The Blog

Anti-Gravity and Oil Prices

OPEC has kept the price of oil above $28 for some time; there are a host of reasons it won't be coming down anytime soon.

11:00 PM, Dec 15, 2003 • By IRWIN M. STELZER
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THE PRICE OF OIL has jumped about 7 percent in the past two weeks. Under ordinary circumstances, and for most commodities, volatility comes as no surprise and is of little consequence. But oil is different. For one thing, its price is affected by a powerful cartel, OPEC, that tries to lock in price increases. For another, it is so crucial to the functioning of industrial economies that past price jumps have thrown America and, in some cases, the world, into protracted periods of sub-par growth.

The major consuming countries long ago decided to acquiesce in the producing nations' cartel behavior. In return, OPEC informally agreed to cap oil prices at around $28 per barrel. Never mind that over $20 of that price constitutes profits to the Saudi royal family and the typically unsavory rulers of other countries that sit atop the world's oil reserves. Industrial countries figured that so long as prices stayed below the cartel cap, their economies would be able to grow at reasonable rates.

But a funny thing happened on the way to the promised land of a $28 price cap--prices have hit around $32, and stayed there. The cartel's managers blame the decline in the value of the dollar. Oil is traded in dollars, and the dollars that the producers are getting buy fewer of the baubles that Arab princes fancy in London's Harrod's department store and the watering holes in the South of France. So to maintain their purchasing power, the Saudis and their cartel partners are preventing production from rising to bring prices down to the agreed ceiling.

Several other factors have converged to drive up crude oil prices. Start with the demand side. The economic recovery in America is stimulating demand as more trucks deliver more goods to factories, warehouses, and stores, while a cold snap drives up the demand for heating oil. Add in low inventories, and you have a prescription for higher prices.

More important, China's thirst for oil seems to know no slaking. Imports are running 30 percent to 40 percent above last year's level, according to the latest report from the International Energy Agency, and China has displaced Japan as the world's second largest consumer of oil, behind the United States. China now accounts for about one-third of the annual increase in worldwide demand for oil.

Infrastructure constraints are preventing demand from growing even more rapidly. Electricity is being rationed, forcing some manufacturing plants to shut down one day each week. Petrol and diesel are in such short supply that the government has introduced rationing and refiners are raising prices in defiance of government price ceilings. Forecasters at the Development Research Center, a Chinese think tank, are guessing that the number of cars in China will quintuple to 100 million (about half the U.S. total) in the next 10 years. The International Energy Agency expects China to be importing 10 million barrels per day by 2030, which is about what America currently buys from the world's producers. It now looks as if Warren Buffett had it right once again when he snapped up 13 percent of the shares of state-owned PetroChina.

DEMAND GROWTH would not be putting such pressure on prices if supply could be expected to grow commensurately. But it most likely won't. OPEC is already producing more than its stated quota, and so is in a position to cut output at the first sign of price weakness. Hopes that Iraq will soon return to world markets in a significant way are repeatedly dashed. One reason is the sabotage of pipelines needed to get Iraq's oil to market. More important in the long run is the fact that the damage to that nation's oil fields from years of neglect during Saddam's rule is more serious than at first thought and will take billions of dollars (and time) to repair before Iraq can add substantially to world supplies. Indeed, at present the Iraqi oil industry cannot even meet domestic demand for petrol, diesel oil, and heating oil.

Nor will relief come from Venezuela, where a Castro-loving president has reduced the industry's productive capacity by slotting his political cronies into top executive positions. Or from Africa: Human rights groups are urging western oil companies to shun Sudan; thousands of troops have been unable to prevent crooks from siphoning more than 100,000 barrels per day from Nigeria's pipelines, adding to the chronic chaos that afflicts that country's industry.