(Good-bye) party time
Fault
lines as oil rises above $50 a barrel
October 20, 2004
iranian.com
During the first eight months of
this year, the price of oil has risen to nearly $55 from just
under
$29. For the last 30 years, the price of oil has been the single
most important determinant of the economy and the stock market.
However, there is something amiss in this whole equation of steep
oil price rise. Whilst in the short term it provides opportunity,
to me, in the long term, it sounds like a death knell for OPEC.
Oil pricing is a two-edged sword, as I recently explained to an
OPEC country oil minister, which is hard to manage. Let it drift
too low and quota-cheating necessitated by the single commodity-
dependent economies of OPEC take the bottom of the oil prices like,
oil at below $10; keep it too high, long term impacts are disastrous.
Thus, rich oil nations like Saudi, Iran, Iraq and Kuwait are caught
up in a quandary. They need to maintain oil at a price that helps
them grow their single commodity dependent economy to a multifaceted
economy, but at the same time keep new producers and threatening
new tech advance out of the contention. The authors of 'Oil Factor,'
a gloomy book about energy, claim that the oil price will soar
above $100 a barrel by the end of the decade, and possibly sooner.
The Oil Depletion Analysis Centre (ODAC) is a stunning group convinced
that the world is perilously close to an oil shock induced by
scarcity, not politics. Thanks to the surge in the price of oil
to nearly
$50 a barrel, the predictions of OACD and Oil factor authors
look realizable. The cartel's export earnings are running at almost
three times what they were in 1998, when a barrel fetched only
around $10.
OPEC's 11-member states produce 26 million barrels of oil a day
- 39% of the world's oil production, which accounts for half of
all oil
exports. They are swamped with extra $360 billion's by end of 2004.
It seems Russia that produces equal barrels to Saudi should one
day become the swing producer, but if one scratches the surface
a little, he would realize that on reserves Saudi and their closest
allies in OPEC belong to different breeds of oil producers. The
two groups as a result should have conflicting oil pricing policy.
Saudis and their allies represent nearly 25 percent of the global
reserves of more than 800 billion barrels. Nations with miniscule
reserves within OPEC like Venezuelans, and Indonesians, need
higher price now that they may be running out of oil in the next
twenty
years.
However, Saudis, Iranians, Iraqis and Kuwaitis with much
larger reserve base extending beyond five decades need balanced
prices that may continue the 'party of oil' a bit longer until
their economies' dependence on single commodity is shifted.
This fault line within OPEC where OPEC is divided into rich reserve
nations and poor reserve nations would lead to a rethink within
OPEC, as Saudis and their allies definitely support a more
balanced
regime of oil pricing.
Those who remember the oil-price shocks of 1973-74, 1979-80 and
1990 should now be suffering restless nights. On all three occasions
crude oil prices tripled, inflation soared and the world economy
went into recession. However markets reacted positively to Greenspan's
recent comments. "While high oil prices (a whopping $54.86
per barrel today at the close) have sliced about 0.75 percent off
GDP growth, the effect won't be nearly as bad as the 1970s oil
crisis
and the global economy will adjust."
It is imperative to reconcile
the gloomy and rosier pictures. Ironically, in inflation-adjusted
terms, a barrel of oil is cheaper than it was in 1980, when
it cost $81 in today's money (in 1864 newly-discovered oil hit
a
giddy $8 a barrel - $92 in 2004 dollars). Post first oil price
crisis
the global response was on the demand side-notably energy
efficiency, including vehicle fuel economy.
To write an article
with contrary logic is a difficult uphill task, but when
Economist wrote that infamous piece predicting oil below $10
for eternally,
it was premature; like predictions of below $10 were unsustainable.
Today, oil at post $50 would be equally untenable.
Hedge funds have made the situation even worse by making big
bets that oil prices will continue to rise because of the imbalance
in supply, demand, stocks and continuing political uncertainty
in the Middle East. OPEC officials say this speculation accounts
for up to 20% of the recent oil price. It is in the interest
of OPEC to keep prices low otherwise the future prospects of
oil, as a commodity, looks very bleak as global uncertainties come
down
and technological advancements bring efficient use of oil in
the forefront.
The world's apparently unquenchable thirst for
oil
is
fuelling a boom in exotic kinds of exploration technology
for use in much deeper waters; five to ten years ago, if you came
up with
the idea of a directional well that stretched 25,000 feet,
the oil man would have said you're dreaming. But today, they
are
just kicking them down one after the other.
The world has consumed 78.7 million barrels a day in the second
quarter of this year. The three big industrialized economies, the
U.S., Europe and Japan, are all growing in harmony, a rarity event
and indicator of global prosperity despite all the pessimism inherent.
China, India, Russia and Brazil known as BRIC'S collectively referred
to as 'sick man of global economies' in the 70's are now booming
economies sucking in oil to power their manufacturing and make
gasoline to fuel their industry.
