that variations in oil export revenues can have a direct impact on the standards of living of a good part of the population, which in turn would have an impact on the domestic political situation. These countries therefore need, sometimes desperately, to maintain the export revenues at the levels they already are (or even increase them to take into account fast-growing populations).
So you have a situation where the importing countries badly need to import the oil, but the producing countries just as badly need to export it. It's an unstable balance, determined first by the fundamentals of the market (the supply-demand balance) and then by international politics and strategy.
In this context, Saudi Arabia was an exception for the past 20 years: it was the only country with significant unused production capacity, which meant that, as the largest exporter it could have a real influence at the margin on the demand-supply balance. As one of the lowest-cost producers, this influence was even stronger. This power was demonstrated to buyers in the 70s via the two oil shocks, where SA was the biggest player within the OPEC cartel. It was also, more interestingly, demonstrated to other sellers in 1986 when the country increased its production, flooded the market with its oil and caused the oil price to collapse. Ever since, it has been accepted as the world's "central banker" for oil.
The difference today is that SA, not having invested enough in recent years due to lowish prices, does not have that much spare capacity available anymore. When you add in unexpectedly higher demand (due to US, Chinese and Indian growth), uncertainty on production levels in several producing countries (strikes in Nigeria and Norway, political crisis in Venezuela, the Yukos fracas in Russia) and geopolitical instability in the Gulf region, and you have a recipe for crisis, where nobody really controls the price anymore, despite the efforts of many.
The Persian gulf countries control most of the remaining reserves and will thus have growing market power in the future, which may translate into geopolitical power as they will control a large enough portion of oil production to be able theoretically able to cut off supplies and bring other countries to their knees.
But higher oil prices and higher dependency on a few sources also lead others to seek alternatives. Amongst the alternatives, you can find more expensive reserves (including very deep offshore, oil sands), new technology/substitutes (GTL, which requires natural gas, renewable energies, energy efficiency by users, public transportation, etc...), all of which help to bring the market back to an equilibrium.
And remember that the oil revenues by producing countries will be spent, usually in industrialized countries, thus bringing it back into the economy. The net effect of such massive movements of funds is equivalent to a massive - and brutal - shift in tax policies within industrialized countries, and can thus also be compensated by domestic tax reform. (Actually, one of the reasons for the 70s crisis was the producing countries were not able to spend and recycle all of their revenues back into developed countries; another is that they spent a lot of it on weapons, which is not the most productive use of our resources).