The Integrated Global Oil Market

According to the United States Energy Information Administration (EIA), in 2007 the United States imported on average over 13 million barrels per day.[i] Of those 13 million barrels, only about 2.2 million barrels come from nations in the Persian Gulf, a mere 16% of total imports, or, less than 10% of total oil demand for the United States. Would a disruption of oil traffic in the Strait even affect the United States?

The answer to the above question is an emphatic YES. Years ago, it used to matter which countries produced oil specifically for which other countries. Now, the global oil market is fully integrated, "essentially a global auction."[ii] According to the EIA, "The fact the oil markets are physically inter-connected, with supply for a region coming from another region, means that of necessity even local gasoline prices feel the impact of prices abroad."[iii] It is because of this integration that any major supply disruption would ripple through the entire global oil market, regardless of which countries import the specific oil that has been disrupted. This is why disruption in the Strait of Hormuz is a disruption to the United States oil supply.

The following sections highlight key considerations for understanding the global oil trade with respect to the Strait of Hormuz:

  • Global Demand & Supply of Oil 
  • The Price of a Barrel of Oil 
  • The Future of Oil and the Strait of Hormuz 

Global Demand & Supply of Oil

The flow of oil throughout the world is driven by supply and demand. While oil is produced in much of the world, the Middle East dominates in terms of both production and proven reserves.

 regional oil production

Source: U.S. Energy Information Administration, 2005 International Energy Annual Table 2.2

world oil reserves

Source: U.S. Energy Information Administration, 2005 International Energy Annual Table 8.1

In terms of demand, North America, and specifically the United States, is the largest consumer of oil and oil products. Nevertheless, all countries throughout the world depend on oil to varying degrees for transportation, heating, and power generation.

world oil demand

Source: U.S. Energy Information Administration, 2005 International Energy Annual Table 1.2

Because the countries with greatest demand are not the countries with greatest supply, trade is fundamental to the oil market. The United States is somewhat of an exception, as it is the second largest producer, but domestic demand exceeds domestic supply at current prices" and presumably even at much higher prices, too.

The Price of a Barrel of Oil

The consumer price of oil is shaped by the product's underlying costs as well as market conditions at all stages of production and distribution:[iv]

  • Its raw material, crude oil 
  • Transportation from producing field to refinery 
  • Processing oil into refined products 
  • Transportation from the refinery to the consuming market 
  • Transportation, storage, and distribution between the market distribution center and the retail outlet or consumer 

"On a pre-tax basis, crude oil prices are the most important determinant of petroleum product prices, and often the most important factor in price changes as well. Crude oil prices reflect an overall market balance."[v] Consequently, external regulation of supply, specifically the Organization of Petroleum Exporting Countries (OPEC) production quotas, has substantial influence on the price of crude oil, and therefore on the price of all petroleum products.

In addition to the price of crude oil, transportation at many steps along the way is clearly an important factor in the oil market. Tankers are the most efficient means for intercontinental transport, while pipelines are best for land-based transit.

Storage also plays an important role in trade patterns and prices. When inventories are full, this ready availability of large supplies drives down the price of oil. In contrast, when stocks are relatively low, prices tend to increase.

Because the global economy depends on oil, governments supplement private inventories with their own reserved, including the U.S. Strategic Petroleum Reserve (SPR) and the International Energy Agency (IEA) strategic stocks, designed to serve as a buffer to critical supply disruptions.

While the price of crude oil, transportation, and storage influence a baseline global market price, various location-specific factors also affect particular regions, countries, or even states. Governments are increasingly imposing environmental regulations on energy consumption. Different parts of the world require varying quality levels of gasoline, for example, which require different levels of refining that can drive up prices in some areas. Governments may also substantially influence the price to consumers through taxes and tariffs. Geography can also influence how much a region is affected by global fluctuations in price. More isolated places will be harder hit by an unexpected increase in demand or reduction in supply and will take longer to recover from such changes in price.

