Colin Barr

Following the money in banking, economics, and Washington

How Egypt spells oil spike

January 31, 2011: 1:21 PM ET

Egypt may not cause an oil shock this week. But trends that have been playing out there for decades show why another bruising bout with sky-high prices may be unavoidable.

Let's assume that unrest in the world's No. 27 exporter will be contained, keeping the current U.S. price of a barrel of crude nearer $90 than $100. For now, that's good news for a global economic expansion that's addicted to the stuff.

Bad trends for oil guzzlers

But a look at Egypt's oil profile (see chart, right) is hardly an uplifting experience. Production has been sliding for two decades, while domestic use has been rising at a higher rate. As a result, a country that in 1990 was able to export something on the order of 400,000 barrels a day is now a small net importer.

You surely don't care that Egypt is addicted to foreign oil. But the upshot of its switch to net petroleum consumption is that other, bigger oil addicts – such as the United States, which you may well care about – will inevitably find themselves fighting over a smaller supply of global oil exports. The terms of this battle will surely involve higher prices.

This is one reality of so-called peak oil -- a school of thought that contends, over the loud objections of Exxon (XOM) et al., that global crude production has likely gone as high as it will.

A diminishing supply of oil exports is bad enough news for big consumers like the United States. But what really stands to tighten the screws on oil fiends is the rising demand for that shrinking supply, driven by the head over heels growth of everyone's two favorite emerging market economies, China and India.

Squaring the shrinking oil export market with the surging global demand for fuel, we have something called peak export theory. This camp argues that we are doomed to a steady, double-digit annual rise in oil prices till the global economy, like Roberto Duran in New Orleans, finally whimpers "no mas" -- at which point a recession will send prices down to a lower if still excruciatingly high level.

Oil at $200 in the boom and $120 in the bust? It seems outlandish, but remember, oil cost just $9 and change in December 1998 and just $16 three years later, in the wake of the 9/11 attacks. Since 1998, it has risen at a 14% annual compound clip. At that rate, why not look at the stratosphere?

How high will it go?

"Egypt is a perfect case history for peak export theory," said Jeffrey J. Brown, a Dallas area petroleum geologist who has been making this case on the oil drum and other oil publications. "We're only going to see prices rise as more and more exporters slide down the curve toward being importers."

Brown contends Saudi Arabia, the biggest oil exporter in the world and the third-biggest supplier to the United States, after Canada and Mexico, is already sliding down this curve. He notes that since Saudi crude production hit its recent high in 2005 near 10 million barrels a day, output is off 3% while domestic use is up 7%.

The result? A 6% decline in Saudi exports, over a span in which the average price of oil has risen from the mid-$50s into the $80s and $90s.

Many observers assume Saudi Arabia maintains spare capacity that it could call into use should prices rise too high. But Brown notes that while Saudi Arabia responded to the 2000-2005 oil price runup by raising output, it hasn't done so in response to the price surge of the past five years.

Indeed, Saudi Arabia's production over the past five years has fallen short of its indicated 2005 capacity by some 2 billion barrels, he said.

"Something changed in early 2006," said Brown.

He estimates the global pool of available net oil exports could shrink to 27 million barrels a day in 2015 from 41 million barrels in 2005, thanks to slowing production and a surge in demand from India and China.

Under this scenario, Brown says, the two biggest developing nations will slurp up nearly a third of global oil exports by 2015 – tripling their share in 2005.

Can prices keep rising well into the triple digits without sending the global economy off the rails? It's possible it can, he contends, if you take a look at oil consumption over the past dozen years or so.

While U.S. consumption is basically flat with 1998 levels, oil use has surged in China, India, Morocco and Kenya, to name a few. It figures to keep rising in those places because energy consumption there fuels real growth -- something that has been in short supply here of late.

"Developing countries have been outbidding us for oil," he said.

So if you think $3-a-gallon gas is a problem, imagine what fuel prices might be in 2015, if the world develops the way Brown expects. Of course, there is a bright spot, sort of.

"Our forecast is that the U.S. is well on the way to becoming 'free' of its dependence on foreign oil," Brown says. "Just not in the way that many people anticipated."

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About This Author
Colin Barr
Colin Barr
Senior Writer, Fortune

Colin Barr has covered finance for Fortune.com since November 2007. Previously he was a writer and editor for TheStreet.com, winning a 2006 Society of American Business Editors and Writers award for "The Five Dumbest Things on Wall Street," and for Dow Jones Newswires. He is a 1991 graduate of Penn State and lives in Port Washington, N.Y., with his wife Meena Bose and their two kids.

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