Oil in Troubled Waters a Survey of Oil April 30Th 2005
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Oil in troubled waters A survey of oil April 30th 2005 Republication, copying or redistribution by any means is expressly prohibited without the prior written permission of The Economist The Economist April 30th 2005 A survey of oil 1 Oil in troubled waters Also in this section Not so shocking Does the oil price matter any more? Page 4 Global or national? The perils facing Big Oil. Page 8 The incredible shrinking companies The way oil reserves are booked needs reforming. Page 10 The bottomless beer mug Why the world is not running out of oil. Page 13 Consider the alternatives Is the age of oil drawing to a close? Page 16 Prices are sky-high, with prots to match. But looking further ahead, the industry faces wrenching change, says Vijay Vaitheeswaran HE time when we could count on usually mean one of two reference crudes: Tcheap oil and even cheaper natural Brent from the North Sea, or West Texas In- gas is clearly ending. That was the gloomy termediate (WTI). But when ministers forecast delivered in February by Dave from the Organisation of the Petroleum Ex- O’Reilly, the chairman of Chevron Texaco, porting Countries (OPEC) discuss prices, to hundreds of oilmen gathered for a con- they usually refer to a basket of heavier ference in Houston. The following month, cartel crudes, which trade at a discount to Venezuela’s President Hugo Chavez glee- WTI and Brent. All oil prices mentioned in fully echoed the sentiment: The world this survey are per barrel of WTI. should forget about cheap oil. The recent volatility in prices is only The surge in oil prices, from $10 a barrel one of several challenges facing the oil in- in 1998 to above $50 in early 2005, has dustry. Although at rst sight Big Oil seems prompted talk of a new era of sustained to be in rude health, posting record prots, higher prices. But whenever a new era in this survey will argue that the western oil oil is hailed, scepticism is in order. After all, majors will have their work cut out to cope this is essentially a cyclical business in with the rise of resource nationalism, which prices habitually yo-yo. Even so, an which threatens to choke o access to new unusually loud chorus is now joining oil reserves. This is essential to replace Messrs O’Reilly and Chavez, pointing to in- their existing reserves, which are rapidly triguing evidence of a new price oor of declining. They will also have to respond $30 or perhaps even $40. Confusingly, to eorts by governments to deal with oil’s though, there are also signs that high oil serious environmental and geopolitical Many people generously helped with this survey. prices may be caused by a speculative bub- side-eects. Together, these challenges Particular thanks go to Edward Morse, Fatih Birol, ble that could burst quite suddenly. To see could yet wipe out the oil majors. Daniel Yergin and David Victor. A full reading list is at which camp is right, two questions need www.economist.com/surveys answering: why did the oil price soar? And The ghost of Jakarta what could keep it high? But back to the question of why prices shot An audio interview with the author is at To make matters more complicated, up in the rst place. The short explanation www.economist.com/audio there is in fact no such thing as a single oil is that oil markets have seen an unprece- price: rather, there are dozens of varieties dented combination of tight supply, surg- Past articles on the oil industry are at of crude trading at dierent prices. When ing demand and nancial speculation. www.economist.com/oil newspapers write about oil prices, they One supply-side factor is OPEC’s clever1 2 A survey of oil The Economist April 30th 2005 2 manipulation of output quotas. Back in tify. Other supply worries arose from the tional Economics in Washington, DC, reck- 1997, at a ministerial meeting in Jakarta, crackdown by the Russian president, Vlad- ons that the cartel itself may be to blame the cartel decided to raise output just as the imir Putin, on the oil company Yukos, and for the speculation: by declaring its inten- South-East Asian economies were hit by from civil strife in Venezuela and Nigeria. tion to prop up prices, rst at $30 and now crisis, sending prices plunging to $10. Des- Some pundits think the fear premium may at $40, OPEC has given Wall Street a free perate to engineer a price rebound, Saudi have added $7 to $15 to the cost of oil on fu- put option (because investors believe the Arabia targeted inventory levels: when- tures markets in New York and London. cartel will cut output to stop prices falling). ever oil stocks in the rich countries of the Adding to the froth has been the sud- Supply constraints coincided with a OECD started rising, OPEC would reduce den inux of new kinds of nancial inves- huge boom in oil demand. Global oil con- oil quotas to stop prices softening. It tors into the oil market. Some are merely sumption last year increased by 3.4% in- worked like a charm. chasing the huge returns recently oered stead of the usual 1-2%. Nearly a third of Another supply-related factor has been by oil. Big equity funds, fearful of what that growth came from China, where oil the shortage of petrol in the American $100 oil could do to their holdings, might consumption rocketed by perhaps 16%. market. Over the past year or two, prices invest in oil futures at $40 or $50 as a cheap One senior European oil executive claims have spiked as reneries have been unable insurance policy. OPEC ministers love to that, in contrast with the embargoes and to meet local demand surges. blame hedge funds for high oil prices, but supply-driven price rises of the past, This Supply concerns have also played a they are only partly correct. The net long is the rst demand-led oil shock. part in the so-called fear premium. The positions (that is, their speculative bets on And it was not just China that used a lot nerve-wracking uncertainty before the in- higher prices) held by such funds peaked more oil. India’s oil consumption too leapt vasion of Iraq, and the terrible terrorist at- in March last year and dropped through last year, and America’s was quite robust. tacks in Iraq and Saudi Arabia afterwards, 2004, but oil prices kept rising regardless. In fact, despite $50 oil, global oil demand have pushed up prices to a higher level Phil Verleger, an energy economist as- in 2004 grew at the fastest rate in over 25 than the fundamentals would seem to jus- sociated with the Institute for Interna- years. The global economy also grew at a1 Not so shocking Does the oil price matter any more? OW is it that oil prices have been able low global ination and strong demand- happen quickly. Hto shoot from $10 a barrel to over $50 led growth, which meant it was easily ab- In fact, argues Fatih Birol, chief econo- without triggering an economic shock? sorbed. In contrast, the 1970s oil-price mist of the International Energy Agency, The conventional reckoning is that every hike came at a time of high ination, present price levels may already be $10 hike in the oil price will knock half a wage and price indexation and economic dampening the current cyclical upturn. In point o global GDP growthand yet the malaise. Mr Rogo argues that the particular, they may be hurting the rise to $50 seemed to make little dier- world’s central banks have also become world’s developing countries. Many poor ence to the global economy last year. Oil much more credible ination-ghters, so countries are more dependent on im- is priced in dollars, so the steep dollar de- oil-price rises have not been feeding ported oil and use energy far less e- preciation in recent months should have through to higher interest rates. ciently than do rich countries as they helped the European Union. Yet despite Another important factor is that the make a dash for manufacturing-led that boost, the euro-zone countries grew OECD countries have become much less growth. Economists are still trying to by only 2% last year, whereas America, energy-intensive, thanks to the shift from make sense of the non-shock of 2004, which was fully exposed to the oil-price manufacturing to services. America, for but some lessons are already clear. First, hike, grew at 4.4%. China, with growth of example, uses only half as much oil per the world’s utter reliance on petroleum around 10%, was in a class of its own. unit of GDP as it did 30 years ago. In value for transport still leaves it highly vulner- Ken Rogo, a professor at Harvard and terms, oil’s share of OECD commodity able to an oil shock at some price. That, ar- former chief economist of the IMF, argues imports plunged from 13% in the late gues Mr Rogo, is reason enough for that the world really did not have a clear 1970s to 4% in the late 1990s. America, the world’s biggest oil con- picture of the relationship between oil sumer, to impose a carbon tax: Either we and GDP. He now thinks that a gradual When the pips start to squeak raise the price of oil, or OPEC will.