Oil Eyes & Gas Gauges

Oil Eyes and Gas Gauges
(Good Times, Santa Cruz, Jan. 2003)

Ronnie Lipschutz

   Is the impending war all about oil? Over the past few months, there has been a lot of speculation about the “true” reasons for attacking Iraq, and logic seems to point to the black stuff. But would we care about Iraq if all it produced were Brussel sprouts and broccoli? The answer is that it is the price of oil that matters most, because that determines the political future of American Presidents. Other things may intervene, but no one can win re-election if gasoline goes over two dollars a gallon.

   This is precisely where we are over a barrel.

   You might recall that, early in its tenure, the Bush Administration undertook a review of national energy policy. Vice President Cheney spent most of his time meeting with energy company executives—we still don’t know exactly with whom or for how long—and he later dismissed the idea that conservation and greater efficiency could have any positive impact on energy policy. Instead, the White House opted for more energy— oil, coal, nuclear. That the supplies required might not be available or might be horrendously costly did not seem to matter.

The flaws in this approach are best seen by considering the numbers. Domestic oil production has been in decline for a number of years while the demand for petroleum products has increased. Consequently, the rate of imports has been climbing steadily. Because of the geographic distribution of known oil reserves, most of those imports will have to come from the Middle East. But even those deposits are not infinitely large; many analysts believe that, sometime during the next thirty years, those sources will begin to give out, too.

Given these facts, you might expect some cautionary predictions about oil supply and demand over the next few years. If so, you are wrong.

Late in November, 2002, the Energy Information Administration (EIA), an arm of the U.S. Department of Energy, issued its early release of the Annual Energy Outlook 2003.    According to the EIA, no disruptions or changes in oil production are to be expected by 2025. U.S. economic growth will be a consistent 3 percent, while miles traveled will grow by 2.4 percent per year. Oil prices will hardly rise at all in constant dollars, even as demand grows from 76 million barrels per day to 123 million. The Organization of Oil Exporting Countries’ (OPEC) share of world oil production will rise from its current 38% to roughly 50%, while the Middle East’s share will increase from 21 to 42 million barrels per day. Of this, Saudi Arabia’s daily output will expand from 8 million to 22 million barrels a day. Iraq, possessor of the world’s second largest oil reserves after Saudi Arabia, will see its contribution to this flow grow far beyond the million or so barrels produced today under UN sanctions to 8 million or so.

Whether these numbers make sense is anybody’s guess. Right now, the Saudis have some 260 billion barrels in what are called “proved reserves,” and a reasonable guess is that there might be as much as another 100-200 billion barrels yet to be discovered. Iraq possesses about 112 billion barrels and there may be another 75-100 billion not yet found. The other Persian Gulf countries have about 200 billion barrels between them, and maybe 50 billion not yet found. All of this adds up to some 575 billion barrels of known reserves and 350 billion barrels of possible reserves. However you do the math, if the EIA is to be believed, by the end of this century most of the Middle East’s oil will be gone.

   None of this is certain, of course. Saddam Hussein represents one of those uncertainties, Saudi Arabia another. The production increases required for the EIA’s scenario are prodigious, by any measurement, and it is not immediately evident that the Saudi monarchy will have any interest in going along. Nor is it obvious that an independent Iraqi regime governed by Hussein or his successors will see through a program to increase production the required levels. Finally, the capital to finance such growth will have to come from somewhere and, given the current price of oil, neither regime can afford to pay these costs out of pocket.

   Here, then, is one of the keys to President Bush’s war plans. In the short run, Saddam Hussein could hold the world’s oil supply to ransom simply by threatening to hit the Saudi fields, as he did in 1991. In the longer run, a collapse or radicalization of the Saudi Arabian government could put an enormous dent in that oil supply, and wreck the global economy. Either would drive up the price of oil and gasoline, driving the United States into recession and the occupant of the White House out of office. What better solution than to put the transnational oil companies back in control, under the watchful eye of the American military?

This is the first of several columns on oil and war. Ronnie Lipschutz is Professor of Politics at UCSC, and can be contacted at rlipsch@cats.ucsc.edu.

And what will this oil cost? Surprisingly, the EIA assumes At the beginning of this month, the spot market price of a barrel of oil passed $30 for the first time since a short-lived price spike in 1991. At the same time, in real terms, oil is much cheaper today than it was during the 1970s or, for that matter, at any time since its first commercial production toward the end of the 19th century.

