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Derek Brower: Put your own house in order

For a solution to resource nationalism, it’s time to look closer to home By Derek Brower, journalist SO YOU don’t like the way your dealer treats you? You think he’s a bully? He doesn’t respect you? And you simply can’t trust him? Well then stop buying drugs from him. Alas, like any other addict, oil consumers just can’t stop buying their drug. In fact, we buy it in greater quantities every year. Earlier this month, the price of oil hit a new record of $78.77 a barrel (/b). Goldman Sachs, an investment bank, says it will climb to $95/b by the end of the year. The previous record high was last August, at roughly the same time of the month as this year’s. But 2007 is different. Analysts say that while last year’s rally was more about market perception – of coming shortages of fuel and crude stocks, mixed with the threat of disruptions in supply from the Middle East as a result of Israel’s war with Lebanon – this year’s rise is based on fundamentals. “There simply isn’t enough crude in the world right now,” says Manouchehr Takin, an analyst from the Centre for Global Energy Studies. Opec had taken almost 1m barrels a day (b/d) of oil off the market in the last year and while demand has continued to rise, the supply of oil hasn’t. The International Energy Agency (IEA) says that the world will face a dire supply crunch within five years. That’s bad news for consumers. And it is bad news for anyone who wishes to see unsavoury oil regimes become weaker. To execute a policy of resource nationalism is far harder in an era of low oil prices. High oil prices have emboldened leaders like Venezuela’s Hugo Chavez, Iran’s Mahmoud Ahmadinejad and Russia’s Vladimir Putin. High oil prices have never prompted the elites of oil producing countries to start cleaning up their rampant corruption or start fixing the structural problems in their societies. So what should consumer nations do about this? Should they push Opec to pump more oil? Hardly. First, it is not in Opec’s interest to increase output. Theoretically, Opec has as much at stake as consumers when it comes to keeping the oil market well balanced. Too low a price and their countries lose valuable hard currency receipts. Too high a price and Opec risks seeing demand for oil fall. Once bitten, twice shy But right now, Opec thinks the market is ticking along nicely. “There is good balance between supply and demand,” Ali Naimi, Saudi Arabia’s oil minister, said last month. And Opec is wary about what happened last year. After 2006’s August rally, market hype persuaded Opec to increase supply and promise that more oil would be available if the market needed it. Prices fell by nearly $25/b between August and January. The analysts say that this year the market is different. But Opec is hardly going to fall for the same rhetoric again. And in historical terms, this month’s “record oil price” is still some way off the true highs of 1981, when it is adjusted for inflation. Then, oil traded at $101/b in real terms. That prompted worldwide recession and a decade of relatively weak demand growth for oil. But as the statistics from the IEA show, demand over the past few years has continued to rise with oil priced between $50/b and $78/b. That means prices aren’t yet too expensive. But the real reason that consumers shouldn’t expect Opec to rescue them is that it isn’t Opec that is driving the market. True, Opec could pump more oil. How much spare capacity it has is debatable. Iran and Venezuela, the two most hawkish Opec members, are generally considered to be already pumping at near maximum capacity. Between them, Nigeria and Iraq have millions of barrels of oil a day that could be produced but aren’t. But changing that situation quickly would rely on a series of large miracles. Outside of Saudi Arabia the amount of spare capacity Opec has to call on is questionable. And the cartel says it is fulfilling its part of the bargain. Last month, Opec’s statistical bulletin showed that the group’s rig count (336 in 2006), the number of rigs it has at its disposal to use for extracting oil and gas, was the highest in its history. And the year-on-year growth (11.6% more rigs in 2006 than 2005) is greater than for the countries outside of Opec. The number of wells completed in Opec countries in 2006 was 15% higher than in 2005. Outside of Opec, the figure was 9.4%. Those statistics are as much of an indication of upstream spending that Opec ever offers; and they show that high oil prices are pushing more exploration for oil and gas within the group. Stop blaming others Rather, what is driving the market is what is happening inside the consumer countries. Rising demand is one market fundamental. The EIA says world demand will rise by another 2.5% in 2008, to 88.2m b/d. At the same time, many of these countries – be they dwindling oil provinces like the UK or underperforming ones like Opec-member Indonesia — aren’t producing enough oil of their own. Brazil, a significant consumer in its own right, was expected to increase output by around 200,000 b/d this year. The number was closer to 40,000 b/d. Non-Opec production simply hasn’t materialised as expected. But there are still other factors. The main one is refining capacity in the US. It isn’t adequate, so when demand for oil products rises, as it has done over the summer, bottlenecks arise in the refining process. Earlier this year that was exacerbated by a series of accidents of God that shut down refining capacity. In turn, that puts pressure on refiners to buy the right kind of oil to process, increasing the price of West Texas Intermediate on world markets. Or they buy products that have been refined elsewhere, pushing up prices for crude somewhere else. “There is a total disconnection in the crude markets,” says Stephen Schork, a former trader and now head of the Schork Report. The market has been led higher by the shortage of refining capacity in the US. “Crude has just been along for the ride.” And then there’s speculation. Opec says that “speculators” are pushing up prices. And its spokesmen point to US inventory data as proof that no physical shortage of oil exists at the moment. Last week US stocks fell sharply by 6.5m barrels to 344.5m barrels. Opec considers anything above 300m barrels in US inventories to be ample. Even the US’ own department of energy says that that is sufficient. Instead, argue some analysts, it is investors who are supporting the market. Pension, hedge and investment funds have been buying heavily into oil for several months. Schork says that last month for every barrel of crude sitting in storage in the Cushing, Oklahoma storage hub, investors were holding five futures contracts. Their importance to the market is two-fold. First, their buying has hardened the bull run of the last few years. And second, their position in the market makes producers like Opec even more worried about a collapse. The last thing the cartel wants to do is spook the speculators into shorting oil. Dissecting the oil price into speculation, geopolitics, supply and demand fundamentals or any other factor is a mug’s game. But whatever Opec is saying the curve of the oil futures market, which has moved from contango (where a premium is placed on oil to be delivered in future) into backwardation (where a premium is placed on oil to be delivered promptly) this summer, is a classic indication of scarcity, say analysts. Asking producers to change this situation, however, is pointless. Much of the strength of the oil price is down to the actions of consumers. If Western democracies truly wish to take heat out of the oil market – and deprive many corrupt regimes of their lifeblood – then they should stop asking Opec for more oil and start taking actions themselves. Building new refineries, for example, is a less dramatic energy policy than invading a foreign country, but it would serve US strategic interests. So would steps to curb demand for hydrocarbons. Climate change, conflict in the Middle East and the aggressive actions of oil producers are all indirect results of the world’s ever-greater addiction to oil. They will all continue if the oil addicts don’t look at their own behaviour. Record oil prices this month should be the occasion for consumer governments to start taking serious steps to break their addiction. Make oil cheap again – not through over-supply but through under-demand. www.derekbrower.com