Oil on the boil
Tuesday, 22 July 2008

Dilip Hiro

When will it end, this crushing rise in the price of gasoline, now averaging $4.10 a gallon at the pump? The question is uppermost in the minds of American motorists as they plan vacations or simply review their daily journeys. The short answer is simple as well: "Not soon."

As yet there is no sign of a reversal in oil's upward price thrust, which has more than doubled in a year, cresting recently above $146 a barrel. The current oil shock, the fourth of its kind in the past three-and-a-half decades, and the deadliest so far, shows every sign of continuing for a long, long stretch.
The previous oil shocks — in 1973-74, 1980, and 1990-91 — stemmed from specific interruptions of energy supplies from the Middle East due, respectively, to an Arab-Israeli war, the Iranian revolution, and Iraq's invasion of Kuwait. Once peace was restored, a post-revolutionary order established, or the invader expelled, vital Middle Eastern energy supplies returned to normal. The fourth oil shock, however, belongs in a different category altogether.

Unlike in the past, the present price spurt has been caused mainly by global demand for energy outstripping available supply. Alarmingly, there is no short-term prospect that supply will match demand. For a commodity like petroleum that underwrites and permeates every aspect of modern life — from fuel to fertilizers, paints to plastics, resins to rubber — "balance" requires a 5% safety factor on the supply side.

At present, however, spare capacity in the oil industry is less than 2%, down from more than 6% in 2002. As a result, the price of oil responds instantly to negative news of any sort: a threat against Iran by an Israeli cabinet minister, a fire on a Norwegian offshore drilling rig, or an attack on an oil facility by armed rebels in Nigeria.

Behind the present price surge, other factors are also at work. Take the sub-prime mortgage crisis in the U.S. It flared almost a year ago, drastically lowering the market value of the stocks of banks and allied companies. The concomitant downturn in other equities led investment fund managers and speculators to direct their cash into more productive markets, especially commodities such as gold and oil, driving up their prices. The continued weakening of the U.S. dollar — the denomination used in oil trading — has also encouraged investment in commodities as a hedge against this depreciating currency.

The earlier oil shocks led non-OPEC (Organization of the Petroleum Exporting Countries) nations to accelerate oil exploration and extraction to increase supplies. Their collective reserves, however, represent but a third of OPEC's 75% of the global total. By the turn of the century, these countries had pumped so much crude oil that their collective output went into an irreversible decline.

A mere glance at the oil production table of the authoritative BP Statistical Review of World Energy — published annually — shows declines in such non-OPEC countries as Britain, Brunei, Denmark, Mexico, Norway, Oman, Trinidad , and Yemen. Over the past decade, oil output in the U.S. has declined from 8.27 million barrels per day (bpd) to 6.88 million bpd.

The exploitation of the much-vaunted tar sands of Canada — expected to cover the global shortfall — only helped to raise that country's output from 3.04 million bpd in 2005 to 3.31 million bpd in 2007, a mere 10% in two years.

In the 1990s, overflowing supplies and cheap oil had led to an overall decline in oil exploration as well as under-investment in refineries.

These two factors constitute a major hurdle to hiking the supply of petroleum products in the near future.

In addition, new hydrocarbon fields are increasingly found in deep-water regions that are arduous to exploit. The paucity of the specialized equipment needed to extract oil from such new reserves has created a bottleneck in future offshore production. The world's current fleet of specialized drill ships is booked until 2013. The price of building such a vessel has taken a five-fold jump to $500 million in the last year. The cost of crucial materials — such as steel for rigs and pipelines — has risen sharply. So, too, have salaries for skilled manpower in the industry. Little wonder then that while, in 2002, it cost $150,000 a day to hire a deep-water rig, it now costs four times as much.

While the oil supply remains essentially static, worldwide demand shows no signs of tapering off. The only way to cool the energy market at the moment would be to reduce consumption. Luckily — from the environmentalist's viewpoint — soaring gasoline and diesel prices have begun lowering consumption in North America and Western Europe. Gasoline consumption in the United States dropped 3% in the first quarter of 2008, when compared to the previous year.

When it comes to energy conservation, there is a far greater opportunity for saving in the affluent societies of the West than anywhere else in the world. An average American uses twice as much oil as a Briton, a Briton twice as much as a Russian, and a Russian eight times as much as an Indian. It was therefore perverse of U.S. energy secretary Sam Bodman to focus on the way the Chinese and Indian governments subsidize oil products to provide relief to their citizens — and to urge their energy ministers to cut those subsidies to "reduce demand."

It is true that China and India, which together account for two-fifths of the human race, are now major contributors to the growth in global oil demand. But it's an indisputable fact that only by increasing per capita energy consumption from current abysmally low levels can the Chinese and Indian governments hope to lift hundreds of millions of people out of grinding poverty.

In a country like India, for instance, half of all households lack electricity, so hurricane lanterns, fueled by kerosene, are a basic necessity. Subsidized kerosene, also used for cooking stoves, helps hundreds of millions of poor Indians. To cut or eliminate the subsidy on kerosene would only intensify poverty.
In truth, when it comes to energy conservation, the main focus at the moment should be on the 30-member Organization for Economic Co-operation and Development (OECD), a group of the globe's richest nations which cumulatively consumes nearly three out of every five barrels of oil used anywhere.
Among OECD members, Japan provides a model to be emulated.

When it comes to energy conservation, Japan provides a glaring counterpoint to the United States. Consider what's happened in both countries since the first oil shock of the mid-1970s when prices quadrupled.

That price hike initially led to a drive for fuel efficiency in the U.S., Western Europe, and Japan. It also gave a boost to the idea of developing renewable sources of energy. Ever since, Japan has followed a consistent, long-range policy of reduction in petroleum usage, while the U.S. first wavered and then fell back dramatically.

Under the presidencies of Gerald Ford and Jimmy Carter, the U.S. modestly improved the fuel efficiency of its vehicles, as stipulated by a federal law. President Carter also announced a $100 million federal research and development program focused on solar power and symbolically had a solar water heater installed on the White House roof.

During the subsequent presidency of Ronald Reagan, when oil prices fell sharply, energy efficiency and conservation policies went with them, as did the idea of developing renewable sources of energy. This was dramatized when Reagan ordered the removal of that solar panel from the White House.

In the private sector, utilities promptly slashed by half their investments in energy efficiency. President George H.W. Bush, an oil man, followed Reagan's lead. And his son, George W. (along Vice President Dick Cheney, former chief executive of energy services giant Halliburton) has done absolutely nothing to wean Americans away from their much talked about "addiction to oil."
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