And the “market price” of oil is more than merely of academic interest to those who occupy the White House. As U.S. President’s have learned, much to their sorrow, the price of gasoline at the pump is of much greater interest to the American electorate than democracy or poverty or justice in other parts of the world. In 1992, Presidential candidate William Jefferson Clinton proposed a 50 cent per gallon tax on gasoline; by 1993, Congress forced him to accept a five cent increase. The oil will flow out of the Persian Gulf no matter who governs those countries; the question is whether it will flow in sufficient quantities to keep American drivers from voting against the President (not that they would do any differently).

Pennies at the Pump, Billions in the Bank

Ronnie Lipschutz

   What will happen to the price of gasoline during the coming decades. Interestingly, the EIA report to which I referred in my last column predicts that prices will hardly change from today’s. There will be small variations up and down but, overall, the real cost of oil will not vary much. That assumption is necessary if annual growth is to reach 3% All of this seems unduly optimistic, especially if war breaks out.

Oil markets are funny things—or, rather, they are not so funny. During the last month or so, the cost of a barrel on the international market has gone from somewhere in the mid-20s to over $30. We are told, as a result, that gasoline prices will soon begin to rise, and could go over $2.00 per gallon by the summer, when demand is high. If there is a war, and supplies from the Persian Gulf are cut, the price could go even higher.

   It all depends on the market, which responds to “supply and demand.” According to the standard story (sorry, no pun intended), when the cost of petroleum rises, as it did during the 1970s, consumers will use less and supply will come back into balance with demand. The price will decline and consumers, finding energy to be less expensive, will increase their consumption. Oil supply must meet demand, or prices will rise, demand will drop, and markets will clear. All of this is “automatic,” or so goes the story.

There is very little that is automatic in the oil business, however. From its very inception, the story of oil has been about struggles to control supplies and markets, all in order to keep profits high, always in the face of too much product in the market. For the simple fact of the matter is that, even today, a large fraction of the world’s oil costs next to nothing to produce. Most of the market price for that oil is pure profit. But another large faction of world’s oil costs a great deal to get out of the ground, and if prices go too low, profits disappear. As it turns out, the very cheap oil is found primarily around the Persian Gulf, more expensive oil, in other parts of the world.

One of the peculiarities of the global oil market is that the price of a barrel is roughly the same everywhere, no matter what it costs to produce. High-quality Arabian light oil commands a premium of a few dollars over heavy Venezuelan crude, but if a barrel sells for $35 on the spot market, every other barrel in tankers, pipelines, fields and storage will be the same price. So, even if it costs less than a dollar to get a barrel out of the ground—as is the case in Saudi Arabia—that barrel will go for $35.

In the wake of the 1973 October War between Israel, Syria, and Egypt, the Arab members of the Organization of Petroleum Exporting Countries (OPEC) decided to punish the United States and the Netherlands for their support of Israel, and imposed an oil embargo on them. Later that year, OPEC unilaterally raised the per barrel price of oil from around $3 to $12. During the remainder of the decade, prices continued to rise slowly and, as a result of the collapse of Iranian oil production during the Islamic Revolution, reached as high as $40 per barrel (the equivalent today of about $100 per barrel).

   All of that money had to go somewhere. A lot of it—hundreds of billions of dollars—came out of the pockets of Western consumers and ended up in OPEC bank accounts, both public and private. No one shed tears for the great transnational oil corporations, the “Seven Sisters.” They, too, cleaned up and reaped windfall profits, since all of their oil could be sold for the same stratospheric prices. A few years later, as a result of economic decisions by the Reagan Administration, the oil market collapsed, and prices dropped to less than $10 per barrel. A lot of oil people went broke during the 1980s; even President Bush did not escape that fallout.

Among the many lessons during the 1970s and 1980s was the revelation that low oil prices were as bad for the oil industry and politics as high ones. High prices are bad for a President’s re-election prospects; low prices are bad for the oil industry. If prices are too high, people won’t vote for you; if they’re too low, companies won’t fund you. Price stability is key to rational economic decision-making and no one is going to invest in oil prospecting and production if they cannot depend on making a profit. Stable oil prices also keep consumers quiet. But price stability requires a balance between global supply and demand, and an unmanaged oil market tends towards wild swings.

