The Next Huge Oil Spike

Oil prices are now hovering near $100, now that the world seems relatively stable: Egypt and Libya are out of the news, Osama bin Laden is dead, and Iranian President Mahmoud Ahmadinejad will not be chairing the next OPEC meeting. However, sky-high oil prices are not as far off as you may think. Sparks flying among the large Middle Eastern oil-producing nations could send prices soaring for years to come.

Two weeks ago, my colleague David Lee Smith warned Fools to carefully watch the story unfolding in the Middle East. Should the U.S. leave Iraq in December, Iran and Saudi Arabia could begin to vie for power and influence in the region. Iran has been active in trying to influence the region recently, and Saudi Arabia and other countries are getting antsy. Just last week, The Wall Street Journal reported that Saudi officials have been talking with other Muslim nations to join an informal Arab alliance against Iran. Some analysts worry that more nations could be pulled into troubles between the two Middle Eastern powers.

Why this matters
Chaos and unrest have a much larger effect than most people realize. When large oil powers go through chaotic times, a significant amount of their oil-producing capabilities is lost for years. Often, these countries never return to the production levels they had before chaos started.

Let's examine the historical data:

Country

Year

Event

Pre-Event Production (MMB/d)

Production Low Point (MBB/d)

Recovery Level (MMB/d)

Years to Recovery

Iran 1979 Revolution 6.0 1.3 3.5 15
Iraq 1980 Iran-War 3.5 1.0 3.0 10
U.S.S.R. 1989 Collapse 12.0 6.0 10.1 20
Iraq 1990 Gulf War 3.0 0.5 2.5 10
Venezuela 2002 PDVSA strike 2.8 1.2 2.6 9
Iraq 2003 Invasion 2.5 1.4 2.5 8
Libya 2011 Revolution 1.6 ~0.4 - -

Source: ARC Financial, U.S. Energy Information Administration.

Iran and Iraq in the early '80s provide interesting examples. The Iranian revolution of 1979 followed by the Iraq invasion in 1980 caused Iran's oil production to drop nearly 80%. The invasion cost Iraq dearly as its production dropped 70%. It took Iraq a decade to return to a level near where it was at before the war. In Iran's case, it took 15 years to return to a level 40% below its prior production. It has not been able to produce more than 4.2 MMB/d since.

More recently, Libya has so far lost roughly 75% of its daily production of 1.6 million barrels of oil per day. Using the past as an example, Libya's oil-producing capabilities will not have an effect on the world markets for years to come.

Why this happens
In any war-like situation, you might expect pipelines, wells, and other necessary infrastructure to be destroyed. However, the damage is much broader. The "brain-drain" of experienced workers fleeing the country is a large factor in the loss of production. Skilled workers aren't apt to quickly return, and replacements are hard to come by for a country that has just (in the past five years) gone through chaos.

Beyond that, functioning governments take time to rebuild, and money for new projects is hard to find, as investors demand huge returns for the high perceived risk of the nation. It took nearly seven years for the Iraqi government to auction off some of its oil fields to ExxonMobil (NYSE: XOM  ) , Royal Dutch Shell (NYSE: RDS-B  ) , and BP (NYSE: BP  ) and that was with the U.S. working feverishly to protect Iraq's oil assets during the war. I doubt you will see Total (NYSE: TOT  ) or ConocoPhillips (NYSE: COP  ) returning to Libya anytime soon after losing most of their investment in the country.

The possible future
It is a big "if," in terms of if the big Middle East three fall into chaos, but it's still worth pondering what could happen:

Country

Current Production

Low Point?

Saudi Arabia 10.5 MMB/d ?
Iran 4.2MMB/d ?
Iraq 2.5MMB/d ?

Source: U.S. EIA.

While we can't know the future for sure, it's good to follow the Boy Scout motto of "be prepared." If any of the three were to be affected, particularly Saudi Arabia, oil prices would skyrocket for years. 

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Dan Dzombak is an Eagle Scout (Troop 646). His musings and articles he finds interesting can be found on his Twitter account: @DanDzombak.

Motley Fool newsletter services have recommended buying shares of Total A. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (29) | Recommend This Article (111)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 03, 2011, at 1:30 PM, jimmy4040 wrote:

    Very interesting article, and highly unusual for MF. For my money the "safest" oil stocks are those involved in Canadian tar sands, or a generalized etf.

  • Report this Comment On June 03, 2011, at 1:35 PM, TMFDanDzombak wrote:

    @jimmy4040 Thanks! (I think)

  • Report this Comment On June 03, 2011, at 1:45 PM, jimmy4040 wrote:

    It was a compliment. Two things MF shys away from are financials and commodities, relatively speaking. That's a WHOLE big slice of the economy not to be invested in!

  • Report this Comment On June 03, 2011, at 1:52 PM, TMFDanDzombak wrote:

    Thanks!

    Not sure I agree about financials, but commodities definitely.

