The Escalating Cost of Oil, Apr 05 | What’s the Result on Global Growth?


AH, SPRING IN IOWA! Grass greening, trees budding, flowers blooming,children playing baseball and softball, and farmers preparing their fieldsfor planting.

The trouble is, the only things deeper than the furrows in those fields arethe furrows in the farmers’ brows as they watch the price of fuel rise.The same goes for any operator of a motor vehicle.

As tree sap has, oil and gasoline prices have been rising and rising. Earlylast fall, oil was $35 a barrel. In early April (as I was writing this), itreached $57 a barrel and looked as though it might go even higher.

Based on my sense of market gyrations, this situation looks like a speculativebubble. However, I have felt this way since last fall, and I firmly believethe fundamental laws of supply and demand are still in place. However, thereare some notable circumstances that are causing problems.

Let’s start with OPEC. Over the course of its history, OPEC has hadsubstantial production capacity. In 2002, Argus Research estimated its sparecapacity at 20 percent. By this winter, that figure had been cut in half.

Except for Saudi Arabia and Kuwait, every OPEC member is producing at fullcapacity. On March 16, it announced it would increase production by 500,000barrels a day to 27.5 million barrels a day (mmb/d). (This figure doesn’tinclude Iraq.)

In February, OPEC produced 27.6 mmb/d. A survey of analysts conducted by ArgusResearch expects production to climb to 28 to 28/5 mmb/d, leaving OPEC with5 to 6 percent spare capacity. However, we have no idea how much more the cartelis capable of producing.

Non-OPEC production is growing, but only as quickly as new production comeson line. One would think that current prices would fuel massive explorationsto develop new resources.

Major oil companies seem to believe that today’s prices are an aberrationand will decline in time. Smaller companies, even if they double their efforts,are not likely to have much impact. Moreover, new resources take some timeto develop.

Nevertheless, on a recent trip to my boyhood home in Oklahoma, I found drillingcompanies large and small combing over productive territories looking for pocketsof oil (and natural gas) that have been overlooked.

The next problem is refining. No new refineries have been constructed in theU.S. in 20 years. Through retrofitting and expansion, companies have boostedtheir refineries’ capacities somewhat.

Attempts to curb air pollution are another factor. In the U.S., Tier II regulationsare in the second year of a three-year plan to decrease the sulfur contentof gasoline. The scenario is similar for diesel. Refiners have two ways toachieve the limits:

1. Upgrade their refineries.

2. Increase their usage of crude oil with low sulfur content. The new ruleshave the double effect of increasing demand for low-sulfur crude and limitingcapital spending on projects that will increase the use of cheaper, lower qualitycrudes.

Then there is consumption. When the price of oil rose to $42 a barrel, itwas supposed to curb demand. It didn’t. $55 oil isn’t having anyeffect either. Anyone for $60?

The International Energy Agency has increased its forecast for global oildemand for 2005 twice this year from 83.9 mmb/d to 84.3. Most of the demandis coming from such developing countries as China and India. Demand in theU.S. is at a slow, stable rate. In Europe, it is minimal.

Nevertheless, the rising price of oil is likely to strangle global economicgrowth. Once that situation becomes clear, demand should drop, and the priceof oil will fall. If this scenario plays out, everyone will feel the pain.

As was the case in the 1970s, the situation begs some questions: At what priceof gasoline will we change our driving habits? When we buy our next vehicles,will we concentrate on fuel consumption? When will we turn down our home thermostatsin winter and up in summer?

There isn’t any right answer to demand (although I feel like murderingowners of Hum Vees and other gas-guzzlers).

When you consider a family in China that just bought its first car, the taskof improving efficiency becomes that much more difficult.