that have shaped the geopolitics of the last 40 years. The most strategic and troubled chokepoint remains the Strait of Hormuz, which has been used as a bargaining card by Iran to negotiate with the West and put pressure on neighboring oil-producing countries.
In the case of China, the world's second-largest oil-consuming nation, the situation is much more complicated, because its oil imports need to move through two major chokepoints and a troubled South China Sea, as shown in Figure 1.4.
FIGURE 1.4 Oil maritime routes and chokepoints
Data Sources: US Energy Information Administration analysis based on Lloyd's List Intelligence, Eastern Bloc Research, Suez Canal Authority, and UNCTAD, using EIA conversion factors. Estimates are for year 2013.
China imports over 70 % of its crude oil from the Middle East and the traditional sea route has been through the Indian Ocean, the Strait of Malacca, and the South China Sea. China remains concerned about its security of sea lanes, especially those passing through the Strait of Malacca and the South China Sea, through which an estimated 80 % of its oil imports transit. Also, in the absence of a significant global naval presence, China is not comfortable relying on oil imports passing through the South China Sea, which is surrounded by countries that are perceived to be part of a US-led containment coalition. These potentially hostile countries include the Philippines, Japan, and Taiwan, which were once referred to as an “unsinkable aircraft carrier” by General MacArthur. As a nation that is not a US ally, China fears the disruption of its oil imports in the case of hostilities in the region.
In order to alleviate the disruption risks, China has done a formidable job developing trade links with its Central Asian neighbors and building infrastructure in close South Asian neighbors to gain access to the Indian Ocean. Together with Pakistan, China has been developing a megaproject called the China Pakistan Economic Corridor (CPEC) consisting of a network of highways, railways, and oil and gas pipelines over 3000 km running from the port of Gwadar all the way to Kashgar in China. The CPEC will give China access to the Arabian Sea not far from the Strait of Hormuz. Similarly, China gained access to the Bay of Bengal via Sino-Burma pipelines, which transport oil and gas from the port of Kyaukphyu to Kunming (Yunnan Province). In addition to cutting the shipping time of Middle Eastern and African crude oil significantly, these two shortcuts are game-changers on the chessboard as they help avoid crowded South China Sea waters and any unexpected hostilities in transit. Additionally, as mentioned earlier, China has also been working closely with its neighbors in the east and the north, signing megaprojects allowing Russia to trade its oil and gas in Yuan or Roubles using trade-offset mechanisms to minimize its dependence on the US dollar and related unpredictability in financing costs.
Oil prices are particularly vulnerable to events such as war, internal strife, or terrorist attacks, especially in the sensitive Middle East region. For example, oil prices spiked in the wake of the Gulf War and the Iraq War of 2003, as well as during the “Arab spring” rebellions across a number of countries in North Africa and the Middle East. In such environments, oil prices trade at a premium to prices implied by supply/demand balance, and this is sometimes dubbed the “fear premium.” In contrast, resource nationalism, in the form of higher royalties or outright nationalization of assets, has been decreasing in recent years and many national oil companies are opening up to collaboration with global oil companies due to the scarcity of capital and technological know-how to exploit new reserves.
Long-Term Supply and Demand
To understand the long-term demand and supply in commodity markets, let us take a look at a few of the indicators that are used.
Production and Reserves
The supply of crude oil can be gauged by the production of crude oil (measured in millions of barrels per day), the amount of reserves of crude oil, specifically proved reserves (Figure 1.5), and the ratio of reserves to production (Figure 1.6), which gives an estimate of the number of years that the reserves can be expected to last. As expected, when the production of crude oil is high, prices are generally lower, although in general supply growth has tended to lag demand growth, leading to a gradually rising average price over the last two decades.
FIGURE 1.5 Distribution of oil reserves by region at the end of 2013; total proved reserves accounted for 1687.9 billion barrels
Source: BP Statistical Review of World Energy 2014.
FIGURE 1.6 Reserves-to-production (R/P) ratios by region at the end of 2013
Source: BP Statistical Review of World Energy 2014.
Long-term prices are affected by the amount of reserves remaining. Proved reserves of oil (also called “1P”) are those reserves that can be recovered in the future from known reservoirs with reasonable certainty (usually 90 % confidence) under present-day economic and operating conditions. Probable reserves correspond to a 50 % confidence level of recovery (called “2P” or proved plus probable), and possible reserves are those that have a less likely chance of being recovered (at least a 10 % chance) and are called “3P” (proved + probable + possible). Disclosures regarding reserves can be affected by local accounting rules and whether the company reporting the figures is private or public. Since a number of national oil companies are private, the reserve numbers reported by them do not have the same level of scrutiny.
Reserve growth predictions are also affected by developments in technology. For instance, prior to the large-scale commercialization of hydraulic fracturing (“fracking”) technology to exploit shale oil reserves and other technological innovations of the last decade, it was widely believed that oil would turn expensive. This was because oil production in the USA had peaked in the early 1970s (known as Hubbert's peak after M. King Hubbert, a US geologist) and the world's production was expected to peak in 1995. However, the introduction of new technologies and the increased viability of developing more difficult-to-extract reserves, such as oil sands, with higher prices of crude oil have combined to allow oil production to continue to grow.
In addition, in recent years there has been a discussion on reviewing the reserves of companies to account for “unburnable reserves” arising from the fact that it would be impossible to utilize some of the reserves if global warming targets are to be met. Similarly, carbon capture and storage (CCS) technologies would need to be developed before all the disclosed hydrocarbon reserves could be tapped. However, it is not yet clear if there is an appreciable impact of this concern on oil prices or the stock prices of energy companies.
Refining and Consumption
Refining capacity is an indicator of the maximum supply of oil products. Demand can be gauged from the consumption of crude oil and the consumption of individual refined products. Refinery throughput or capacity utilization is another measure of the demand for refined products. Data on imports and exports, as in Figure 1.7, can also provide clues about the geographical distribution of demand and supply as well as the energy security of individual countries or regions.