  • Report this Comment On June 03, 2011, at 5:46 PM, williamsr13 wrote:

    Iran is not an Arab country. Furthermore, “Iran” is a cognate of “Aryan” and literally translates to “Aryan Nation” in Persian. Iran shares a religion and some political and economic interests with Arab countries, but the people of Iran are primarily Persians and they speak Farsi and other Persian languages, not Arabic. Iran is not a member of the Arab League and not considered an Arab state by the United Nations. Otherwise, I agree with most of what you said.

  • Report this Comment On June 03, 2011, at 5:48 PM, Boomerchef wrote:

    Canadian stocks look so good, and the dividends are great - until the government takes their cut, and then there's not much left.

  • Report this Comment On June 03, 2011, at 7:06 PM, TMFDanDzombak wrote:

    @williamsr13 True. I'll send a note to the editors and have that sentence changed.

  • Report this Comment On June 03, 2011, at 7:13 PM, TMFBreakerRob wrote:

    Ahhh.....you beat me to it, williamsr13! (Regarding Iran not being Arabic).

    I would suggest that the oil picture is more complicated than the article addresses. You have rising consumption in developing countries, perhaps falling consumption in developed ones, peak oil...perhaps offset somewhat by new drilling and recovery techniques. And then there is a wild card of alternative fuels (such as oil from algae or coal). Ultimately, it would appear that high and rising prices are the future (driven largely by net increases in consumption meeting peak oil)...and political upheavals are the frosting on the cake (so to speak).

  • Report this Comment On June 03, 2011, at 7:25 PM, TMFDanDzombak wrote:

    @TMFBreakerRob True. The oil picture is indeed more complicated. This frosting on the cake though is what causes oil prices to spike quickly if it should come to pass.

  • Report this Comment On June 03, 2011, at 9:35 PM, dontwin wrote:

    70% of all oil contracts are written by Wall Street hedge funds. According to one authority, without Wall Street screwing us, the true cost of oil would be $65. It is about time our government does something to stop this wall street gambling!

  • Report this Comment On June 03, 2011, at 9:43 PM, jimmy4040 wrote:

    "Ultimately, it would appear that high and rising prices are the future (driven largely by net increases in consumption meeting peak oil)...and political upheavals are the frosting on the cake (so to speak)."

    Two problems, consumption isnt' going up very much usually by less than 2% a year worldwide, often by less than 1. Second, there is no such thing as peak oil, only peak light sweet crude, which we have probably already passed.

  • Report this Comment On June 03, 2011, at 11:06 PM, Seutz wrote:

    Hi Dan,

    If this is true and will occur, ie:$150 barrel oil. The world will be thrown into a depression for decades. Although I hope that the Arab countries have reforms and economic growth, the turmoil would be devastating to the world economies. Everything would slow. Travel, commerce,trade, etc. It would be terrifying. I pray you are not correct. But, unfortuneatly I think you are.

  • Report this Comment On June 04, 2011, at 12:53 AM, MichaelDSimms wrote:

    Having spent time in the area, I have to agree, very dicey situation over there. There is no love love lost between the 2 cultures and a shooting war between them would cause global oil prices to skyrocket. I think the question is not if, but when, and where will the US stand. Defense stocks might not be a bad idea as well as domestic oil companies like XOM, COP, MRO etc. Hate to see it happen because it will cause a lot of pain for a lot of people.

  • Report this Comment On June 04, 2011, at 8:09 AM, TMFDanDzombak wrote:

    @dontwin Don't really believe that. Have a source?

  • Report this Comment On June 04, 2011, at 8:12 AM, TMFDanDzombak wrote:

    @Seutz Growth would slow but I don't know about decades. Humans are very resilient, I think we'd just see a large shift away from oil and towards electric and nat gas vehicles.

  • Report this Comment On June 04, 2011, at 8:13 AM, TMFDanDzombak wrote:

    @MichaelDSimms Thanks for the comment and suggestions

  • Report this Comment On June 05, 2011, at 3:58 AM, stef333 wrote:

    About doubting Total will go back soon to Lybia, I have the impression that a few of the Nato partners are already trying to position themselves as prefered partners of the future Lybian government (France at first was a little slow in abandoning Ghaddafi, but then was the first and most active in pushing for military action against Ghaddafi, I would be surprised if Total wasn't planning on resuming operations in Lybia as soon as possible).

  • Report this Comment On June 05, 2011, at 8:42 AM, Seutz wrote:

    Hi Dan,

    Thank you for your response. I too have read the " Rational Optimist" and believe in human resilancy, but the suffering that $150 /barrel of oil would cause would still be catastrophic. The trickle effect of this would be beyond huge. That is why I pray you are not correct. Pray won't help of course, but it is the only course of action. Does someone want to see DOW 4,000-5,000 again?

    I certainy don't!

  • Report this Comment On June 05, 2011, at 9:42 AM, TMFDanDzombak wrote:

    @stef333 With how things are going, as soon as possible looks like it will be a while.

  • Report this Comment On June 07, 2011, at 3:31 PM, gimponthego wrote:

    EVEP..the ideal stock for this situation. Plus, it generates a $3.04 annual Div. My "agents" say it's in an inverted H&S ($51+) and a good time to enter.

