At the moment, crude inventories and OPEC spare capacity are still above normal levels as a result of the global recessions, but they are steadily working themselves back toward historic averages. Stable economic growth in 2011 can help restore the market to a balanced situation by early 2012. As long as the world economy does not slip into another recession, oil markets may remain tighter over the next two years than they were over the past two.

Beneficial for energy stocks — to a point
In general, a tightening crude market may be beneficial for oil stocks. But, we are closely watching the impact that higher oil prices may have on global demand. Oil prices increasing too fast could actually cause energy equities to struggle, as investors may quickly start to worry about the burden this could have on the early stages of the economic recovery.

Emerging-market demand a key factor
Demand from emerging markets is a significant factor in the supply expectation. For example, China is the world’s second-largest consumer of oil. The country’s continued growth has contributed to the global tightening of supply. Although the World Bank, and other organizations, project a more robust GDP growth rate for emerging markets than developed countries in 2011, any slowdown in economic growth will likely have an impact on the demand for oil. And China, like other emerging nations, is struggling with inflationary pressures that could force them to make policy changes to counter rising prices and slow growth.

Markets still susceptible to disruptions
Oil prices soared early this year following the four-day closure of the Trans Alaska Pipeline System (TAPS) due to repair work. And while the pipeline carries about 12% of U.S. production, fortunately it looks like the impact of this event will be fairly minor. Inventories at the Valdez tanker port, where the pipeline ends, appeared sufficient to meet short-term needs. The pipeline is now back in operation, and North Slope producers are ramping up output back to pre-leak levels.

However, this event does illustrate how susceptible the energy markets are to even the smallest disruption. In many parts of the world, including the United States, the energy infrastructure is old and has been subject to under investment for years. TAPS was completed in June 1977, and has been in continuous operations since then. If the early January leak becomes the first of a series of necessary repairs, there may be an impact on the supply and price of oil.

Gulf drilling activity slow to rebound
Although the moratorium on oil drilling in the Gulf of Mexico has officially been lifted, industry activity is still well below typical levels. The new Bureau of Ocean Energy Management, Regulation, and Enforcement has been slow to issue new drilling permits. The industry and government are both working to implement additional safety measures to ensure a quicker response to potential drilling mishaps in the future. We expect it will be well into 2012 before Gulf of Mexico activity gets back to normal.

The work stoppage in the Gulf has had the biggest impact on the companies that own the drilling rigs, and we expect this to continue. These companies are finding jobs outside of the United States, but that, too, is a slow process. Lower drilling activity in the Gulf is just one more factor that may contribute to the tightening of the global oil market, in our view. As with the drilling rigs, the oil industry will re-direct investments that were planned for the Gulf of Mexico to projects in other regions in the world. However, the transition could result in lower oil production in the next couple of years than would have occurred were it not for the accident in the Gulf.