Here is another opinion: "Oil Boom and Doom"
smartmoney.com
THE PRICE OF crude oil rose above $47 a barrel Wednesday in trading on the New York Mercantile Exchange, setting yet another record and inching toward $50.
The reason for the surge? Take your pick. There's the war in Iraq, the battle in Najaf and attacks on critical pipelines in the south of the country. There's the legal imbroglio of Russian oil giant Yukos. And there's the "situation in Venezuela," a catchphrase for uncertainties surrounding President Hugo Chavez and his stance toward his country's nationalized oil company, Petroleos de Venezuala.
More important, however, is the realization by oil traders that global refining capacity, in the face of heightened demand driven by economic growth, has suddenly maxed out. That has neutralized the traditional strategy used by the Organization of Petroleum Exporting Countries — incrementally increasing production, usually in Saudi Arabia — to moderate the price of oil.
And it means the price of oil won't be coming down any time soon, says oil expert Philip Verlanger, senior fellow at the Institute of International Economics and founder of economic-consulting outfit PKVerlanger LLC. Verlanger thinks the only thing that will bring down the price of oil is, unfortunately, a recession. And that recession, he says, could be global.
"I'm afraid it's going to take a fairly serious recession to bring prices down," Verlanger says. "A drop in U.S. and global demand. In time, higher prices will cut consumption some. But what it's really going to take is a global economic slowdown."
SmartMoney.com recently talked with Verlanger about the crippling rise in oil prices. We discussed whether oil could hit $50 a barrel, how the current situation reminds him of the early 1970s and whether President Bush should consider opening up the U.S. Strategic Petroleum Reserve (SPR).
SmartMoney.com: Last week, Saudi Arabia said it would pump an extra one million barrels a day, and the price of crude rose. That should have us worried, right?
Philip Verlanger: We should be very worried. The price of oil depends on the ability to process the crude into products that you and I can consume. We have some refinery constraints around the world right now that are pretty tight. What that means is that the incremental increase in Saudi crude can't do much good. There are serious refining constraints. The Saudis can announce what they want to announce, but we have a tightness in product markets. There's also a very tight heating-oil market in Europe, and it's not clear that it's going to clear up anytime soon. The other part of the problem is kind of unnoticed. The forward price of oil in say two or three years has risen very dramatically. If I'm a Japanese buyer and I'm worried about future oil prices — the Japanese have done this in the past — I can go buy on the futures market and hedge my costs. The December 2006 crude-oil price settled at $38.08. If I just look back a year ago, the December 2006 contract was at $24.67.
SM: So the market is saying this is a long-term trend.
PV: Yes. There are buyers who are very worried about capacity constraints, and this has become a real problem.
SM: Part of that reaction to the Saudi announcement was based on speculation that the quality of the new Saudi oil was poor, right?
PV: That gets back to the refining constraint. Companies like Shell (RD, SC) have refineries in the Gulf Coast that can take the world's worst crude and convert it into very clean gasoline. But there's no more capacity. Those units are full.
SM: A recent analysis by research group Petrologistics showed that Saudi production actually declined to 9.13 million barrels a day in July from 9.52 million a day in June. How surprising is that?
PV: Their production probably went down because they couldn't find ships to move it and probably because the buyers weren't out there to buy it. Right now, there's a premium on the light crudes that produce a lot of the gasoline. Those are being bid up, and the Saudis are producing all the light crudes they can. Their incremental production is the heavy variety that no one wants. Also, some of the refineries are being shut down to be retooled. The Europeans are introducing rules requiring sulfur to be cut dramatically, and the refineries have to shut down to accommodate that.
SM: A lot of experts are forecasting $50 per barrel in the coming months. How likely is that?
PV: I think we could see $50. If one steps back and looks carefully at the situation, the world energy balance today is as precarious as it was in the fall of 1972 or the spring of 1973. We're short of refining capacity. There is rapid [demand] growth. The energy crisis of 1973 came because we'd had several years of 5% global growth in petroleum demand. We were running into problems with getting enough clean fuels. The situation has an awful lot of similarities. So I think it's quite possible that we'll see $50 barrels of oil, and it's not out of the question that we could see $60.
SM: That sounds pretty troubling, considering that the oil crisis triggered the stagflation economy of the 1970s.
PV: To say that we're going to go to stagflation is probably wrong. I've done some macrosimulations, and what you see is much slower growth because of oil, and probably a recession next year. The reason is this capacity constraint. The macroeconomists keep saying that higher oil prices do not have the impact on the U.S. or world economy that they used to. The rule of thumb for the U.S. is that $10 a barrel cuts U.S. GPD by three-tenths or four-tenths of a percent. But when you don't have any more oil, and you need more oil to grow, the question then becomes, how large a price increase do you need to stop economic growth? If $10 doesn't do it, maybe we get $20, if $20 doesn't work, maybe we get $30. So certainly I think that $50 is in shooting distance.
SM: What do you think the surging price of oil could do to China's economy, which has been greased by relatively cheap fuels?
PV: It slows the Chinese growth. The Chinese are running a huge trade surplus with us. Clearly, the dollars they receive from selling us the goods you buy at Wal-Mart (WMT), they use to buy oil. The Chinese could certainly cover their oil import needs by selling some of the U.S. bonds they've bought. The Asian countries have been huge buyers of U.S. Treasurys. That would be a major problem. In some ways, that's a perfect economic storm.
SM: What might happen to make the price of oil fall? Will the end of the summer driving season have any significant impact?
PV: No. If we were to suddenly park all of our SUVs, that would help. But that's not happening. I'm afraid it's going to take a fairly serious recession to bring prices down. A drop in U.S. and global demand. In time, higher prices will cut consumption some. But what it's really going to take is a global economic slowdown.
SM: Should President Bush consider opening up the Strategic Petroleum Reserve if prices go much higher?
PV: I fell on my sword back in January arguing that our policy [concerning the SPR] had added $7 or $8 to the price of crude by squeezing inventories. It wouldn't do much good right now unless they released light crude. If they released light crude, that would do some good. It might also bring prices down for a while because you'd create some margin calls for all the oil-futures positions that are held by all these foreign buyers. That has historically worked. But [then] Governor Bush criticized President Clinton strongly back in September 2000 for using the SPR, so he's kind of tied his hands.
SM: The Fed blamed the slowing of the U.S. economy on the high price of oil. But the Fed also has predicted that growth will accelerate, implying that oil will get cheaper in the next few months. How reliable is that forecast?
PV: You're going to have to ask them. I've been scratching my head trying to figure that one out. |