China, now the world's No. 2 oil
consumer after the U.S., is importing 20% more oil by volume
than it was a year ago.The IEA forecasts the world will consume
80.6
million barrels a day on average in 2004, up from 78.7 million
barrels a day in 2003 and 77 million barrels a day in 2002. One
thing that major pundits of the hedge funds are missing in this
blind pursuit of ever-higher oil prices is the impact of petroleum
intensity on pricing. The United States has in fact been following
the path of lowering oil intensity-oil consumption per dollar
of gross domestic product (GDP)-since the late 1970s.
Global economy was consuming around 65 million barrels of oil
in the early 80's; however, the total size of the global economy
was only 12 trillion dollars. Today, a global economy of nearly
50 trillion dollars consumes slightly higher oil. The world is
becoming a very efficient user of oil. If lessons from the first
oil crisis are to be learnt, then we need to appreciate that these
price rises will ultimately reduce the consumption of oil.
Thoughts
are now turning to reducing oil, not producing it, even more spectacular
results can be ensured. With new technology, new energy forms are
possible, not that they don't exist, they are very uneconomical
at $35 /barrel, but at $55, even some form of fuel
cell becomes an attractive option.
On top of that anyone who underestimates
the potential of exponential growth of development and research
would do that at his own peril. The biggest and most efficient
consumer, the U.S., consumed about 6.2 billion barrels, up 4.2%
from a year
earlier. It is expected this year the US consumption to be 6.8
billion barrels.
Now let's look closely at the US petroleum intensity
for which the date is easily available - from 1950 to 1980
it would take 1.6 barrel of oil to produce 1000 dollars of
GDP, in 2004 it takes .8 barrel, nearly half the consumption of
1980's,
to produce $1000 of GDP.
In 1978, the total consumption of
oil in a much smaller GDP of $2.2 trillion in 1998 was 6.6
billion barrels of oil; presently, for slightly higher consumption
of
around 7 billion barrels of oil, US GDP has grown to 11 trillion
dollars.
Reduced gasoline demand plus price-induced conservation has
reduced U.S. oil consumption by 2.8 million barrels per day.
Oil in the medium term, as it breaks new highs, can continue
this manic one-way move up, however, the best way to break the
high price of oil is to have this high price for some time, bear
in mind the silver mania. Commodity traders can sometimes well
overstate the fears of disruptions; right now it is generally
believed that Alqaeda is planning a global terrorist attack on
major installations
in Saudi Arabia so as to choke Saudi oil.
Recent violence in
Saudi Arabia, including a deadly attack by Islamic militants
in the Saudi
oil city of Khobar, and a fear that al Qaeda-linked forces
are attempting to provoke civil war in the kingdom have raised
fears
about interruptions in oil supplies. Combine these worries
with Russians trying to cow Yukos, which accounts for 2% of the
world's
oil supply. Other doubts like the future of new discoveries
add a new dimension of uncertainty; new oil finds are proving intangible.
Some other fears that dominate the rumor mongering oil markets
are that new production has been low in the two biggest oil-producing
regions, the Persian Gulf and the Caspian Sea, that they
are short of pipelines and ports. It is also argued that
U.S. refineries
are presently running at near-full capacity, providing a
chokepoint for gasoline supplies to American consumers.
It
is argued that
oil companies found an average 6.8 billion barrels of new
oil a
year in 2001-2003, compared to 11.4 billion barrels a year
in
the previous five years, since it takes take three to 10
years from
discovery to production.
Saudis as swing producer is the key to oil prices; most OPEC
members produce nearly at full capacity already. Only Saudi Arabia
and the United Arab Emirates have spare capacity. Saudi Arabia
remains the kingpin of oil. It has a quarter of the world's proven
reserves, about 262 billion barrels of oil, under its vast desert
expanses. Add in the reserves held by the country's allies in
the OPEC cartel, and the total is a whopping 815 billion barrels-some
three-quarters of world reserves.
 Most of the extra oil in case
of global crisis would have to come from Saudi Arabia, the
world's largest oil producer, by far its largest exporter and OPEC's
traditional
swing producer. It has an estimated two to three million barrels
a day of spare capacity. When doubts are cast on Saudi swing
production, all bets are off.
That 'concerted terror attacks'
is
a daredevil
kind of planning, in my humble opinion, but in a milieu where
sensationalism sells, this story has a top seller. Oil Age
will end one day, as
Zaki Yemani said. Oil was dirt cheap below $10's, it is
now $53's above what it takes to produce in Saudi Arabia. Even
OPEC
realizes
the long term impact of high prices on the ability of inefficient
oil nations to produce a lot more at around $30-32 a barrel.
The present state is very tentative; new productions which
are high cost production and were, until very recently, uneconomical
to produce would need ample reassurance to come back to life. Current
levels of pricing are quite attractive and highly incentivised
for 'dull producers' to go back on an investment spree. The reason
less oil was found in 2001-2003 was not due to lack of fields,
but lack of investments (who would want to discover more oil at
$20-25 a barrel?).
