The coming oil glut that will force prices to drop sharply

The outlook for the oil price remains mired in much confusion. Peak oil theorists see production in terminal decline. Others, who expect the oil price to revisit its 2008 highs, argue that rapid demand growth from emerging markets, most notably China, will underpin a long and aggressive rally in the price. Some even argue that as the world runs out of oil we shall slip back into pre-industrial ways as energy is rationed and human behaviour has to change as a result - an argument that has been regularly trotted out over the last five centuries. First, in Britain in the 16th century as the country was perceived to be running out of wood, its then primary energy source. Then 300 years later by economist William Jevons who believed that Britain's coal supply, and therefore primary energy supply, was in terminal decline.

Market price signals, however, have an uncanny ability to change long-term supply and demand dynamics. Indeed, the high and rising price of oil from 2004/05 onwards, but most particularly in 2008, would appear to have delivered a very clear and identifiable supply response. Using conservative assumptions we expect that the future supply of oil will increase by approximately 9-10m barrels per day by 2017. That equates to a 10-12 per cent increase in global production capacity. Importantly it will more than absorb our estimated 5m bpd increase in Chinese demand, the biggest single driver of demand growth, over that timeframe.

That increase in supply reflects four key trends that are playing out at a country level. First there are those countries where politics, ageing fields and a poor investment environment have resulted in and are likely to continue to result in falling or, at best, stable production, despite often plentiful oil reserves. This group includes Venezuela, Mexico, Russia, Nigeria and Iran (representing 26 per cent of the world's reserves). Second is a group of countries, mostly western, where production peaked a number of years ago and where that trend seems likely to persist. This group typically fits the peak oil theorist's prescriptions and includes the UK (peaked in 1999), the US (1970 peak) and Norway (2001 peak).