New York Times: With Geopolitics, Cheap Oil Recedes Into Past

With Geopolitics, Cheap Oil Recedes Into Past
By JAD MOUAWAD
New York Times

IT was a year that people in the oil markets are unlikely to forget - a year that prices set records, forecasts lost touch with reality, and almost everything that could go wrong, did. It was also a year that politics returned to the oil market.

And the trend is likely to continue this year. While oil prices have declined since October, many of the issues that have vexed the oil industry in 2004 are expected to recur. Cheap oil increasingly looks like a thing of the past.

Through the 1990's, prices were stable, supplies were secure and there was plenty of extra capacity to keep energy costs low and world growth buzzing. At an average of $20 a barrel, oil was viewed as just another commodity.

But then came ethnic and labor troubles in Nigeria; chaos and protests in Venezuela before President Hugo Chávez won a referendum allowing him to stay in power; hardball energy politics in Russia; and the continuing insurgency in Iraq.

While supplies of oil to the world markets were rarely interrupted, the uncertainties created by these events raised crude oil prices in New York by two-thirds this year, to a high of more than $55 a barrel in October. And as energy costs surged, many analysts, traders and politicians woke up to the reality that oil was different from cocoa or coffee.

"Oil is a political commodity," said Robert Mabro, president of the Oxford Institute for Energy Studies, one of the world's foremost energy experts. "Geopolitics is the most fundamental issue if you're looking at oil markets. People seem to have forgotten that since the 1980's."

Of course, this is not the first time that oil and politics have mixed.

Decades ago, militant governments in Iran and Libya, for example, nationalized their oil sectors, forcing American and European companies out and taking charge of their natural resources. Then came the oil embargo and the price shocks of 1973-74 and 1978-81, with long lines for gasoline and steep rises in inflation.

But for the most part, politics had dropped off the energy map since then. In the 1980's, energy experts largely discounted a war between two of the Persian Gulf's top oil producers, Iran and Iraq, because Saudi Arabia and some other OPEC nations could simply crank up their production to make up for losses.

Even the invasion of Kuwait by Iraq in the summer of 1990, and the subsequent embargo on their oil exports, roiled energy markets for only a few weeks.

But in recent years, the oil industry has undergone a fundamental change. While demand has steadily increased each year, the industry's exploration efforts have not kept pace in new discoveries.

Now that worldwide production is running at full speed to meet increased demand, there is no cushion left in the system to weather a potential blow to producers like Iraq, Venezuela, Iran, Russia or Nigeria.

So, once again for oil markets, politics matters.

For instance, said Amy Myers Jaffe, the associate director of Rice University's energy program, Saudi Arabia's oil industry is no longer seen as being impenetrable to terrorist attacks; tensions in the Persian Gulf could swell over Iran's nuclear program; Nigerian factions may erupt in violence; and the fighting in Iraq goes on.

"All kinds of things can affect this market," Ms. Jaffe said, "especially when you're in a razor-thin situation. The only thing that could dramatically alter the outlook is a major economic recession."

The heightened geopolitical risk has translated into higher prices, something analysts call a "risk premium." Crude oil prices have averaged $30 a barrel since 2000, but last year crude oil in New York climbed to an average of $41 a barrel. While energy prices are high, adjusted for inflation they are below the level in March 1981, when crude oil approached $70 a barrel in today's dollars. Still, analysts do not expect prices to fall anytime soon.

High world prices since mid-2002 have helped sustain the economic recovery of Russia, which is raising output, according to the Energy Information Agency of the Department of Energy.

The former Soviet Union, of which Russia is by far the biggest country, is the world's largest producer, the agency says, followed by Saudi Arabia and the United States. The biggest consumers are the United States, which imports over half its needs; China; Japan; and the former Soviet Union, which uses about a third as much as it produces. Leo Drollas, chief economist for the Center for Global Energy Studies in London, expects oil prices to be higher in 2005, on average, than they have been this year. The institute was founded in 1990 by Sheik Ahmed Zaki Yamani, the former Saudi oil minister.

Even oil companies, which are usually extremely conservative about their price outlook, are coming around to that realization. Lord Browne, the chief executive of BP, now sees a new bottom of $30 a barrel for the next few years.

"There is something fundamental holding prices up, whether that's at $45, $40 or $35 a barrel," Mr. Mabro of the Oxford Institute said. "And politics won't improve things. Except if you believe a miracle is going to happen in Iraq."

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Prudent Investor Says: This article practically demolishes such arguments that the current oil conundrum has been a function of free markets. Oil has fundamentally been the epitome of the collective government’s self-serving interest, ineptitude and inefficiency as much as the fiat money standard. For as long as governments persist to intervene the markets will remain distorted simply due to resource misallocation. And such inefficiencies pave way for unintended consequences as seen in today’s oil prices.