By
Cyrus
H Tahmassebi
World oil markets are in a state of total chaos and this is
nowhere more evident than in the United States. The price for
West Texas Intermediate (WTI), a benchmark crude oil for the
US, has shot up by nearly 100% in less than a year and a substantial
portion of this increase has taken place over the last six
months. WTI closed at $139.64/B on 26 June. It was trading
at an average price of $29.07/B in the second quarter of 2003
and around $80/B at the end of last year. Some analysts are
now projecting the price to rise to as high as $150/B by the
end of the year.
The spike could not have come at a worse time.
The US economy, facing one of its worse housing and financial
crisis in generations,
has been teetering on the verge of a severe recession since
last August with no sign of a quick turnaround. Skyrocketing
costs of the Iraq war coupled with rising inflationary pressures
had already weakened the government’s ability to stimulate
the economy through monetary or fiscal policy. With crude oil
and other energy prices escalating daily, bringing the economy
out of its current doldrums will be an even greater challenge.
To address this burgeoning energy crisis, the
US government’s
actions so far have been moot or nonexistent, President George
W Bush’s touting for offshore and Arctic National Wildlife
Refuge (ANWR) drilling notwithstanding. In fact in some instances,
(eg promotion of ethanol or saber rattling against Iran) government’s
actions are believed to have contributed to higher inflation
and/or higher oil prices.
Years of failure to act or at least be prepared
to respond to adverse developments in the world oil markets
is now manifesting
unpleasant consequences. Unfortunately, now that the chickens
are coming home to roost, the only really visible response
so far seems to be one of finger pointing. The major culprits
identified in the public discourse by the politicians and some
analysts include such perceived villains as major oil companies,
OPEC, speculators, gasoline excise taxes, and of course the
environmentalists who are accused of hindering the development
of domestic oil and gas resources and thus preventing the country
from achieving “energy independence”.
Unfortunately, despite these rhetorics, sometimes uttered
with genuine sincerity, most experts would argue that the roots
of the current crisis actually lie elsewhere. In order to thoroughly
understand the scope and gravity of the current energy challenges
faced by the US (and to a lesser degree by other major consuming
markets), it is necessary to analyze this crisis in four different
parts. First, what is the nature of the current crisis and
is it in any way different from the ones we faced previously?
Second, what are the remedial actions and policy measures that
are needed to address the current challenges? Third, what lessons
do we need to learn from the current crisis in order to avoid
even much bigger and more severe crises in the future? Finally,
what are some of the myths and realities concerning this crisis
and why is their clear distinction crucial to the development
of a sound energy policy for the future?
The Nature Of The Current Crisis
World oil markets have been through numerous crises of one
kind or another in the past, but most of them were prompted
by political events. For example, the 1952 nationalization
of the oil industry in Iran, the 1973 Arab oil embargo, the
1979 Iranian Revolution, the 1980-88 Iran-Iraq War, and the
1991 invasion of Kuwait by Iraq all jolted the world oil markets
and sent prices higher. However, when the dust settled and
tranquility returned to the markets, oil prices gradually reverted
back to their pre-crisis levels.
The current market environment, however, is
believed to have emerged in response to a number of structural
and fundamental
developments in the markets and may not only remain with us
indefinitely but, if left unchecked, may actually intensify
in the years ahead. In a nutshell, what makes the current crisis
so unique is the fact that world oil demand over the last decade
or so has increased quite rapidly, gradually eliminating all
of the 15mn b/d of excess production capacity that once existed
in the OPEC countries. Although supplies are currently sufficient
to satisfy the market demand, there is no assurance that this
will continue to be the case even in the near future. Furthermore,
this balance is very tenuous as even a slight drop in supply
could trigger a big jump in the world oil prices. Furthermore,
the projected increase in world oil demand is expected to surpass
the anticipated increases in supply even under the most optimistic
scenarios. Thus, the market’s vulnerability and the unreliability
of its tenuous balance are likely to intensify.
The current tightness in the world oil markets and the potential
for a major and sustained imbalance in the world oil markets
could have been completely averted, or at least alleviated
significantly, if the governments in the major consuming markets
and producing countries had planned in advance and implemented
those plans in a coordinated and cooperative fashion. Unfortunately,
as time went by there was neither a substantive public discourse
of the real problems nor any sign of urgency on the part of
these governments to undertake a sound planning with effective
counter measures. Given this state of unpreparedness, there
is really no guarantee that this crisis will soon come to an
end or even improve markedly.
It is not as if there were no advance warnings about the events/developments
that are now believed to be the underlying factors contributing
to the current crisis. This writer has delineated the issues
in a number of articles and conference presentations*, warning
against the potential adverse consequences of a number of issues.
Among the factors identified as major emerging issues were:
complacency on the part of the major consuming countries over
supply prospects and a resultant lax policy on fuel efficiency;
over-reliance on the notion that OPEC and particularly Saudi
Arabia, Kuwait, and UAE would always strive to maintain an
adequate amount of spare capacity to forestall undue price
spikes; and the supply-constraining impact of using prolonged
economic sanctions as a means to exact political concessions
or change government policies/behavior in the major producing
countries with adverse relations with the West and US.
