HURRICANES hit America’s offshore oil rigs, temporarily closing down about 10 percent of the nation’s oil production. Insurgents hit Iraq’s oil facilities. Rebels led by Alhaji Mujahid Dokubo-Asari hit Nigerian oil fields. Terrorists hit foreign oil workers in Saudi Arabia. Putin hits Yukos. All unrelated events, all with the same effect: higher oil prices, proving that the industry’s production, transportation, and processing facilities are stretched to the limit.
With prices now hovering at the psychologically significant level of $50 per barrel, economists have retuned their models, politicians have re-examined their nations’ energy policies, and finance ministers are using the IMF-World Bank meetings that officially start today to examine the implications of $50 oil for inflation, interest rates, and the U.S. balance of payments.
All of these reappraisals suffer from a very important difficulty: a lack of reliable information. The Saudis say they can and will quickly produce 1.5 million more barrels of oil daily, but many observers think this is a wild overestimate. The Russians say that their assault on Yukos will not interfere with the company’s exports, but observers note that shipments to China have been curtailed because Yukos hasn’t enough money to pay the railroads. China says it welcomes foreign investment to develop its oil and gas fields, but the country’s largest producer, PetroChina, has aborted two years of talks with Shell, Exxon, and Russia’s Gazprom. OPEC claims victory in the war against high oil prices immediately before prices jump several dollars per barrel. Traders, presumably astride up-to-the-minute information, predict a 3.4 million barrel draw-down in U.S. inventories in a week in which inventories actually rise by 3.4 million barrels.
Most confusing of all are the statements by those who really should know what is going on in oil markets: the chief executives of the major international oil companies. Lord Browne, chief executive of BP, denies there is a worldwide shortage of oil. He told the Financial Times, “There isn’t really a supply crunch at the moment. . . . Supply can be forthcoming in significant quantities. OPEC is being very determined and, if you look at non-OPEC capacity additions, they’re going to come on pretty strong starting at the back end of the year.” Not so, says David O’Reilly, CEO of ChevronTexaco: “There is a lack of spare capacity out there.”
And the differences of opinion among the industry’s top executives relate to future prospects as well as to the current situation. Browne says that OPEC countries are quite capable of expanding output without help from international oil companies (IOCs), while Lee Raymond, Exxon’s boss, told a meeting of OPEC officials that the world’s growing need for oil can be met only if the IOCs are allowed to explore in the producing countries now closed to them.
To add to the confusion, experts are sharply divided as to the consequences of $50 oil. The International Monetary Fund responded to a 30 percent rise in oil prices since its last forecast by cutting its new forecast of world economic growth in 2005 by one-half of a percentage point, to a still-robust 4.3 percent. But consider this: The U.S. government a few days ago revised its estimate of this year’s second quarter growth up by one-half of a percentage point–from 2.8 percent to 3.3 percent, as predicted in last week’s column. If revisions to already-reported data can be on the order of half a percentage point, one wonders why any forecaster believes it worthwhile to try to wring half-point accuracy from his models of future growth.
Finally, we have the confusion sowed by financial markets. Economists expected that high oil prices, which push up the costs incurred by electricity generators, airlines, chemical companies, auto companies, steel companies, and other fuel-intensive industries, would be reflected in fears, if not the fact, of higher inflation. That, they reason, would drive up interest rates. But high oil prices have coincided with a drop in interest rates, as investors reckon that $50 oil will slow economic growth and so reduce inflationary pressures.
Making sense of all of this is no easy task. But a few sound conclusions are possible. The level of oil prices is due in part, but only in part, to the threat of supply interruptions, as Lord Browne argues. But there is no question that the industry is under stress: production capacity is struggling to keep up with the growing demand of China and of the recovering United States, and that capacity cannot be expanded unless the Middle East countries open their industries to IOC capital, and the IOCs make that capital available by revising upward their estimate of the prices they will be able to realize for newly discovered oil.
The strains on the system do not stop at the production level. American refiners are struggling to meet demand, and unless environmental restrictions are eased and long-term price expectations raised so that new capacity is built, the United States will have to choose between rising product prices and a substantial increase in imports of refined products. That would exacerbate a trade deficit already at levels that are difficult to sustain, threatening a devaluation of the dollar, which is already much on the minds, and in some cases on the lips, of the finance ministers meeting in Washington today.
Later this month OPEC’s long-term planners meet in Jeddah to decide whether $50 oil represents a new price level, or a bubble about to burst. The results of that meeting might just provide a clue as to whether the cartelists are willing to open their countries to much-needed foreign capital and expertise. Shortly thereafter, the U.S. elections will be concluded, forcing the winner to concentrate on a sensible energy policy, rather than campaign nonsense about independence from Saudi oil.
Irwin M. Stelzer is director of economic policy studies at the Hudson Institute, a columnist for the Sunday Times (London), a contributing editor to The Weekly Standard, and a contributing writer to The Daily Standard.