Additionally, seasonal swings in demand, such as the increased demand for heating oil in the winter and increased consumption of gasoline in the late spring and summer travel season, frequently cause fluctuations in oil prices. Because world oil demand changes more frequently and more rapidly than world oil supply, stocks are drawn down in peak seasons, and prices go up accordingly.

There are also now spot markets, futures markets, and sophisticated financial instruments that help prices react to supply and demand conditions. These transactions help signal to the market the "physical supply/demand balance, as well as the market's expectations."[vi]

The Future of Oil and the Strait of Hormuz

In 2006, the EIA estimated that average daily worldwide oil production stood at 84.60 million barrels, while average daily demand, or consumption, totaled 84.66 million barrels.[vii]The EIA expects worldwide oil demand to reach 97 million barrels per day (mbpd) by 2015 and 118 mbpd by 2030.[viii] Of those 118 million barrels, the EIA projects that 57 million of them will come from OPEC countries - with over 75% (or 42 million barrels) of that originating from the Persian Gulf. A signficant chunk of oil will continue to flow through the Strait of Hormuz chokepoint.

Of course, the EIA projections above assume over the next 30 years oil prices will incrementally rise, leading to additional investment in exploration and production infrastructure and gradual increases in oil supply over time across a number of oil producing regions (not just the Persian Gulf). However, not all oil industry experts think that oil production will gradually increase. "Peak Oil" theorists [ix] argue that the limiting factor of supply isn't investment in exploration and production infrastructure, but rather is the availability of the resource itself. They believe that the world production of oil has already peaked. Whether they are right or not, even critics of peak oil theory tend to agree that the relative importance of the Persian Gulf as a reservoir of global oil supply will increase in the future, as the world exhausts oil in Europe, the United States, and other areas first. This trend will only increase the strategic importance of the Strait of Hormuz.[x]

[i] Energy Information Administration, U.S. Imports by Country of Origin. Online. Available: http://tonto.eia.doe.gov/dnav/pet/pet_move_impcus_a2_nus_ep00_im0_mbblpd_a.htm. Accessed: June 25, 2008.

[ii] Energy Information Administration, Oil Market Basics: Prices. Online. Available: http://www.eia.doe.gov/pub/oil_gas/petroleum/analysis_publications/oil_market_basics/price_text.htm. Accessed: February 10, 2008.

[iii] Energy Information Administration, Oil Market Basics: Prices. Online. Available: http://www.eia.doe.gov/pub/oil_gas/petroleum/analysis_publications/oil_market_basics/price_text.htm. Accessed: February 10, 2008.

[iv] Energy Information Administration, Oil Market Basics: Prices. Online. Available: http://www.eia.doe.gov/pub/oil_gas/petroleum/analysis_publications/oil_market_basics/price_text.htm. Accessed: February 10, 2008.

[v] Energy Information Administration, Oil Market Basics: Prices. Online. Available: http://www.eia.doe.gov/pub/oil_gas/petroleum/analysis_publications/oil_market_basics/price_text.htm. Accessed: February 10, 2008.

[vi] Energy Information Administration, Oil Market Basics: Prices. Online. Available: http://www.eia.doe.gov/pub/oil_gas/petroleum/analysis_publications/oil_market_basics/price_text.htm. Accessed: February 10, 2008.

[vii] Data from the EIA website at http://www.eia.doe.gov/emeu/international/oilproduction.html.

[viii] U.S. Department of Energy, Energy Information Administration, International Energy Outlook 2007(Washington, D.C., 2006) p. 29.

[ix] Colin Campbell and Matther Simmons are some of the most famous contemporary peak oil theorists. For example, see Matthew Simmons, Twilight in the Desert (Hoboken, New Jersey: John Wiley and Sons, 2005).

[x] Eugene Gholz and Daryl G. Press, "Energy Alarmism: The Myths That Make Americans Worry about Oil," Cato Policy Analysis no. 589 (April 5, 2007), p. 6.

This page last modified in August 2008