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Oil Prices to Breed Discontent This Winter 16 August 2000

Summary

The price of crude oil rose to more than $32 per barrel on Aug. 15, reaching a 10-year high. While the upsurge was attributed to a comment made by Venezuelas president, it actually reflects current market conditions. An increase in oil production by the Organization of Petroleum Exporting Countries (OPEC) would help alleviate prices but is unlikely to occur. High energy prices will persist through the winter and affect every sector of the global economy.

Analysis

Crude oil prices rose to more than $32 per barrel on Aug. 15. The price spike was widely attributed to a comment made by Venezuelan President Hugo Chavez that oil producers should not allow prices to drop below their current levels. Chavez is currently touring nations that make up the Organization of Petroleum Exporting Countries (OPEC) in preparation for a September heads of state summit in Caracas. However, the price spike actually reflects current market conditions. High energy prices, which will affect every sector of the global economy, are likely to continue throughout the winter

The only dependable method of attaining relief from high oil prices would be to increase production. Saudi Arabia announced in early July that it would unilaterally increase production by 500,000 barrels per day (bpd). However, according to the U.S. Energy Information Administration (EIA), Saudi production has only increased by 150,000 bpd. Since global demand tends to slacken in the autumn, OPEC will be reluctant to boost production. As well, individual members of OPEC have recently opposed increases; when Saudi Arabia announced its decision to boost production in July, it faced a solid wall of opposition.

Consequently, the global economy faces a dual threat from flat supplies and diminished stocks. U.S. crude stocks are at a 24-year low. More importantly, low gasoline stocks in the United States and Europe are pushing refineries to favor gasoline production at the expense of heating oil.

Last winter, heating oil stocks were already at a 10-year low. This winter, American and European deficits will be 50 percent and 20 percent worse, respectively, according to the International Energy Agency. Reflecting this crucial shortage, the price of U.S. heating oil hit a six-month high this week  and this near the end of the summer, when demand is generally at its lowest.

These price crunches will lead to higher prices for other petroleum products, as well. Already, U.S. natural gas producers are expecting a 50 percent increase in prices this winter.

Higher energy prices will hit every sector of the global economy, but the damage will not be uniform. In Europe, various energy taxes already constitute more than 80 percent of the price of gasoline. As a result, gasoline prices begin from a level about triple that of U.S. prices. An additional 30 cents on a $4 gallon of gasoline in London is not nearly as noticeable as an additional 30 cents on a $1.2 gallon of gasoline in New York. Europeans are also used to paying far more for natural gas, so again, the rising prices wont be shocking.

The United States, with its preference for cheap energy, lacks this safety mechanism. Any increases in price will hit far harder in percentage terms. While the U.S. economy grew at an impressive 5.2 percent in the second quarter, higher energy prices could still trigger the inflation that Alan Greenspan fears. The United States depleted energy reserves will only exacerbate this problem.

But it is the developing world that will be the hardest hit. Oil demand in Asian states alone has already increased by almost 600,000 bpd in the first half of the year. And most Asian states lack substantial energy reserves or significant energy taxes. This all makes them far more susceptible to price shocks. Any rise in crude prices will directly impact their still-fragile economies.

Unless OPEC agrees to a significant production increase during its September meeting  a highly unlikely event  the world will face sustained high prices and energy-induced inflation, especially in developing economies.

http://www.stratfor.com/SERVICES/giu2000/081600.asp

-- Martin Thompson (mthom1927@aol.com), August 28, 2000