As crude prices threaten to cross $50, a debate rages on which way they will move over the long term. The doomsayers say they will stabilise at $70; the optimists argue they will tumble to $15. Outlook examines arguments on both sides of the oil divide.
Up At $70 a Barrel
It signifies the end of what Daniel Yergin, the author of The Prize: The Epic Quest for Oil, Money and Power, describes as “the age of the hydrocarbon man.” For, the era of a global oil glut and low prices is virtually over. The bottomline is: the oil that’s available is limited and even the figure of over a trillion barrels of proven reserves may have been fudged. While nations have a selfish interest in claiming high reserves—known as political reserves to boost their diplomatic clout—oil companies like Shell have admitted that they too have been prone to exaggerations.
In 1987, Iraq suddenly doubled its estimates for no apparent reason, and Saudi Arabia has overstated its production abilities.
Couple this with the realisation that the rate of fresh discoveries peaked in 1962! Based on the Hubbert Curve, designed by M.King Hubbert, a geologist who predicted the 1973 oil shock way back in 1956, experts say that while global demand has increased consistently, no major fields have been found in the past two decades. Colin Campbell, a prominent geologist, predicts that the world is fast approaching ‘Peak Oil’, when we would have achieved the ‘absolute limit’ of production levels of 83 million barrels per day (bpd). Given that the current production is around 80 million bpd, the peak is around the corner as rising demand collides with slowing discoveries.
If one includes the possible supply disruptions in this scenario, crude may even sell for $100. Increased terrorist activities in Saudi Arabia, the world’s largest producer, and the continuing violence in Iraq are obvious problem areas. Other ‘hot spots’ include Nigeria and Venezuela. Not to forget the troubles plaguing Norway and Russia, who together export nearly 11 per cent of the world’s demand. Norwegian workers are demanding high wages and threatening to go on strike, and Yukos, Russia’s second-largest oil producer, says it will halt production unless the deadline to pay its $3.4 billion tax dues is extended.
But won’t high prices offer an incentive to oil majors to look for new sources and restart existing ones where drilling costs are high? A Goldman Sachs report (June 8, 2004) states that a price of $30 is enough to “keep older, high-cost fields cost-effective” as well as “attract the substantial spending required to develop the necessary infrastructure and new supplies.” Another report (August 4, 2004) by Oppenheimer, an investment firm, says that a lower price of $20 is enough for members of OPEC (a cartel of oil-producing nations), whose cost is $5 or below, and to “generate investment returns…for the majority of companies in the oil patch.”
The problem is that the investments required to find new reserves is likely to be much higher than in the 1970s. Goldman Sachs estimates that oil majors (and minors) may have to pump in $2.4 trillion, or thrice their spendings in the 1990s, over the next decade to meet the growing demand.
In addition, oil majors like ExxonMobil and ChevronTexaco are not interested in boosting their exploration and production (E&P) budgets. In 2004, E&P spends are estimated to grow 9 per cent, or less than half the growth witnessed during the years that followed the past jumps in global oil prices. As an analyst in Lehman Brothers puts it, “Companies are listening to what the institutional shareholders want…. Production goal is a secondary goal (for them), if it’s a goal at all.”
Another argument against high prices is that the negative impact on all economies will force governments to take steps to reduce consumption and increase production. Experts say that a $10 increase in oil prices reduces global economic growth by 0.5 per cent. However, studies have shown that a hike in crude prices doesn’t affect economies or their energy usage over a significant period.
In developed nations, there’s a temporary blip, but oil demand continues to show positive growth rates. As far as the newly industrialised countries (NICs) are concerned, demand virtually shoots up. Since prices of almost all commodities rise in line with the increase in crude prices, there’s a transfer of wealth from the rich consuming nations to the poor exporting ones. And the excess earnings allows the latter to buy more oil, even at the high prices.
Down To $15 a Barrel
In 1973, the famous Club of Rome came out with a report (Limits to Growth) in which it predicted that the 550 billion barrels of oil remaining in the world will run out by 1990. Well, crude is still gushing out of thousands of wells, proven reserves have grown, and the world consumed a further 600 billion barrels between 1970 and 1990. At least in the case of crude, doomsayers have always been proved wrong—again and again. For instance, in the 1970s, they said that prices will cross the $100 mark by 2000. And we still have another $55 to reach that point. So, will the dire predictions about continuing high prices be proved wrong this time too? Obviously yes.
The current rise is not really dictated by a demand-supply mismatch, but by growing fears of supply disruptions. For example, any problems in Saudi Arabia will ensure that 10 per cent of gobal production vanishes instantly from the marketplace. Given such political risks (in nations like Saudi Arabia, Iraq, Nigeria and Venezuela), the markets have started increasing the quantum of ‘risk premium’ in crude prices. Today, some experts feel that this premium constitutes over a third ($15) of the selling price. Even the conservative estimate is a figure of 25 per cent. In the past, risk premium, as a percentage of total price, has gone beyond 30 per cent in 1974, 1979, 1987 and 1991—all of them periods of major oil shocks.
Therefore, once these fears go away, prices will plummet. They will fall further because of new oilfields that have been discovered—or are being discovered—in Africa, Central Asia and West Asia. The new oil is likely to join existing supplies in the next few years, and production may go up once Iraq stabilises and Libya becomes an aggressive supplier. Iran, which claims to have huge reserves, may also emerge as an important player in the global crude game. So, the problem in the near future will be that of a glut, not a production crunch.
Consider this scenario. Iraq, with 110 billion barrels of proven reserves, doubles its production from the pre-US attack days. Saudi Arabia, Kuwait and Iran aggressively woo foreign investors to increase supplies. And non-OPEC production grows at just two-thirds the rate it did between 1985 and 1995. If all this happens, argue Amy Myers and Robert A. Manning in their article in Foreign Affairs (Jan/Feb 2000), “oil markets could even be more oversupplied than in 1998—the year prices collapsed to $8 a barrel. To consume all the oil that will probably be pumped out over the next 10 years, world oil demand would need to grow by more than 3 per cent, instead of the 1.8 per cent annual growth rates between 1980 and 1995.”
Yet another piece of good news: technological developments have slashed the cost of drilling oil in older fields, and improved the chances of finding new wells. Here’re some statistics to prove this: production in existing wells has gone up by 25-60 per cent, average US costs of finding new fields has fallen from $15 a barrel in the 1980s to $5, and drillers today are four times as successful in finding natural gas and six times more in oil compared to the situation before the first oil shock of 1973. And don’t forget: the cost of drilling oil in West Asia is still quite cheap, at an average of $5 a barrel.Even the increased costs in the past two years due tighter security measures—like military escorts with oil tankers—adds just another $4.So, a price of $15-20 is still a lucrative one for the region that accounts for the bulk of global supplies.
Contrary to popular belief, high crude prices may not benefit the oil-producing nations. For, such a scenario “portends higher prices in the oil services industry, higher expenditure by oil companies and oil-producing nations, and an asset and cost inflation in oil provinces.” More importantly, past evidence proves that such countries have no idea on how to absorb the excess earnings. Hence, they get riddled with corruption, wastage, and a backlash from an angry public. Also, higher prices force consuming nations to reduce energy intakes. In fact, from 1980 to 1995, states the Foreign Affairs article, “the amount of energy used in the United States per constant dollar of gnp declined from $16.47 to $13.44. Europe and Japan made even bigger gains in efficiency.”