Monday, September 27, 2004

My Favorite Subject (but I know it bores everyone else).

Oil futures hit just under $50/bbl today ($49.8?). I predict the price will exceed the important "psychological threshold" of $50 later this week. The Houston Chronicle had another good article about what is driving oil prices in Sunday's paper.

Sept. 25, 2004, 12:57AM
Needed: three 1-billion-barrel oil banks

The oil market is losing its shock absorbers.
It's too early to celebrate the recent decline in oil prices after they nearly hit $50 a barrel. None of the reasons that created the price spike -- the strong thirst for crude in China and India, the dismemberment of the Russian oil giant Yukos, the terror strikes against oil facilities in the Middle East -- has gone away. Like the hurricane season in Florida, the oil market may be facing even more violent storms.
The lesson from the recent price jump is that the oil market has too little wiggle room to deal with supply disruptions. We have been told for years that such disruptions could be offset by the spare capacity of the 11-member Organization of the Petroleum Exporting Countries -- the ability of some producers, chiefly Saudi Arabia, to inject extra oil into the market when other suppliers falter.
This spare capacity has been the oil market's main source of liquidity.

Despite Saudi Arabia's reassurance that it possesses an immediately available spare capacity of 1.3 million barrels a day and is accelerating plans to bring new oil fields into production, this is all too little, too late. Demand for OPEC crude will rise by at least 2 million barrels a day by the end of next year, and production from new fields might take a long time to be brought online.
At the same time, no oil-producing country outside of OPEC seems to be willing to create new spare capacity by investing billions of dollars in oil infrastructure that would sit idle most of the time. At about $45 a barrel, oil countries prefer to cash in as many petrodollars by producing at full throttle.
As a result, the oil market today resembles a car without shock absorbers: The tiniest bump on the road can send a passenger to the ceiling.


However, according to Luft "there is another way."
To compensate for the erosion in OPEC's spare capacity, major oil consuming countries should take steps to insulate their economies from supply disruptions by creating liquidity mechanisms of their own.
At its current capacity of 700 million barrels, the U.S. Strategic Petroleum Reserve, or SPR, barely suffices to tide the U.S. economy over if there is a severe disruption of oil supplies.
While certainly costly in the short term, expanding each of the U.S., European and Asian strategic reserves to contain 1 billion barrels would have the long-term benefit of keeping the market liquid. The stored oil could be released at will to compensate for supply reductions.
An expanded SPR also would signal to OPEC that the oil weapon can no longer be used against oil-consuming countries.

There is much to be done to make the world less dependent on oil originating from unstable parts of the world by building more efficient automobiles and producing next-generation fuels to power them. But this will take many years.
In the interim, the world economy should not be at the mercy of oil kamikazes determined to go for its jugular and unstable countries.
Building a robust oil bank and managing it responsibly is the only short-term mechanism to bring about stability at gas stations.
Without such a mechanism, $50 a barrel for oil could well become a fond memory.

Personally, I am deeply cynical about the possibility of humans, and especially democratically-elected governments (or the Bush Administration for that matter), to act in a proactive manner for the benefit of the economy as a whole. Without a discernable near-term political advantage, no government will make a move, especially one for the "greater good of the populace", but also one that might hurt a specific campaign contributor. Consequently, I would bet the farm that oil prices are going higher - much higher.