Economics, Demography & Oil
What’s Going On?
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10/14/04
1
Oil and the Middle East:
Four Possible Questions
Does 9-11 explain recent oil market moves?
Do the current problems in Iraq explain the oil
market?
Is the world going to be more dependent upon
Middle Eastern oil?
What will this mean for U.S. Middle East Policies?
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2
1999: Year of Change
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3
A Closer Look: Weekly 2002-2004
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4
Moving into the 40’s
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5
Oil is different because it is
‘Strategic’
Modern economies require oil
Modern military power requires oil
States intervene when dealing with
oil because price volatility creates
distrust of markets and politicians like
to claim “solutions”
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6
Historical Notes
Churchill and Admiral Fisher—don’t
depend on coal and the politics of coaling
stations
GB Invests in the D’Arcy Concession—
Anglo Persian Oil (now BP) is formed
Lawrence overturns the Mid East in WWI
and oil becomes the currency of Middle
East Geopolitics
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7
Oil and the Cold War
The “Dark Side” of Cheap Oil
U.S. begins from a position of ‘independence,’ but gradually
becomes a significant importer of oil (after 1971)
The Soviet Union’s interests in the Middle East during the Cold
War become the context for ‘resource nationalism.’ (Libya) US
loses its absolute control over Middle East Oil, but not its
interest in a stable oil supply
OPEC tries to regulate oil prices but the cartel is unstable in the
face of burgeoning non-OPEC supplies. Saudi Arabia then
imposes “discipline,” and oil falls below $10/barrel in 1986
undermining longer term reserve development
The Soviet oil industry collapses under the price pressure and
revenue losses hasten the collapse of the entire Soviet state
“Energy Independence” in the U.S. falls by the wayside but
lingers as a continuing political theme
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8
The Post Cold War Oil Market
From the end of the first Iraq War until 1996, crude oil rises
from about $20 to over $25 with a pit stop at $15 in 1993
The US economic “boom” begins after the Mexican Crisis
(1994) and oil moves above $25
With the Asian Crisis of 1997, falling world aggregate demand
conditions push oil downward toward $12/barrel, again
undermining new capacity expansion.
After the Russian default (September 1998), oil essentially
triples to an unsustainable $37/barrel during the Tech Boom
In the Bust of 2001, oil collapses once again, climaxing with the
9-11 attack driving down consumption, but the US recovery in
2002 moves oil up again, this time over $50
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9
Government or Markets?
Understanding Recurrent Themes
Oil demand is price inelastic and for fast growing economies,
highly income elastic
Over time, new sources of oil become harder to find and more
costly to develop
If oil were strictly a ‘market commodity,’ oil supply would be far
more responsive to expanded demand conditions, but oil is a
‘strategic resource’
Sources of ‘cheap reserves’ are under government control,
making it virtually impossible for private companies to ignore
governmental policies regarding oil supply development
The SPR undermines private incentives to hold private
inventories (the law of unintended consequences) creating
conditions for even more price volatility
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10
Crude Oil isn’t the Only Thing
petroleum products are the ‘inflammables’
‘Crisis’ not only about crude supply but about the supply of
refined products. Can have adequate crude and inadequate
product supply, but high product prices invite bad policy
Refined product supply very affected by NIMBY sentiment
Balkanization of gasoline supply reflects our Federal system
The US has insufficient ‘cracking’ capacity to use cheaper
heavy, sour barrels. Why is refining an area of
‘underinvestment?’
US energy policy is political parochialism in extremis. Supply
expansion or demand restriction? Which party wins in
November?
Only a crisis will stimulate political cooperation but usually the
wrong policies are chosen
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11
Demographics of New Oil Demand
New Sources of oil demand growth include China and India
See next slide
China is responsible for some 40-50% of additional demand
Other Asian Demand is also rising (India, Korea, etc)
Oil demands include transportation fuels and space heating (or
power generation). Oil demand in the emerging markets is
highly income elastic and petroleum products are used less
efficiently than in the developed countries
These sources of new demand are likely to continue rising
Oil price instability leads these governments to adopt State-run
oil reserve holding (adding to demand) but undermining a
market based solution
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12
New Demands
Annual World Oil Demand Growth
Million Barrels per Day
3.0
History
2.5
Forecast
2.0
1.5
China
1.0
US
0.5
0.0
-0.5
19911999
Average
2000
2001
2002
2003
2004
2005
Source: EIA, Short-Term Energy Outlook, September 2004.
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13
Why Can’t the Market do the Job?
Vicious Circles!
Private Inventory Holding and the SPR
New Government ‘strategic reserves’
The financialization of oil markets
Risk sharing and uncertainty
Government can create uncertainty and undermine
markets by state reserve-holding
Financialization plus insufficient ‘excess capacity’
produces additional price volatility
Price volatility produces more political intervention
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14
Why Are Prices More Volatile This Time?
economists: no spare capacity
prices have upside volatility when
excess capacity drops below a critical
value (3mb/d). See slides 16-17-18.
financialization: futures are heavily
influenced by traders and the marginal
barrel is priced this way
Financial optics attract bad politics
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15
Excess Capacity Problem
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16
Spare Capacity and Pricing
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17
DESPITE ‘DEBATES’ PROBLEMS
WILL REMAIN
WTI Spot Price, 2004 – 2005
Implied Equilibrium Around $40
Significant OPEC Production Growth Is
Required in 2004 and 2005 to Balance Demand
50
3.0
Stage 2 – “OPEC Loses Control”
45
40
35
2.0
1.5
Annual Oil
Demand
Growth
Annual Non-OPEC
Production Growth
$/Barrel
30
25
20
15
1.0
10
Sources: History: EIA; Projections: Short-Term Energy Outlook, September 2004.
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Nov-05
Sep-05
Jul-05
2005
May-05
2004
Mar-05
2003
Jan-05
2002
Nov-04
2001
Sep-04
2000
Jul-04
0.0
May-04
0
Mar-04
5
0.5
Jan-04
Million Barrels per Day
2.5
Source: EIA, Short-Term Energy Outlook, September 2004.
18
New Oil Supply is a long run
proposition subject to politics
(“all politics are local”)
Alaskan North Slope
Gulf of Mexico
Territories of the Former Soviet Union
West Africa
Venezuela
Brazil
Libya
PG countries including Iraq, Iran and Saudi Arabia
Global Warming and the Green Movement
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19
Oil and the Middle East:
Four Possible Answers
Does 9-11 explain recent
oil market moves?
Do the current problems
in Iraq explain the oil
market?
Is the world going to be
more dependent upon
Middle Eastern oil?
What will this mean for
U.S. Middle East
Policies?
ECOMENTARY
www. ecomentary. com
9-11 heightened fears of
terrorism, creating
“uncertainty” but not
fundamental
Only superficially. Key is
expanding capacity
Yes, because it is the
cheapest barrel and the
reserves are known
Inevitably, the geopolitics of
energy cannot be avoided
20
“oil is a greasy business”
Calouste Gulbenkian as quoted in The Seven Sisters
Calouste Gulbenkian: “Mr. Five Percent,” long ago discovered a
basic truth about oil. Oil generates a great deal of money. The
“pen may be mightier than the sword,” but money trumps the
pen!
Jessup’s Law: politicians can’t handle the truth because they
fear their electorates. The result is almost always an inferior
solution to an energy dilemma
The “CRIC”cycle (courtesy of Robert Feldman) applies to
Energy Policy in the US
Crisis
Response
Improvement
Complacency
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