Judging by the rise of U.S. inventories of crude oil, all’s well at the moment in the land of energy. Commercial stocks of crude (excluding the Strategic Petroleum Reserve) are far above where they were 12 months previous. So why is the price of crude dispatching a decidedly different, if not ominous message?

The combination of ascending crude inventories and rising prices runs contrary to the laws of common sense and Economics 101. Rising supplies, from lumber to pork bellies, are usually associated with falling prices. But the term “usually” leaves the potential for the occasional variation on a theme, and the here and now just so happens to be one of those variations.
For the week ended August 12, U.S. commercial crude oil inventories totaled 321.1 million barrels, excluding the SPR. That’s up about 15% from a year ago, according to data from the Energy Department. In fact, crude inventories at current levels are well above the average range that’s prevailed since December 2003.
If rising oil inventories are destined to have a moderating impact on prices, destiny’s taken a holiday. No word yet on when, or if the vacation ends, and the mystery keeps the market bubbling. Indeed, it’s hard not to notice that while oil inventories in the U.S. advanced 15% over the last year, oil prices have climbed by roughly 45% over that span.
Clearly, inventory trends aren’t moving markets these days. Arguably, the far more relevant variable is the world’s spare production capacity, or the lack thereof. Global spare capacity in the oil industry has fallen to its lowest level in 30 years, advises the Energy Department.
The future path of that spare capacity promises to cast a long shadow on oil prices for the foreseeable future, and perhaps for eternity. That leads to the topic of what drives spare capacity? Supply and demand, of course. More specifically, Mr. Market is focused on the global oil industry’s ability to keep new production capacity growing at one step ahead of demand. Alas, the news on this front invariably flows slowly, if not imperceptibly in the short term.
But this much is clear: Barring some extraordinary discovery of new oil wealth, much of the spare capacity relative to demand growth turns on the usual suspect in the matter of oil: Saudi Arabia. The debate increasingly is one of whether the Saudis have the goods. They say they do, but skepticism is growing, as evidenced in part by the rising price of oil.
No one really knows if the House of Saud can materially increase production in the years ahead. Even the Saudis, we suspect, aren’t quite sure. Managing the massive oil supplies that grace the Saudi peninsula is a far more complicated, and slippery (no pun intended) task than most people appreciate.
Regardless, the challenge of delivering more and more crude going forward will require nothing less than extraordinarily successful results in discovery and production, along with maximizing output of existing oil fields. How extraordinary? As a step toward an answer, we’ll close by quoting Sadad al-Husseini, the recently retired head of Saudi Aramco’s exploration and production division, courtesy of the current issue of the New York Times Magazine, where he discusses the trend of ever-rising global oil demand and the problem of quenching that thirst on a global scale:
“The problem is that you go from [average worldwide oil consumption of] 79 million barrels a day in 2002 to 82.5 in 2003 to 84.5 in 2004. You’re leaping by two million to three million a year, and if you have to cover declines, that’s another four to five million.” In other words, if demand and depletion patterns continue, every year the world will need to open enough fields or wells to pump an additional six to eight million barrels a day–at least two million new barrels a day to meet the rising demand and at least four million to compensate for the declining production of existing fields. ”That’s like a whole new Saudi Arabia every couple of years,” Husseini said. ”It can’t be done indefinitely. It’s not sustainable.”