Desires vs. Markets
A couple of recent articles have speculated about the role that the demographics of Saudi Arabia will play in keeping the price of oil high in the years ahead, including this one in the Financial Times (subscription required.)

There's little doubt that the Saudis, in particular, and the Arab world in general, face a demographic crisis, and that much of the political unrest we see in that region is driven by a large and growing youth population. With a median age below 20 and high unemployment, the Saudis will need sustained high oil revenues to meet the demands on their social services.

However, desires alone don't drive markets. Clearly the US desires much lower oil prices, but our wishes don't make it so. The question is what other conditions need to exist in order to facilitate keeping prices high, since not even the Saudis can set the price of oil arbitrarily high just to suit their own needs, without disrupting the market. I see at least three other necessary conditions:

First, demand for oil would have to remain strong. This may seem like a foregone conclusion today. After all, the US economy is recovering, American driving patterns appear impervious to higher gasoline prices, and China is going great guns. But any number of things could dampen demand in the years ahead, such as another Asian economic slowdown, or unexpectedly rapid market penetration of fuel saving hybrid cars or clean diesel engines.

Second, the Saudis would have to convince the rest of OPEC that it is in their interest to adhere closely to quotas and avoid cheating, i.e. overproduction by individual members. That, too, seems like a slam dunk, in light of the recent success of this strategy. But once Iraq stabilizes, any new government there will have an enormous incentive to expand production, and they have the potential to blow huge holes in OPEC's dam, given enough time. Libya may be in the same position much sooner, as I indicated last week. However, these countries will have to compete for investment with opportunities in other countries.

This brings us to the third key factor; to sustain high oil prices, the growth of non-OPEC oil production would have to slow or stall. That, too, seems like a reasonable bet, with North Sea production plateauing and US production well past its peak, but it does not reckon with the potential of Russia, West Africa, and the countries in the Caspian region to add enough production in the next 3-5 years to ruin OPEC's calculations. But this, too, depends on the strength of demand, availability of capital, and OPEC policy.

So although understanding the impact of demographics can give important insights into Saudi oil policy, no issue, in isolation, will dictate the global price of oil. This complex and dynamic market has stymied numerous past attempts at prediction and control. As I've indicated in recent blogs, I think the willingness of the Saudis and other Middle Eastern producers to invite in foreign capital and capabilities will have at least as much influence on the future supply and price of oil as the Arab demographic bubble, unless it results in a full-blown revolution in the Kingdom.