September 2004
Cheap Oil Prices May Be Over
Cheap oil prices may be a thing of the past. Uncertain supplies from Iraq, hurricanes in the US and increased usage in China have all helped push up the price of oil.
John Browne, CEO of BP Plc, said the era of cheap oil may be over because of tensions in the Middle East and persistent growth in demand.
“It is unlikely that we will see the weak prices of the 1990s ever again,” said Browne in an interview in Vienna, where OPEC is sponsoring a conference on energy markets. “Prices will be higher.”
Oil prices in New York surpassed $49 a barrel in August, a record in more than two decades of futures trading, as demand surged and supplies were disrupted from Iraq, holder of the world's third-largest oil reserves. In 1998, Opec flooded the market as demand slowed, sending oil to a low of $10.72 a barrel in December of that year. New York crude averaged $19.71 a barrel in the 1990s.
BP, the world's second largest publicly traded oil company, raised its forecast for oil prices earlier this year when assessing the viability of new projects.
Lee Raymond, Chairman of Exxon Mobil Corporation, speaking at the same conference, said OPEC and other oil producing countries need to open more land to exploration to meet an expected 50% increase in demand in the next three decades. He said he isn't sure oil prices will be persistently high.
“Whether or not there has been what has been described as a ‘paradigm shift’ has yet to be seen,” Raymond said. “We’ll only know the answer to that in hindsight.”
Restraining spending
After adjusting for inflation, oil prices remain a fraction of those seen during the shocks of the 1970s and 1980s. Oil would need to surpass $70 a barrel to match the levels of June 1981.
As prices surge, oil and gas companies are restricting growth in capital spending, instead giving extra cash to shareholders through stock buybacks and higher dividends.
Browne said violence in the Middle East, especially in Iraq, significantly contributes to current oil prices. Oil producers worldwide have about 1 million barrels of idle production capacity, he said. That amount is less than what comes from Iraq, where sabotage has slowed output.
New exploration
Saudi Arabia, Iran and Kuwait, which hold 40 % of the world's oil, prohibit foreign companies from owning energy reserves, which their governments consider national resources.
Some countries, including Saudi Arabia, rely on their national oil companies for drilling. In contrast, countries such as Qatar have formed partnerships with international oil companies who provide cash and technology.
On Wednesday, OPEC raised its output quota by 1 million barrels per day (bpd) to 27 million bpd as of 1 st November, after two past increases failed to halt this year's increase in prices.
“I wouldn't be surprised if we see a weakening of demand given these high prices,” Browne said. “It concerns me if it damages the world economy.”
Global economic slowdown
Experts agree that higher oil prices are negative for economic growth, especially for countries which are heavy oil importers.
As prices rise, consumers become more cautious and profits fall. Countries' exports decline and trade deficits rise.
In fact, America's Federal Open Market Committee attributed economic softness to the “substantial rise in energy prices” when it met last month.
The International Monetary Fund has suggested that a permanent $15 a barrel oil price hike would reduce the level of GDP by 0.6% in the first year and 0.9% in the second and third years.
How bad will it be?
Some analysts argue that the impact could be less severe than expected.
The strength of the euro and the yen against the dollar have softened the impact of higher oil prices on the European and Japanese economies, said Dr Zain, Senior Energy Analyst at the Centre for Global Energy Studies.
Many OECD (Organisation for Economic Co-operation and Development) countries have become more energy efficient and some have even reduced their reliance on oil by investing in sustainable technologies, he added.
HSBC argues that as much as 80% of the rise in prices can be attributed to growing demand. This reflects domestic investment growth in certain countries, particularly China and India, and as such, is less damaging for economic growth than a rise solely attributed to falling supply.
But such an analysis, which suggests a muted impact on economic growth, is weakened by the fact that prices are now being driven higher by reports of uncertain supply, interrupted refining due to recent hurricanes and falling stockpiles of commercial crude oil.
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