The Middle East and Oil

With revolution fermenting in Egypt and elsewhere in the Middle East, it's time to look at the energy situation in the region.

For most of 2009 and 2010, the oil market ignored the sparks in the Middle East. Traders said that spare global oil production capacity was more than enough to cover any disruption in oil supplies.

But now as demand for oil hits record levels, the market seems to have re-discovered geopolitical risk. Oil demand surged by 2.7 million barrels a day last year, the second biggest annual increase in 30 years.

The pace of the demand increase is exceptional. Oil consumption in the 2010-2011 period will increase by almost 5 million barrels a day. That is equivalent to more than half of the current production of Saudi Arabia!

However, there are more than just geopolitical risks in Egypt and elsewhere to the flow of oil from the nations in the Gulf region.

The Middle East also faces tremendous social pressures, as do many other emerging economies. The region's economies need to be able to create enough jobs to absorb the explosive growth in population.

High unemployment and poverty are playing as big a role as political freedom, if not bigger, in the protests across the various countries in the region.

And guess what? To get strong economic growth, you need energy. Lots of it...which means that oil exports from this critical area of the globe may drop in the years and decades ahead.


Gulf Region's Energy Investments


Due to these mounting pressures, the Gulf region has begun to shift its energy investment focus away from oil production. Investments are increasingly centered on domestic electricity and water developments.

Saudi Arabia alone plans to spend $80 billion over the next eight years in power generation and transmission capacity to keep pace with industrial and desalination needs.

Darren Davis, managing director and head of HSBC Middle East's resources and energy group, says these areas are likely to dominate energy investments in the coming years because of an increasingly acute power shortage.

He says, “It's less about developing new oil capacity in the Gulf these days and more on how to deal with rapidly rising domestic energy demand.”

The region's rapid population growth and rising affluence has put pressure on power production. The power is needed mainly for air conditioning and water desalination. These are vital in a region with little rainfall and sweltering sun for much of the year.

Not surprisingly, the electricity shortage is most acute in the summer months. During this season, many countries are forced to burn crude oil to meet demand for power.

This was pointed out in a report from Credit Suisse last July. According to the report, global demand for oil fell by 1.7 per cent in 2009. But demand in the Middle East for oil rose 3.8 per cent in 2009, partially due to the need to fuel power generation.


Saudi Arabia


The Credit Suisse report specifically pointed to Saudi Arabia as an example. During the peak of the summer heatwave in 2009, the country burned close to 1 million barrels of oil per day just to keep those air conditioners humming.

Saudi Arabia sits on a quarter of the world's oil reserves. But with no rivers or lakes, the kingdom is facing a challenge in keeping pace with rising energy demand for power and desalinated water for both home and industrial use.

Demand for electricity in the desert country is expected to rise sharply in the years ahead. It is expected to rise at an 8 per cent annual rate and is expected to triple to 121,000 megawatts by 2032.

Senior Saudi official, Hashim Yamani, president of the King Abdullah Atomic and Renewable Energy City, spoke about the country's current oil consumption patterns.

He said that the country currently burns a total of 3.2 million barrels of oil a day. If the current consumption growth rate continues, he warns, the world's largest oil exporter will need 8 million barrels a day of oil by 2028 to meet its domestic needs. This is roughly equivalent to its current production!


The Future for MidEast Energy


This would be a disaster for the large oil consuming nations like the United States and Europe. Think about it – most Middle Eastern oil would be consumed domestically and not exported.....

The take away for investors? First, we have rising demand for oil, especially from emerging economies. Add to that the lack of investment into increasing oil production and rising domestic oil consumption in the Gulf. The result is that oil prices will stay elevated at much higher levels and for longer than most on Wall Street expect.

The best way to play this trend is through the purchase of an exchange traded fund from US Commodity Funds. It is the United States Brent Oil Fund (NYSE: BNO) and it based on a Brent oil futures contract. London-traded Brent oil recently traded over $100 a barrel and much more accurately reflects global oil market conditions than the US-traded WTI oil contract.