  • Report this Comment On June 07, 2011, at 5:03 PM, TMFDanDzombak wrote:

    @ginponthego Thanks

  • Report this Comment On June 10, 2011, at 11:27 AM, bepah1 wrote:

    I respectfully disagree with the author. We have been trading oil at artificially inflated prices for some time andI expect that given the row at the OPEC meeting this week, that oil may finally head toward a more 'market' oriented price, without the risk premium. Long term, to be sure, oil will go up; but for now (and perhaps with the breakup of OPEC) prices may move to the 80-85 range.

    Saudi Arabia has stated that they will increase production and the price seems to be reflecting that. Add in the reduced demand and prices should go down. Oil is one of the most risky investments in the short run. Buy the oils on dips if you are looking for long run holds.

  • Report this Comment On June 10, 2011, at 1:32 PM, Godan5 wrote:

    The more You speculate about the price of oil the more Oil companies raise prices. It gives them a reason to do so thinking that people expect it. Please stop...I question who you work for or your motives for writing this story.

  • Report this Comment On June 10, 2011, at 2:41 PM, dc46and2 wrote:

    @Godan5:

    Speculative bubbles always burst, so speculation cannot explain the long-term upward trajectory in the price of oil. However, the increases in the price of oil are easily explained by the dynamics of supply and demand, along with currency devaluation.

    No firm that sells oil needs "a reason" to raise prices! At all times, they sell for as much as they can. They are only restricted by competition from other sellers. People writing articles on the Internet doesn't have anything to do with it.

    If you want to learn about these things, I recommend you visit a library and check out a book on microeconomics.

  • Report this Comment On June 10, 2011, at 3:08 PM, andrewm3773 wrote:

    I believe that oil price will go up but the world economy will not tank, although there will be a temporary shock.

    Consumer behavior study shows that long term consumer demand remains resilient against short term changes. This is why consumer demand is the largest component in aggregate demand, and yet the smallest contributor in the change (delta) of the aggregate demand. The change (delta) matters more than the level to determine the impact on economy.

    One reason of this behavior could be due to the fact that consumer demand is more sensitive to real dollar not nominal. If we compare barely 25-30 years ago, consumer necessities in real dollar terms (inflation adjusted), are much cheaper today. Buffet once commented that the average American today lives a probably a better lifestyle than the Rockefellers.

    The 2nd reason is substitution effect. Consumers spend a lot more today on discretionary and lifestyle items like i-pod/pad/phone/nintendo etc. Rationally specking, I don’t see myself filing for bankruptcy, eating half the burger or shutting up my family to hide in the closet during holidays, even if gas price increases by even 25 cents. (although it will pinch a little with my very modest income).

    I believe that the “demand destruction”, “doomsday” etc. theories apply more to Wall Street and hedge funds who have ginormous leveraged positions, and therefore even 10 cents change in oil price could make the difference between fortune and bankruptcy for them.

    I didn’t see any objective survey/study with actual consumers indicating that consumers would prefer to substantially “degrade/destroy” their lifestyle to buying gas for few additional cents. I just found this term coined by some anayst one morning in the journal and other financial media. Therefore I have my reasonable doubt on how much an average Wall Street analyst speak the voice of the general population without any objective survey.

  • Report this Comment On June 10, 2011, at 3:41 PM, jtmccjr wrote:

    Do not underestimate the demand component. China, India, Indonesia and other large nations will increase their consumption of oil. We have reached then end of the oil glut. The financial collapse and subsequent world recession has masked the demand issue. As the world economies pick up steam the demand for oil will rise and put constant upward pressure on prices. This increase in price will be a huge motivator to keep oil flowing, even in areas of unrest. Certainly instability in oil producing countries could have a temporary effect on oil prices but I think the greater influence will be by sustained increases in the price of oil. How high it will go will be determined by the fast growing economies that need it to fuel their expansion.

  • Report this Comment On June 11, 2011, at 12:38 PM, redrover30 wrote:

    The charts on events and recovery time need to include the USA. After the events in the gulf the rules and reg's and permiting process have had a huge slowdown or halt on exploration. This has also created high unemployment in this field. How long will this go on and how long will the recovery time take?

  • Report this Comment On June 14, 2011, at 4:36 AM, dividendgrowth wrote:

    Iraq plans to increase its oil production by 9 million barrels a day (from current level of 2.5 million barrels) until 2020.

    Even the good old USA will dramatically increase its oil production in coming years. EOG alone has captured like 1 billion barrels in one field (Eagle Ford). It seems the world is swimming in shale oil, so instead of getting your spike, a major plunge has become a real possibility now.

  • Report this Comment On June 19, 2011, at 7:31 PM, GtownRJ wrote:

    We have had two administrations in a row that believe the Keynesian model that raising wages will create inflation, so they have made it a matter of policy to suppress wages to combat the inflation caused by their massive government spending. Interesting take on the raise in medical compensation by companies, and the cost increases in that area, does not really talk about which part of the dog is wagging the other however.

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