Re: Will We Hit $100 A Barrel?

mike roberts wrote:

Will We Hit $100?
Such forecasts, once the province of the enviro-fringe, now come from
the likes of Goldman Sachs. Here's why.
By Karen Lowry Miller
Newsweek International
Updated: 3:29 a.m. ET May 7, 2006

May 15-22, 2006 issue - The first oil shock of the 21st century is now
upon us, even if it has not (yet) hit the global economy. This time, the
early fallout is measured in largely political terms—in the growing
cockiness of oil states like Venezuela, the defiance of Iran, the
expansion of state oil companies from producing nations like Russia, the
backlash against hugely profitable oil giants and the near desperation
of incumbent politicians in consuming nations like the United States and
Germany. In recent weeks, as the price of oil passed $70 a barrel, the
price of gas topped $3 a gallon in the United States and ex-oilman
George W. Bush unleashed an investigation into possible price
manipulation by Big Oil, the old power relations of our oil-based world
were clearly being turned upside down.

It may be only a matter of time before the economic shock arrives.
Predictions that a $10 hike in the price per barrel of oil would shave
half a point off world growth rates have yet to pan out, but that
doesn't mean they won't. Our happy surprise that global growth has yet
to slow misses the catch: if the economy can run with a $70-a-barrel
burden on its back, the price is less likely to fall. More and more
companies are tacking on fuel surcharges, and the specter of
petrol-fueled inflation is rearing its ugly head.

Worse, there is an increasingly strong case, perhaps even an emerging
consensus, that we are heading for a new price reality—one that until
now has been the province of oil-conspiracy crackpots and environmental
end-of-timers. This is the world of $100 oil. Goldman Sachs analysts
Arjun Murti and Brian Singer surprised the markets in March 2005, when
prices hovered at about $47 a barrel, by predicting a "superspike" that
would drive oil up from $50 to as high as $105—and suggesting prices
could remain there for five to 10 years. Now predicting $100 oil has
become respectable. Just look at the futures market, where call options
on $100 barrels—a novelty when the first one appeared last year—are now
commonplace.

The reason the new spate of forecasts is so scarily convincing is
because they don't rely upon sweeping but unprovable claims that the
world is running out of oil. This has been the case put forward for
years by "peak oil" theorists, who say today's prices are a symptom of
the fact that we have found all the oil we can pump economically, so
it's all downhill for supply. Since no one has found a way to X-ray the
planet to determine exactly how much oil is left, peak-oil theory is
based in part on faith in pessimistic geology. Oil bulls respond with
their own article of faith: that there is oil down there, and improving
technology can and will find it.

Some of the most worried analysts now assume that the bulls are right:
there is plenty of oil in the earth.

Ridiculous. There is not plenty of oil. We're in the endgame now. OPEC oil
production peaked in October, 2004. There isn't nearly enough new discoveries
or drilling to mitigate a decline in production. Oil is the pillar of all
economic activity, so when the oil supply drops by 5% a year, the economy is
going to really, really suffer. Permanently.

Go look at these figures.
http://www.mees.com/Energy_Tables/crude-oil.htm

But technology alone can't solve
the problem—not soon, anyway—if the industry is not deploying it. "Peak
oil is a red herring," says Barclays Capital analyst Paul Horsnell.
"It's all about fundamentals." The problem is that the major
oil-producing nations have not spent enough—and don't plan to spend
enough—to meet rising demand, particularly from the United States and
China, in the near to medium term. Spooked by past episodes of
overspending in boom times, companies have chosen to sit on their cash,
or return it to shareholders, rather than build new production or
refining facilities. Ultimately, Singer and Murti argue, oil is still a
cyclical commodity (not a vanishing resource), and prices will fall back
to earth. But they expect an extended period of high prices that could
last through 2009 before tapering off through 2014. And already, gas
lines have reappeared in the United States, as consumers hunt for the
cheapest pump prices.

History suggests that the current fundamentals look a lot like the
1970s. Goldman Sachs research shows that oil prices tend to spike during
periods when oil states and companies are investing, then fall as that
spending produces new supplies (charts). Thus, prices shot up as
investment rose in the late ' 70s, then fell as that investment yielded
a new cushion of spare capacity in the 1980s. The price slump that
followed lasted through the late 1990s, depressing investment in oil
while the broader market funneled money into the tech stars of the New
Economy. Over the past 20 years, spare production capacity has fallen
from 15 percent to barely more than 1 percent worldwide, with no
immediate prospect of relief. Goldman Sachs analyst Jeffrey Currie
calculates that the oil industry needs to invest a stunning $3.5
trillion over the next decade just to keep up with rising demand. "We
call it the revenge of the Old Economy," says Currie.

