Oil's Eastern Hemisphere is Shifting, Too

• OPEC's exports earned record revenue last year, but the pressure on the cartel is increasing as Eastern Hemisphere production expands, along with higher unconventional oil production in North America.
• Increasing supply doesn't guarantee lower oil prices in the future, but it will help accommodate growing demand from the developing world, reducing the risk of price spikes such as we saw in 2008.

No one should be surprised that the turmoil in Egypt has caused jitters in the oil markets.  Although Egypt has recently become a net oil importer, the possibility of extended violence or even civil war poses risks to the tanker traffic through the Suez Canal. This has helped to push UK Brent crude to its highest level since April and contributed to higher prices for West Texas Intermediate (WTI) crude than we've seen in over a year.  Yet while these events provide the latest of many prods to nudge oil prices higher, underlying long-term supply trends look favorable.  That's not just because of surging US oil output, which is largely attributable to shale or "tight oil."

US production of crude oil and natural gas liquids grew by roughly 2 million barrels per day (MBD) from 2008-12, with a similar increase expected by 2020, even in the relatively conservative forecast of the US Energy Information Administration.  As a result, US oil imports are shrinking, scrambling long-established supply patterns in the Atlantic Basin. However, North America isn't the only place where supply is expanding, nor is the shale revolution responsible for the production growth in the Eastern Hemisphere, at least not yet.

The big story there is Iraq. Thanks to the development contracts its government negotiated with international firms after the fall of Saddam Hussein, Iraqi production is growing and might eventually reach the potential suggested by its enormous conventional oil reserves. Whether or not Iraq really has 150 billion barrels of oil in the ground-- this figure ratcheted up over the years in an odd two-step with its historical rival Iran--the consensus is that it has ample scope to boost output at relatively low cost. 

As the Financial Times reported, Iraq's plans to increase oil production capacity from around 3 MBD to 12 MBD, which would put it in the same league with Saudi Arabia, are now in doubt due to multiple concerns.  But even with companies seeking to renegotiate service contracts that looked too lean when they were set, and the Kurdistan Regional Government in the north of Iraq signing deals independently of Baghdad, Iraq produced more oil last year than it had since the outbreak of the Iran-Iraq War in 1980. The International Energy Agency apparently expects Iraqi production to nearly double to 6.1 MBD by the end of the decade.

If this comes to pass, it will significantly alter the dynamics within the Organization of Petroleum Exporting Countries, and possibly change OPEC's role in the market. It would lift Iraq well above other producers like Iran, Kuwait, the UAE, and Venezuela--all clustered around 2-3 MBD--and leave it second only to Saudi Arabia. Given recent Saudi domestic consumption trends, the race for future export leadership could be even tighter.

Despite record oil revenue last year, tensions are growing within OPEC, which had welcomed post-war Iraq back into its ranks and didn't constrain its output with an official production quota.  This accommodation is even simpler today, with OPEC operating without country-specific quotas. Yet in the absence of a large increase in demand for OPEC's oil in the developing world, a steadily expanding Iraq will either force painful adjustments on other members or bust the cartel's quota entirely.  Whether that results in rising inventories or merely higher spare production capacity, it would exert downward pressure on oil prices and on OPEC members' national budgets.

Another important shift is associated with the growth of oil output in Kazakhstan, the second-largest oil producer to emerge from the breakup of the Soviet Union.  Production has increased steadily since the 1990s, reaching 1.7 MBD last year. With the startup of the supergiant Kashagan field later this year, the country's production should exceed 3 MBD by 2020, with exports over 2 MBD. That would make Kazakhstan a bigger factor in global oil markets than Iran, as long as the latter continues to be hemmed in by sanctions. 

No one can predict oil prices in 2020 with any certainty. However, the combination of significant supply growth in North America, Iraq and the Former Soviet Union with flat or shrinking demand in the US and Europe provides headroom for further demand growth in Asia and the Middle East itself.  That doesn't necessarily augur a big drop in prices ahead--much of this new production isn't exactly cheap--but it could signal a period of greater price stability than we've experienced for a while.  That's assuming none of the various crisis scenarios erupts in the meantime.

A different version of this posting was previously published on the website of Pacific Energy Development Corporation.