Oil Towards $75, Again

There is an “economic” side of oil prices, a real one and a silly one.

The economic side which does not work in an increasingly hostile and, at least partially, monopolistic environment, suggests that the “equilibrium” price of oil should be about $40. This is now purely academic and my students, associates and I have been calculating this for a while. This price could be good if the world oil business were run by all the rules of economics in a perfect competition. It would be the “break even” number, the price at which an honest profit could be made.

Even then, such a price, in a highly heterogeneous oil word because of just the kind of oil reservoirs and the physics of production, let alone government regulations and environmental concerns, would be the statistician’s definition of well being: your head is in the oven, your feet are on ice but on the average you are comfortable.

The silly side of oil prices is what one can read daily in Bloomberg or Dow Jones wire as in: “Oil tops $72, a10-month high, on Nigerian arrest, US refinery shutdowns” (Bloomberg July 5, 2007). Please…I have often wondered who is behind newswire slogans. I guess they have to find a reason for just that day.

Oil prices, of course, have a real and underlying fundamental basis and this basis has both physical and, especially, geopolitical dimensions. The US continues to increase its oil demand, global warming and alternatives rhetoric notwithstanding. It has become a constantly enlarging target. Ten years ago we were using a little over18 million barrels per day, importing about 46% of that. Now we use almost 21 million, importing 60%. China has gone berserk, with India not far behind. There has never been a country in the history of humankind that increased its oil demand by 20% per year and China did it three years in a row a couple of years ago. This happened while OPEC went from a demonstrable 10 million barrels per day excess capacity 15 years ago to, maybe, a million today, all in Saudi Arabia. This is not to say that OPEC countries cannot produce more. Far from it. The talk of peak oil is quite premature. But make no mistake. They like $75 oil, US friends or foes alike.

I started forecasting the price of oil in April 1999 and I suggested then in an OpEd in the Houston Chronicle that the price of oil was going to hit $30. Lest one thinks this was nothing short of hubris, that day the price of oil dropped to $10, because of the “Asian flu”, an event that did not really reduce oil consumption, just the expected increase. The Economist magazine, not unlike so many other wrong forecasts, just two weeks apart from mine, published a now infamous cover story where they raised the specter of $10 oil through the end of the decade and even suggested $2 oil. I missed my forecast by two weeks. The price of oil hit $30 in January 2000, and hasn’t looked back since then.

But what keeps the price of oil high first and foremost are geopolitical headlines fueled by the energy militants: Hugo Ch??¡vez in Venezuela, the Iranian mullahs, and decidedly Russia under Vladimir Putin. At $75 oil, Ch??¡vez is an 800 pound gorilla. Even at $60 oil, he’s reduced to a monkey. None of them can afford to see the price plunge. Their rhetoric and their political survival depend on high oil prices. One can correlate the price of oil as a function of Iran’s pronouncements on nuclear enrichment, Ch??¡vez constant posturing and Bolivarian impersonations and Putin’s re-Sovietization. There is again an underlying real issue: the shutting off of major multinational oil companies from these countries’ reserves. In spite of record profits I would be quite worried about the future of these super-giant companies had I been sitting in their boardrooms.

And yet we are still lucky. First, the price of oil is still lower than it has been in the past not only after inflation is considered but also after an even more profound adjustment is made, using something we called the “energy intensity”: how much energy is needed to raise one dollar of GDP. This has been going down constantly, less than half of what it was in the 1970’s. Oil prices are not high enough to hurt an economy that has expanded enormously.

But we are even luckier that other, far bigger headlines haven’t happened yet. We are constantly one of these big headlines away from easily $100 oil such as “Israel attacks Iran and its nuclear facilities”, “Al Qaeda manages to disrupt Saudi oil production”, “Ch??¡vez abandons Citgo and no longer sells oil to the United States.”

In the meantime let’s be thankful for $75 oil.