If anything, the uncertainties surrounding global oil investment are
even higher today than in the 1970s. "When you have no margin for error,
Murphy's Law kicks in and anything that can go wrong will," says
independent oil consultant Lowell Feld. If a confrontation with Iran
were to cut off its 2.5 million barrels of exports per day, "there is no
one else to make up the slack," says Feld. Deutsche Bank analyst Adam
Sieminski argues that a supply cut of 2 million barrels a day would be
enough to drive prices to $100. Global Insight chief economist Nariman
Behravesh goes further: "All it takes is a single geopolitical event,
such as an attack on Iran, to trigger a major shortage and even $120 oil."

This situation is the result of a quarter century of underinvestment in
oil supply. Since it takes up to seven years for oil investments to
yield actual oil, even a crash spending program now wouldn't prevent a
superspike. Consider just five of the top 10 oil producers, who together
control more than half the world's reserves. The largest reserves are in
Saudi Arabia, which accounts for nearly all of today's spare capacity
and remains relatively stable, despite recent terror attacks on oil
installations. It plans to invest billions to raise its daily output
from 9.6 million to 12.5 million barrels by 2009.

The rest of the five are all treading water, or worse. The second
largest con-ventional reserves are in Iran, which produces less today
than it did 30 years ago, and is having trouble attracting multinational
investors, who are spooked by its defiant pursuit of a nuclear-energy
program. In Iraq, where oil production plummeted after the 2003
invasion, insurgents attack oil facilities once every three days, on
average. No surprise, investors are staying away. In Russia, oil
investment boomed after the fall of the Soviet Union but has leveled off
since. Gennadiy Shmal, president of the Russian Union of Oil and Gas
Industrialists, has publicly criticized the Kremlin for spending too
little on exploration.

Meanwhile, Venezuela has seen production from its state-owned firm drop
50 percent since 2003 under the radical populist Hugo Chávez, even as he
runs foreign investors out of the country. Chávez claims grand plans to
spend $56 billion by 2012 on new production and refineries, but analysts
are skeptical about his priorities. Columbia University's Adam Louis
Shrier says Chávez "uses oil as a political tool" to advance his social
agenda: hospitals, schools, vacation homes for employees. "The national
company is not about oil or economic performance," he says.

While oil investment is picking up again, there are reasons to suspect
that this cycle will see less money spent more slowly than in the past.
One big reason is politics, and not only in Venezuela. Oil-producing
nations from the Middle East to Russia are raising the government share
of oil revenue to fund the welfare programs that keep reigning princes
and populists in power. Social spending is on the rise at a time when
tapping old and remote fields is increasingly complex, and expensive.
Those costs have also risen because many skilled workers left the
industry during the long investment slump.

Social welfare competes for oil dollars throughout the Middle East, one
of the few regions where populations are still growing fast. As the
number of young people entering the Saudi work force surges, the Saudis
need a minimum oil price of $40 to $50 to maintain their current system
of subsidies for food, housing, education and employment, says Feld. New
Iranian President Mahmoud Ahmadinejad has also promised oil money to
fund social programs, and Russian President Vladimir Putin has pledged
that oil profits will be used to fight poverty in Russia. All of that
siphons off money that could be used to increase oil production.

It also scares off Big Oil, which is sitting on piles of cash but faces
a perilous investment climate. To fund his social schemes, Chávez has
raised the income tax charged to foreign oil companies from 34 percent
to 50 percent, and roughly doubled the cost of royalties to 30 percent;
last month he seized an oilfield outright from the French firm Total and
broke a contract with Eni of Italy. Taxes are so high in Russia, says
Currie, that oil has to reach $80 a barrel for multinationals to make a
15 percent return on capital.

In some ways, international oil companies have undermined their own
incentives to invest, in part by failing to see which way prices were
going. Up until 2003 they based investment decisions on projected prices
of about $15 a barrel, says Columbia University's Shrier. Indeed, many
were so confident that oil would never top $30 a barrel that they
agreed, in West Africa for example, to pay graduated taxes that reached
100 percent at oil prices above $30. Shrier estimates that oil companies
have raised long-term price estimates to about $35 a barrel,
representing "a fundamental change" in the industry that should open the
doors for investment in the future. But it can't come soon enough to
slow the pace of a superspike that may already have begun.

With Michael Hastings in New York
© 2006 Newsweek, Inc.

© 2006 MSNBC.com

URL: http://www.msnbc.msn.com/id/12667616/site/newsweek/

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