Getting All Pumped Up

KILL! SAYS THE SIGN IN the oil-trading room at Mobil's Fairfax, Va., headquarters. KEEP INVENTORIES LOW AND LEAN. It's not clear who the target of this grim directive is meant to be. But in recent weeks gasoline buyers have had the funny feeling it's them. A double-digit price spike at the pumps since February has made headlines and sent journalists out to hunt Big Oil, that favorite bogeyman of politicians and populists. Critics have sought evidence of price-gouging conspiracies hatched from deepest, darkest Texas-or maybe Riyadh. The Clinton administration, quick on the draw in an election year, last week announced an investigation into whether the oil moguls violated antitrust laws.

In fact, the causes of the price jump are far more innocent. First, a long, cold winter drove up oil usage unexpectedly. At the same time, on-again, off-again talks over whether the United Nations will allow Iraq back into the market prompted oil traders to wait until the last moment before buying. Expecting a steep drop in wholesale prices, they bid them up when the talks failed on April 24. Most analysts agreed it was all a temporary blip, and by the weekend the issue was beginning to fade.

It may not stay quiet for long. The sudden upward lurch of prices is also one of the first warning signs that a vast restructuring underway in the industry is starting to ripple its way to the pump. No one foresees a gut-wrenching rise like the '70s oil shocks. But consumers the world over can expect to see far more volatile prices than anyone has witnessed for many years.

The reason goes back to that sign on the Mobil trading floor. Big Oil has, at last, entered the 1990s--the era of downsizing, consolidation and, of course, that universal Japanese import, "just in time" inventorying. Two decades of fairly flat gas prices have been a halcyon time for consumers, but miserable for refiners. Investing in inventories of crude oil and gasoline nowadays means up to a 60 percent loss for every dollar put in. The outcome: an industry that once paid scant attention to efficiency and rate of return is now eager to get lean and mean. Refineries are being shuttered, operations combined and oil terminals permitted to run dry--a cardinal sin in the old days. Why were companies so caught out by the cold winter? Because oil inventories are at a 20-year low, kept that way by companies unwilling to tie up a penny more of capital than they have to. It's all part of becoming what Phil Verleger, an industry analyst with Charles River Associates in Washington, calls the "oilless oil company." While well-stocked storage tanks once "provided free insurance to consumers," says Verleger, the risk is now being shifted to the customer.

That means every time there's a cold spell or a refinery fire, or any of a hundred unforeseen events, supplies could get quickly squeezed, driving up prices. Experts agree that crude-petroleum stocks aren't the problem. Iraq is bound to come back on line soon (talks are expected to resume again), flooding markets with up to 700,000 barrels a day--1 percent of the world total. That will slamdunk prices for a while. And new wells are being opened all over, since the return in exploration and production remains generally high.

The real threat comes from refining and marketing bottlenecks caused by all this cost cutting, In March Mobil announced it would combine marketing and refining of fuels and lubricants with British Petroleum in Europe, and said it was shutting down its refinery in Germany. Exxon, meanwhile, has sold its 190,000-barrels-per-day refinery in Bayway, N.J., and closed another in Vancouver, B.C. European companies will have an even easier time shutting refineries-a hugely expensive task in the United States, thanks to the environmental laws. At Royal Dutch Shell, the world's largest oil company, 1,200 top managers have been told to start looking for another job as the company bids to reach a 12 percent rate of return (from about 10.5 percent today). "We are responsible for the $80 billion investment of our shareholders," Shell chairman Cor Herkstroter told reporters in Holland recently, sounding far more like the accountant he once was than an oil baron. There is one safeguard for consumers. Most oil companies are integrated; they both dig up the oil and then "sell it" to themselves as refiners. So they can't let crude inventories dip too low, lest prices jump too much. Still, analysts fret about supply pressures at the pump. "The closures worry me because I don't see demand slowing down," says Constantine Fliakos of Merrill Lynch.

Most industry observers say there's simply too much supply out there for gasoline prices to climb too high for too long. And while a squeeze in refining may happen over the next six months or so, the mysterious math of supply and demand never takes too long to work its medicine, even in oil. New capacity will spring up. Meanwhile, says Douglas Terreson of Morgan Stanley, "realistically, consumers should expect gasoline prices to be higher." And refiners may finally make a buck.