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Where's the Oil?

Prices and demand are up. Oil industry revenues are sky-high. So why aren't oil companies exploring ways to increase supply?

VLADIMIR PUTIN may have done John Kerry a very big favor. When the former KGB agent threatened Yukos with closure for failure to pay the $3.4 billion in taxes he discovered it owed when Yukos' principal shareholder became a political opponent, oil prices temporarily hit a 21-year high. Never mind that any sensible observer knows that Russia's treasury would drown in red ink, and the ruble collapse, if Yukos--which accounts for 20 percent of Russia's current oil production and one-third of the recent increase in output--were forced to suspend export operations for any protracted period.

So tight are oil supplies that even the threat of a temporary loss of what comes to about 2 percent of world production was enough to send traders into a panic. Russia is, after all, the world's second largest oil exporter, right behind increasingly unstable Saudi Arabia, and Putin's politicization of the industry worries those who look to his country to help meet growing demand.

Which is a triple dose of good news for Kerry. First, high oil prices slow the economic recovery, on which the president is relying to create jobs in the 92 days remaining until the voters go to the polls.

Second, a spurt in oil and gas prices hits lower and middle-income voters hardest, giving the Kerry-Edwards duo an opportunity to cry even more loudly that there are "Two Americas," the privileged who support the president, and the hard-pressed, driving-to-work masses for whom higher gas prices are only one of many woes.

Finally, even a passing threat, such as the shutdown of Yukos, emphasizes America's dependence on foreign oil. Like every president and presidential candidate since the days of Richard Nixon, Kerry is promising to end this dependence so that America will never again have to go to war for oil. No matter that even the most casual student of America's energy situation knows that independence from imports is an unattainable goal, and that it is a lot cheaper to buy high-priced oil than to conquer a country that produces it. At this time of year, perceived political advantage trumps sensible proposals every time.

THE YUKOS INCIDENT is less significant for its immediate political implications than for what it tells us about oil markets in the longer term. Demand for oil is rising rapidly, at the fastest rate in more than three years in the United States. And this despite the fact that high gas prices "caused growth in U.S. gasoline demand to stall out . . . for a second straight month in June," according to the American Petroleum Institute.

And the high prices are doing wonders for the major international oil companies' bottom lines. ExxonMobil, for example, last week reported that it had earned almost $6 billion in the second quarter, an all-time record for any company in a three-month period. But the oil companies are not responding to higher prices and earnings by increasing their search for oil.

Exclude Russia, and BP's output is declining, as are Shell's and ChevronTexaco's. Production at ExxonMobil is more or less flat. Only Total, with its commitment to Africa and Asia, seems to be stepping up production. Bijan Mossavar-Rahmani, CEO of Mondoil, an independent international company, and a close student of the production side of the oil business, says that despite high oil prices and technological innovations that are driving finding and production costs down, the largest oil companies have in recent years replaced only three-fourths of their production.

The result of burgeoning demand and an unwillingness of major companies to plow more into finding oil is a very tight supply situation. Purnomo Yusgiantoro, the Indonesian who is president of OPEC, continues to claim, not very convincingly, that the cartel is eager to push prices down to below $30 per barrel. But as Rafael Ramirez, Venezuela's oil minister, told Reuters, "Most of the countries are near their production limits."

YET THERE IS NO SIGNIFICANT INCREASE in the hunt for oil, despite the conviction among Middle East producers with whom I have spoken that the demand for oil will increase by more than 50 percent in the next 20 years. Industry executives tell me that prospects for supply enhancement from West Africa or the Central Asian Republics are less glowing than press reports suggest, and government officials in Europe point out in private conversations that they fear Russia's exports will be curtailed by continued government intervention. That leaves the Middle East, which experts there say will have to meet two-thirds of future increases in the demand for oil.

My conversations with executives from companies and countries around the world turned up several reasons why high prices seem unable to elicit more oil. One British executive repeats what several Americans told me at a private dinner in Washington: "Prices go up, and prices go down." The fear of a price collapse, induced either by a decline in demand, the outbreak of peace and the consequent removal of the current $7-$10 per barrel risk premium, or a move by OPEC to open the taps so as to deter investment in alternative energy sources, is a real deterrent to long-term investment.

Add to that a powerful insight by a shrewd representative of a leading Middle East producer: He claims that the problem is not a lack of investment by international oil companies (IOCs), since the national oil companies (NOCs) in the Middle East can raise capital on their own. Rather, the problem is that the NOCs need technical assistance and project management skills that only the IOCs possess, but can't seem to work out deals with the IOCs to acquire those human resources. To national pride add the inability of the Saudis and others to protect foreign nationals, and you have an ongoing skills shortage.

There you have it. Demand likely to grow at what the International Energy Agency calls "a breakneck pace," investment in new supplies unlikely to follow suit. That means higher prices for the foreseeable future, and a stick with Kerry can beat the president.

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.

© Copyright 2004, News Corporation, Weekly Standard, All Rights Reserved.

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