The latter point, which admittedly is the most controversial
issue, has been repeatedly discussed in public debates and
in numerous articles. The crux of these arguments is that economic
sanctions, particularly if applied unilaterally or by only
a handful of countries, are bound to become ineffective over
time as the targeted country eventually finds ways and means
of circumventing them or watering down their intended effects.
This does not mean, however, that production in the targeted
country will escape unscathed. What it means is that a potential
line of supply, and thus spare capacity to produce, is likely
to dwindle and thus make the world oil markets more vulnerable
to supply disruptions. For example, some believe that without
economic sanctions imposed over the last two-three decades
on such oil producing countries as Iran, Iraq and Libya, potential
world oil supply or the spare capacity to produce would have
been some 3-5mn b/d higher and thus world oil prices would
have been much lower than what they are today.
Some observers believe that economic sanctions have also had
rather significant impact on the potential or actual supply
of oil from countries other than the ones subjected to economic
sanctions. According to these observers, producing countries
not subjected to these sanctions have been reluctant to increase
production or the capacity to produce more, either because
of sympathy or fear of retribution or political backlash within
their own country.
Finally, some observers believe that the potential
long-term consequences of sanctions and other political/diplomatic
heavy-handedness
used by the West and particularly by the US have not yet been
realistically and objectively evaluated. According to these
observers, the long-term consequences would be huge and broad,
impacting the entire world and its current balance of power.
In this scenario, it is envisaged that within the next 15 years
or so a huge portion of the world’s oil and particularly
natural gas resources will be under the control of a handful
of countries such as Russia, China, India and a few of the
current oil producing countries, by virtue of outright ownership
or long-term binding contractual agreements. Maybe this scenario
is far-fetched, but given its significance and huge ramifications
for the entire world, it can not be dismissed by the West or
the US.
What Are The Policy Options?
Before we begin to discuss the policy options, it might be
helpful to shed some light on a number of misconceptions that
are currently prevalent in public discourse on energy-related
issues.
First, dependence is not the same as vulnerability. In a global
economy, all nations are dependent on one another not necessarily
out of necessity but because of comparative cost advantages.
International trade often takes place not because a country
cannot produce what it imports, but because importing is cheaper
and allows the importing country to use its labor and other
resources in producing other goods and services where it has
a better comparative advantage.
A country becomes vulnerable if it is heavily dependent on
only one or a few countries for its supply and those countries
also command a huge market share in the total global market
for that commodity. A disruption in one of these major producing
countries could have a huge adverse impact on a global scale
and can encompass even countries that did not directly import
from it. Hence, the best way to reduce vulnerability is not
necessarily to stop importing, but to diversify the sources
of supply, promote new sources of supply and assist the smaller
producers with capital and advance technology.
Second, energy independence, which seems to
be in vogue these days, is neither feasible nor in reality
desirable. If the
purpose of energy independence is to shield a country from
the adverse consequences of a supply disruption or rising prices,
due to supply-demand disequilibrium, it would not be achievable
as long as that country has any imports of that commodity.
It is a well established economic concept that the price in
a market place is determined at the “margin”. This
means that even if a country imports only a very small portion
of its oil, it cannot shield itself from the events of the
international markets.
Third, the world is not running out of oil. According to the
latest estimates published in the 2008 edition of BP Statistical
Review, proven oil reserves today stand at around 1,238bn barrels.
At the current level of global consumption, there is enough
oil to satisfy demand for the next 40 years, a period long
enough to provide the authorities enough time to sort out the
problems and envisage a sound long-term solution. A strong
argument can be made that in view of growing demand in countries
like China and India and in the Middle East, the life of these
known reserves could be much shorter. However, this argument
is based on the false premises that no new reserves will be
discovered and that technological advancements and innovations
will have no impact on exploration and production activities
or fuel efficiency in different sectors of the economy.
Bearing these factors in mind, therefore, rather than touting
energy independence, which has been in public discourse on
and off for decades without any really tangible result, it
would be best to resort to market-based measures to encourage
conservation of all kinds, development of alternative fuels,
promotion and application of advance technologies not only
just in the US and a handful of developed countries, but as
extensively as possible everywhere around the globe where there
are promising prospects. Granted that these measures would
not come to fruition quickly, because they are not intended
to be quick fixes, but they can set forces in motion that can
benefit not just one nation, but the entire world with lasting
impact on the standard of living and the environment.
* Tahmassebi Attacks Complacency On Long-Term Oil Supply Outlook.
MEES, 10 January 1994.
Oil Sanctions: Their Effective And Long-Term Ramifications.
MEES, 29 April 1996.
Effective
US Energy Policy Critical To World Energy Balance. Oil & Gas
Journal, 2 April 2001.
Cyrus
H Tahmassebi, was Ashland
Inc’s Chief Economist and Director of Market Research
before his retirement from that company in 1996. He is now
an independent consultant.
Petroleumworld does not necessarily share these views.
Editor's
note: This article was written for
Middle East Economic Survey - MEES and first publish by MEES,
on its VOL.
LI, No 26, 30-June-2008. Petroleumworld
reprint this article in the interest of our readers.
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