The trick is, therefore, to maintain just the appropriate level of production which will result in a “market price” that is neither too low ($10/barrel) or too high ($40/barrel). The former will squeeze oil company profits; the latter will squeeze consumer demand. Even OPEC has come to realize there is no benefit in letting production drop, and it has recently decided to increase production by 2 million barrels a day in order to bring the cost of a barrel back below $35.

   To keep the American and global economies growing, the price of oil must remain relatively constant. But a growing economy consumes more energy, and the world’s economy is addicted to oil. Weaning the United States away from its heavy oil dependence would cause the price of oil to collapse again, generating political and social havoc at home and abroad. It follows, therefore, that oil production must increase at a steady and predictable rate: no surprises. This can happen only if political uncertainties can be eliminated.

Pennies at the Pump, Billions in the Bank
(Good Times, Santa Cruz, Feb. 2003)

Ronnie Lipschutz

    What will the price of gasoline be? The EIA report to which I referred in my last column suggests that prices will hardly change from today’s. There will be small variations but, overall, the real cost of oil will not vary much. This seems unduly optimistic, especially if war breaks out.

Oil markets are funny things. They don’t really reflect the price of producing the stuff. During the last month or so, the cost of a barrel on the international market has gone from somewhere in the mid-20s to over $30. If there is a war, or even expectation of one, the price could go even higher.

    Supposedly, this all depends on “supply and demand.” According to the standard story (sorry, no pun intended), when the cost of petroleum rises, as it did during the 1970s, either more must be produced or less must be consumed. Then supply will come back into balance with demand and prices will come back “into balance.”

There is very little that is automatic in the oil business, however. From the very beginning, as Daniel Yergin related in The Prize,, the story of oil has been about state and corporate struggles to control supplies and markets, in order to keep profits high in the face of too much product in the market. The simple fact of the matter is that, even today, a large fraction of the world’s oil costs next to nothing to produce, and most of the market price for that oil is pure profit.

But another large faction of world’s oil costs a great deal to get out of the ground, and if prices go too low, profits disappear. As it turns out, the very cheap oil is found primarily around the Persian Gulf, the expensive oil, in other parts of the world.

One of the oddities of the global oil market is that the price of a barrel is roughly the same everywhere, no matter what it costs to produce. High-quality Arabian light oil commands a premium of a few dollars over heavy Venezuelan crude, but if a barrel sells for $35 on the spot market, every other barrel in tankers, pipelines, fields and storage will be the same price. So, even if it costs less than a dollar to get a barrel out of the ground—as is the case in Saudi Arabia—that barrel will go for $35.

And it does not take very much to drive up the price of a barrel: a deficit of one or two million per day relative to demand will cause a price spike. Traders and processors will try to hedge against running short by bidding up prices for oil to be delivered in the future. And that will affect the price of oil today, since it can be held in storage until that future date. That’s why the Bush Administration has been considering a release of oil from the Strategic Petroleum Reserve.

Among the many lessons of the 1970s and 1980s was the revelation that low oil prices were as bad for the oil industry and politics as high ones. High prices are bad for a President’s re-election prospects; low prices are bad for the oil industry, especially if a barrel fetches less than the cost of production. If prices are too high, people won’t vote for you; if they’re too low, companies won’t contribute to your campaign.

Price stability is also key to rational economic decision-making. No one will invest in oil prospecting and production if they cannot depend on making a profit. Stable oil prices also keep consumers quiet and avoid political dustups at home. The trick is, therefore, to maintain just the appropriate level of production which will result in a “market price” that is neither too low ($10/barrel) or too high ($40/barrel). But price stability requires a balance between global supply and demand, and an unmanaged oil market tends towards wild swings.

Even OPEC has come to realize there is no benefit in high prices, and it has recently decided to increase production by 2 million barrels a day in order to bring the cost of a barrel back down to around $25. If war breaks out, all bets are off, and it would be imprudent to depend on countries whose political futures are always uncertain. Once again, the bloody logic of U.S. control asserts itself.

    Are there no alternatives?

This is the second of three columns on oil and war. Ronnie Lipschutz is Professor of Politics at UCSC, and can be contacted at rlipsch@cats.ucsc.edu.