In my opinion, the biggest threat to oil future comes from the
GDP growing efficiently on lesser and lesser oil. This also signals
that consumers are shifting towards cleaner economies whereas producers
are loaded with old economy consumption pattern. On the security
side, lesser revenue from oil creates havocs for economies like
Russians and OPEC, even terror becomes difficult to handle if free
jobs of paper-pushers in ministries of Saudi and Kuwait are denied.
Higher oil prices can buy loyalties in commotion-prone Saudi Arabia.
Nicely tied to these handouts, the same people become bigger terrorists
if denied the handouts.
On the other hand, OPEC countries'
higher
commodity prices make them great consumers. If the West keeps
producing cleaner service economy with lesser consumption, and
commodity-rich
OPEC countries fail to understand energy efficiency impact, the
dependence of commodity rich countries on the West will further
increase as higher oil revenues make OPEC populace addictive
to products of the west, as if that has not happened already.
When
taps on oil are turned off the repercussions on OPEC would be huge.
Extreme swings in oil pricing create structural imbalances and
false cradle to grave social demands, they are nearly impossible
to fulfill at low oil prices. As oil makes new highs,
the 'dull producers' by nature of their business as high cost producers,
usually come late to the market. But once they bring that additional
few million barrels, the speculative bubble can puncture pretty
fast. A story based on sensational plots can only fly that much,
perhaps it is the initial high cost of production impediment for
the dull producers that encourages such speculation even further.
On the flip side of this argument, although the supply size
of the dull producers is not more than 2-3 million barrels a
day and
very miniscule in relation to the 78 million barrels daily world
consumption, once market speculators realize that swing production
of OPEC held by Saudis is sustainable at these 50 $ level and even
in the most unlikely event of knocking of Ras Tanura oil terminal
by the terrorists in a coordinated attack will not diminish the
ability to satisfy world consumption, then realism comes into play
and out goes speculation and sensationalism.
Efficiencies of world commodity markets cannot be understated
here. The price levels can be overextended, but the actions in
commodities and currency, or for that matter, stock markets,
are not a rear window image. It is the sum total of all greed
prevalent
within the workings of capitalist economies; it is this ever
present invisible hand and mind of greed and self-preservation
that pushes
these global markets to new highs. Boom and bust are inbuilt
stabilizers of global capitalist markets.
These speculators take
on inefficiencies
and iron them out; it is always a war between weak holders
and strong holders and in the end, the only survivors are those
who
are neither over-leveraged nor get too over carried by pessimism.
By nature, wealth creation and wealth preservation are safeguarded
by 'bodyguards of global speculators.' These speculators, now
headed by major hedge funds, fine tune a trend and then appear
as complete
'demolition businesses' to remove any physical profligacy or
intellectual vanity.
The United States has been a leader in
new exploration and
production technology that has greatly lowered the supply
cost curve here and around the world, and those technical advances
are continuing. In the present war between speculator myths
and physical
realities governing oil price rises, it is the myth of fear
that is exacting the right price from consumers.
In capitalist
economies,
there are no free lunches; too much fear leads to too much
of inbuilt profit, a great thing for OPEC in the short run,
but
a bad omen
in the long term. Now if OPEC is overtaken by greed, a
few years'
highs of these levels of oil will lead to permanence of
greater high-cost supplies and with technological advancement
on
the way, who can say that these high cost producers may come
to
stay.
In such a scenario, for big underground reserve
holders of oil like, Saudi, Iran and Iraq,
it would be meaningless
to have too
much oil in the ground, if new energy-efficient industry in the
next two decades knocks gas guzzling machines out and oil becomes
a cheap commodity with utilization at far more efficient levels.
It is these nightmarish scenarios the producers have to work
with.
New non-OPEC supplies developed in the 1980s
helped bring the original
oil shock period to a close, and prospects are promising now
for substantial additional once oil stays at these
levels, as forgotten
closed down fields become more profitable. Oil price vagaries
epitomize 'free market' no price control economy
at its best. The reason
that global market oil pricing is free from the clutches of
OPEC or any cartel of consumer like OECD signals
the maturity of the
pricing cycles.
The greed inherent within capitalist systems
has to stay awake and alive, that is the only difference
on how capitalist
markets survive every possible assault on its jugular by
the ideological left. Price-controlled economies
like
that of the Russians imploded
under their own weight, even Nehruian socialist model failed
to address India's woes of poverty.
It was only
after free market
was allowed to thrive that India's shining came glowing
up on the radars of international fund managers.
Even the
last bastion of
the socialist economy China, today, is at the extreme right
of the old great leap forward model. Transformations
of economies
only take place when greed, a product of incentive, is
allowed
to unashamedly thrive.
 To have a huge greed-based rally of oil in
late summer/early fall is the best possible
preparation
for a harsh winter; it is
such kind of market inbuilt 'maniac delusions' that has yielded
best survivors of the global economies. We all know that it is
the shape of a 30-year bond yield curve that indicates the direction
of the market economy; it is always the long run that determines
the shape of any nation's future. The concerns on higher oil
prices can only be mitigated by immediate lowering
of oil prices by the
OPEC nations for their own benefit.
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