The Future of Oil Prices

After the price of a barrel of oil hit a new high last week (almost $105), President Bush asked the Organization of the Petroleum Exporting Countries (OPEC) to increase production to drive prices down. Instead OPEC officials said they'd maintain current output levels, a move that could lead to prolonged economic sluggishness for the United States. The cartel's denial looked like political bickering between oil-rich countries—like Saudi Arabia, Kuwait and Nigeria—and their biggest consumer: the United States, which cartel members blamed for economic mismanagement of the resource. But some analysts say that output may not be so easy to increase, even if the producers wanted to. NEWSWEEK's Daniel Stone spoke with J. Robinson West, chairman of global consulting firm PFC Energy, on where the global oil market might be headed. Excerpts:

How political is it for the cartel to reject America's request to raise oil production?
Frankly, this is not the first time that the U.S. has asked OPEC to move, and it's not the first time they've been rejected. So I don't think that's a big deal, and I would have been amazed if they had responded. The U.S. consumer and the president are very concerned. From the standpoint of the OPEC producers and the markets it's a very different situation, and some of these countries, notably Iran and Venezuela, need oil at very high prices in order to finance their economy.

But don't these countries have an incentive for the world's largest consumer to avoid a recession?
Well, first of all, there is enormous worldwide demand. And demand in the United States has remained very high. The politicians in the U.S. always make efforts to increase supply. They do next to nothing about demand. Secondly, demand is growing very rapidly in Asia and the Middle East, so you have got demand factors, some of which are beyond the control of American politicians, and others certainly beyond the control of OPEC officials.

Talking about Asia, what role will a rising consumer continent play in the global oil market?
They're transforming the market. There is analysis that shows a very high correlation between the per capita GDP and car ownership. Per capita GDP in China is still quite low, and car ownership is low. But as per capita income grows, car ownership will grow. This has happened in Korea, the Netherlands and Brazil. It happens everywhere, and as you move up that curve it's inevitable. If you believe the Chinese economy is going to grow—and I believe the Chinese economy must grow—then automobile demand and ownership must grow. If you look at Ratan Tata, a leading Indian tycoon and industrialist, he has introduced the Nano, a new [gas-powered] car that will cost $2,500. He'll bring the automobile to the general public. And if he does that, demand is going to go up.

Will the market be able to meet that demand?
There's very little spare capacity in the world. Most of it is in Saudi Arabia, and most of that is heavy oil. You also have places like Nigeria, where there's a risk built into the market. But another factor is driving the price of oil: a lot of traders are basically shorting the dollar. They believe the dollar is going to go down, so they're buying oil. And that has the effect of pushing the dollar down and pushing the price of oil up even more. Oil has become a financial instrument beyond just the energy markets.

The value of oil is constantly changing, lately reaching new highs with every fluctuation. Everyone wants to know how high could it go.
Well, there are a lot of people that believe that with a U.S. recession the price of oil would soften as the economy softens. But one of the things challenging that right now is this "financialization" of oil that's being used as a hedge against the dollar.

Considering the falling dollar, could there be a push to value oil on a different currency, like the yen or the euro?
No. That would be very difficult. It's not so simple just to switch. But what's happening is that oil-producing countries are shifting out of dollars as soon as they receive them. They're not holding a lot of dollars.

What does that mean for the average U.S. consumer?
That there's downward pressure on the dollar, and it's becoming more expensive for us.

Responding to a reporter asking about the possibility of gas prices reaching four dollars a gallon, President Bush said last month he had no indication it would reach that level. In the short run, is that realistic?
The only question is when. If the economy softens, there's a good chance that oil prices will soften as well, and hence gasoline prices. But in our business we take a longer view. We believe there are a lot of people in the industry that think we're headed for a production and supply crunch. It's not that the world is running out of oil, but that the world is running out of oil production capacity.

So even if the OPEC cartel wanted to increase production, you're saying their capacity to do so would be limited?
Yes. Basically, OPEC is along for the ride. Demand is driving it. Demand and the "financialization" of oil have more to do with it. Now, if OPEC opened up every stop, then they might be able to soften the market somewhat, but then you eliminate all spare capacity, which isn't a good idea either.

How would oil prices react if the U.S. invaded Iran?
It would jump through the roof. Don't ask me for a number. It would destabilize the region from where a great deal of oil flows. I think the price of oil would rocket upward.

Do you foresee a similar effect from an escalation of the conflict along the Venezuelan-Columbian border?
I don't think it's had that much of an impact so far. Frankly, what's had a bigger effect on the global market is mismanagement of the petroleum sector by [President Hugo] Chávez. Although they have huge oil reserves, production is declining due to just sheer incompetence. Venezuelan mismanagement is more significant to the oil market than a possible border skirmish between Venezuela, Columbia and Ecuador.

What about Iraq? What's the timeline there for getting that oil pumping?
I can give you the Talmudic answer by answering a question with a question. You tell me when the political situation will be clarified and an oil law will be passed and I'll tell you when production will go up. One of the things that must happen is the passage of an oil law over who would control the oil contracts and the oil revenues. And the problem has been that they haven't been able to reach a level of agreement between the different factions in that country. This is as central to Iraq as the issue of slavery was in the U.S. This is a fundamental issue in terms of the economic structure of the country.

Could high prices and stretched production capabilities lead to new domestic drilling in places like Alaska or offshore near Florida and California?
It should. The United States is the only country in the world that has large swaths of highly prospective acreage that is off limits. Everyone talks about Alaska, but the industry is much more interested in the Eastern Gulf of Mexico. What the politicians are always trying to do is find painless solutions. Energy policy in the U.S. in the last 25 years had encouraged consumption and discouraged production, which doesn't make a great deal of sense. And instead what we try to do is keep fuel as cheap as possible in the transportation and residential sectors. Those are the two sectors of the U.S. economy that are very inefficient from an energy standpoint.