Goldman: Oil supplies are quickly tightening

Jared Bernstein ticks off some economic trends to fret about in the year ahead. Of interest, especially in light of renewed tensions with Iran over oil shipments in the Persian Gulf, is the chart on oil he posts from Goldman Sachs. The investment bank is predicting that global oil production will once again bump up against capacity by 2013 or so.

That’s a concern because, when oil supplies are tight and there’s little spare capacity left, even minor shifts in the market (not to mention various geopolitical crises) can produce crippling oil price spikes, as we saw back in 2007 and 2008.

Michael Levi and Robert McNally wrote about this phenomenon in a recent essay (PDF) for Foreign Affairs. In the old days, they note, oil producers typically had far more oil than the world needed. As a result, OPEC and Saudi Arabia could keep some crude off the market. This “spare capacity” came in handy during crises. In 2003, for example, after the U.S. invasion of Iraq and a workers’ strike in Venezuela, Saudi Arabia was able to ramp up production by about 2 million barrels of oil per day, a boost of nearly one-third, to quell jittery markets.

But those extra reserves are now dwindling. Fast-growing countries such as China and India are gobbling up more and more crude, and many analysts suspect that Saudi Arabia’s spare capacity is shrinking rapidly. In February of last year, for instance, after civil war shut down Libya’s production, world prices shot up again. And while Saudi Arabia appeared to release more oil into the market to dampen the shock, there was a lot of debate about just how effective the Saudi moves actually were. Goldman Sachs’ analysts, for one, argued that OPEC had much less spare capacity left than anyone thought.

If that spare capacity vanishes, Levi and McNally argue, large and volatile swings in the price of oil will increasingly become the norm. After all, most countries rely heavily on oil, and it’s nearly impossible to find substitutes in short order. So when oil demand outstrips supply by even a little bit, the price can shoot up dramatically.

That seemed to be the case in 2007 and 2008, when oil rocketed up around $140 per barrel and, as James Hamilton has argued, the price spike may have helped tip the United States into recession (though there’s still a fair bit of debate about how big a role speculators played in the price run-up). And if Goldman’s forecast is correct, we could easily find ourselves in that situation again very soon.