Why high oil prices are failing to raise the flow

Analysts say the world is not running out of oil, but rather oil production capacity
Jad Mouawad, Straits Times 30 Apr 08;

AS OIL prices soared to record levels in recent years, basic economics suggested that consumption would fall and supplies would rise as producers drilled for more oil.

But as prices flirt with US$120 a barrel, many energy experts are becoming worried that neither seems to be happening.

Higher prices have done little to suppress global demand or attract new production, and the resulting mismatch has sent oil prices ever higher.

That has translated into more pain at the pump. Experts expect prices above US$4 a US gallon this summer, and one analyst recently predicted that gasoline could reach US$7 in the next four years.

A central reason that oil supplies are not rising much is that major producers outside the Opec cartel (like Russia, Mexico and Norway) are showing troubling signs of sluggishness.

Unlike the Organisation of the Petroleum Exporting Countries, whose explicit goal is to regulate the supply of oil to keep prices up, these countries are the free traders of the oil market, with every incentive to produce flat-out at a time of high prices.

But for a variety of reasons, including sharply higher drilling costs and a rise of nationalistic policies that restrict foreign investment, these countries are failing to increase their output. They seem stuck at about 50 million barrels per day (bpd), or 60 per cent of the world's oil supplies, with few prospects for growth.

'According to normal economic theory, and the history of oil, rising prices have two major effects,' said Fatih Birol, the chief economist at the International Energy Agency (IEA), a group in Paris that advises industrialised countries. 'They reduce demand and they induce oil supplies. Not this time.'

With tight global supplies, geopolitics continues to play a big role in pushing up oil prices.

On Monday, oil futures closed at US$118.75 a barrel, up 23 cents, on the New York Mercantile Exchange, after strikes by oil workers in Scotland and Nigeria that shut down nearly 1.7 per cent of the world's daily production.

Countries outside Opec have been the main source of production growth in the past three decades, as new fields were discovered in Alaska, the North Sea and the Caspian region.

But analysts at Barclays Capital said last week that non-Opec supplies were 'seemingly dead in the water'. Goldman Sachs raised similar concerns in March, saying that growth in non-Opec supplies 'can no longer be taken for granted'.

At the same time, oil consumption keeps expanding. Global consumption is forecast to increase by 1.2 million bpd this year, to 87.2 million bpd, with much of the growth in demand coming from China, India and the Middle East, according to the IEA.

Reduce consumption

In the United States and through much of the developed world, the higher fuel prices have led drivers to reduce their consumption, and gasoline demand is expected to drop this year.

But that drop will be more than offset by the rise in energy demand from developing countries. In the next two decades, demand is projected to jump by 35 per cent, and developing countries will consume more oil than industrialised countries.

Higher oil prices mean record profits for oil companies that have, to some extent, masked the supply problems. Exxon Mobil and Chevron are both expected to deliver knockout performances when reporting quarterly earnings this week, even as they struggle to increase production.

'What is disturbing here is that things seem to get worse, not better,' said David Greely, an analyst at Goldman Sachs. 'These high prices are not attracting meaningful new supplies.'

The outlook for oil supplies 'signals a period of unprecedented scarcity', Jeff Rubin, an analyst at CIBC World Markets, said last week. Oil prices might exceed US$200 a barrel by 2012, he said - a level that would very likely mean US$7-per-US gallon gasoline in the United States.

Some regions are simply running out of reserves. Norway's production has slumped by 25 per cent since its peak in 2001, and in Britain, output has dropped 43 per cent in eight years. Production from the giant Prudhoe Bay field in Alaska has dropped by 65 per cent from its peak two decades ago.

In many other places, the problems are not located below ground, as energy executives like to put it, but above ground. Higher petroleum taxes and more costly licensing agreements, scarce manpower and swelling costs, as well as political wrangling and violence, are making it harder to raise production.

'It's a crunch,' said J Robinson West, chairman of PFC Energy, an energy consulting firm in Washington. 'The world is not running out of oil, but rather it's running out of oil production capacity.'

Mexico, the second-biggest exporter to the United States, seems increasingly helpless to find new supplies to offset the collapse of its largest oil field, Cantarell. A combination of falling production and rising domestic consumption could wipe out Mexico's exports within five years.

Foreign investment could help Mexico produce oil from deeper waters, but that is a controversial proposition in a country where oil has long been seen as part of the national patrimony.

Another country, Russia, is also a focus of analysts' worries. The country is not exactly running out of places to look for oil - a huge chunk of eastern Siberia remains unexplored - and the country has been the biggest contributor to the growth in energy supplies in the past decade.

But Russian energy officials warned recently that the days of stunning growth that followed the collapse of the Soviet Union were over, as the country focuses on stabilising its output. Russia today produces about 10 million barrels of oil a day, up from a low of 6 million bpd in 1996.

The Russian government has been muscling Western companies to gain more control over its energy resources. That rise in energy nationalism could freeze new investment and slow down any meaningful growth in supplies there for years.

As countries like Russia slow down, analysts say Opec will have to pick up the slack. The oil cartel accounts for 40 per cent of the world's oil exports and owns more than 75 per cent of global reserves.

But there are serious concerns that Opec will also find it tough to boost production.

Saudi Arabia, the world's top oil exporter, is completing a US$50 billion plan to increase capacity to 12.5 million bpd, but it signalled recently that it would not go beyond that. That means Saudi Arabia could fall short of the 15 million bpd that most experts had expected it to produce in the long run.

Opec's 13 members plan to spend US$150 billion to expand their capacity by 5 million bpd by 2012. But Opec will need to pump 60 million bpd by 2030, up from around 36 million bpd today, to meet the projected growth in demand.

Analysts say that without Iran and Iraq - where 30 years of wars and sanctions have crippled oil production - reaching that level will be impossible. -- NYT