Are There Any Alternatives?
(Good Times, Santa Cruz, Feb. 2003)

Ronnie D. Lipschutz

    More than 50 years ago, when Harry S Truman was still president, a special commission examined the country’s energy prospects. Fearing that oil supplies might run low or be cut off by the Soviet Union, the commission urged the President to support research into development of solar energy.     Even then, solar was not a pipe dream. People living in Southern California had been using the sun to heat water since the 1920s, and electricity-generating windmills were a well-developed technology. For that matter, buildings had been designed and built to take advantage of the sun for centuries, if not longer.

    But oil was cheap, and a lot more was coming on line around the Persian Gulf. And Truman had other things on his mind. A couple of years later, President Eisenhower, launched the “Atoms for Peace” program. And there ended that. Another missed opportunity.

    The temptation to blame conspirators and corporations for this, and subsequent failures, is great. But the explanation for all of those missed opportunities is rather simpler, and it remains applicable today. It is not that the technologies are unavailable. We know how to generate electricity from the sun and the wind; we are making progress towards cost-effective fuel cells; we might even, someday, get to drive President Bush’s Fabulous Hydrogen-Powered Automobiles. Indeed, we could begin the Great Transition to renewables tomorrow, except for one thing.

    Fossil fuels are too cheap.

    You will recall from the earlier columns in this series that, corrected for inflation, the cost of oil today is as low as it has been at almost any time during the 20th century. Moreover, oil from the Persian Gulf is exceptionally inexpensive to get out of the ground. The price of oil, as it turns out, sets the floor for all other energy sources. But it is a movable floor, and there’s the rub.

    In the United States, most of the oil we consume goes to transportation and industry. Our electricity comes largely from coal, natural gas, hydropower, and nuclear, with a sprinkling of other sources. Nonetheless, in purely economic terms it makes little sense to invest in or pay for an energy source that costs much more than oil. Nuclear is the exception that proves the point. Utilities have been granted all kinds of deals to keep their nukes operating and, even so, no utility has ordered a new nuclear power plant in over two decades because they are so expensive to build.

    How can this be? Let’s say, for the sake of argument, that the cost of solar and wind electricity were to drop to 12 cents a kilowatt hour, including storage and transmission costs. This would be pretty cheap and, in California, almost competitive with other sources of electrical power (my last bill showed an “electric energy charge” of 5.2 cents per kilowatt hour and a “baseline usage rate of 11.6 cents per kilowatt hour). But even that would not trigger a rush to solar.

    Why not?

First, the cost of electricity reflects the current market price of oil, natural gas, and coal and they could be reduced to undercut the cost of renewables. Producing and generating companies have put a lot of capital into fuel sources, transportation systems, refineries, retailers, and power plants. They would probably be willing to suffer considerable losses in order to make sure that those investments would not become worthless.

    Second, not only is the fossil fuel production and delivery infrastructure already in place, transportation, housing and industry have all been configured to the supply and use of those energy sources. Conversion to renewables would require considerable time, energy, and money, all of which would represent both threat and disruption to existing interests and practices.

    Only if the costs of fossil fuels, and especially oil, were to go up and remain high would both the economic incentives and the financial benefits become sufficiently powerful to motivate shifts in our consuming patterns and energy systems. And the most straightforward way to accomplish this goal would be through an energy tax.

How high and how soon?

If we go by the experience of the 1970s, the cost of oil and other fossil fuels would need to rise by a factor of three or four over a relatively short period of time—imagine gasoline rising to eight dollars a gallon and electricity to 40 cents a kilowatt hour by 2010 or 2015.

Such high energy prices would certainly motivate a rapid move toward greater energy efficiency and make renewables much more attractive. There would be a lot of yelling and screaming, of course, which is why the increase would need to be stretched out over a decade or so. Some of these tax revenues could be rebated to the poor and the rest invested in new energy systems (perversely, lower demand for fossil fuels would cause their prices to plummet far below renewables; that’s why an energy tax is the only way to go).

What President and Congress would have the courage to do such a thing? Especially considering how their wheels are being greased. And is there a coal or oil company in the world that would gracefully accept its demise? Name one.

Ronnie D. Lipschutz is Professor of Politics at the University of California, Santa Cruz. You can contact him at rlipsch@cats.ucsc.edu. This is the last of three articles about oil and war.