Oil markets cling to idea of rising demand and falling supplies, senators told

Expectations that supplies will continue to dwindle as demand keeps growing have pushed crude oil prices dramatically higher since the beginning of 2008, two leading energy analysts told US senators.

Jul 25th, 2008

Expectations that supplies will continue to dwindle as demand keeps growing have pushed crude oil prices dramatically higher since the beginning of 2008, two leading energy analysts told US senators.

The notion fails to consider that recent major discoveries are significant and that $140/bbl crude oil prices might slow down demand growth, they told an unusual workshop convened by the Energy and Natural Resources Committee on July 17.

"An attitude has permeated the market that if any oil company says production from a new field will begin in six years, it actually will happen in 10 years. If you believe oil will cost $140 going forward, you'll see quicker demand destruction," said Roger Diwan, partner and financial advisory head at PFC Energy, a Washington strategic advisory firm.

International unrest and a weaker US dollar also have helped push oil prices higher, noted Daniel Yergin, chairman of Cambridge Energy Research Associates. "But there is a shortage psychology that demand will go through the roof and supplies will run out in 4-5 years which discounts significant events such as the substantial deepwater oil discoveries off Brazil," he said.

"When there's a cumulative shift away from the idea of scarce supplies and rising demand, there will be a change. We may need to adjust our demand forecasts to reflect the impact of higher prices," Yergin said.

Invited entire Senate

Energy and Natural Resources Committee Chairman Jeff Bingaman (D-N.M.) held the workshop to give senators who are not on the committee a chance to express their views and ask Diwan and Yergin questions about record-high oil prices. About 20 senators were there at various points, including Majority Leader Harry M. Reid (D-Nev.), who commended Bingaman for holding the event.

"Virtually every committee in the senate has an interest in this. I hope they follow your lead and cast aside partisanship. And I hope this event will bring forward new, sensible ideas," Reid said. While oil price increases clearly have been driven by several factors, he continued, excessive market speculation by non-commercial participants needs to be addressed first. "Without proper oversight, speculation has gotten out of hand. It's where we should start. It's one, but not the only, reason oil prices are so high," he said.

Pete V. Domenici (R-N.M.), the Energy and Natural Resources Committee's ranking minority member, said that Republicans also recognize that excessive speculation has affected oil prices and needs to be addressed. "But we also believe there is a domestic production issue," he told Reid.

"You may have one alternative to increase domestic production and we may have another. That doesn't mean they're mutually exclusive. We're speaking from the same handbook. We merely need to get on the same page," Reid responded.

Kent Conrad (D-S.D.) also thanked Bingaman for holding the workshop. "This is exactly what we should be doing, putting a focus on this issue in a bipartisan way to reach a solution," he said. Observing that there have been calls for several steps to address US dependence on foreign crude by developing alternatives as well as producing more oil and gas domestically, Conrad said that Congress already has passed several bills which have not fully gone into effect.

OSC survey

Bingaman noted that the 2005 Energy Policy Act contained a provision requiring the US Department of the Interior to survey the OCS for the first time in more than 20 years. When it reported back after doing so in 2006, he said he noticed that it had tried to save money by not using three-dimensional seismic mapping. "Neither the administration nor Congress tried to get another survey done with modern, more accurate technology," Bingaman said. When he was asked following the workshop if another OCS study could be part of DOI's fiscal 2010 budget, he said that it might.

Other Democrats questioned whether increasing available OCS acreage would send a strong, positive signal to world oil markets as some Republicans have claimed. Maria Cantwell (D-Wash.) said that bids were received on only 200 million of the 500 million acres of new Gulf of Mexico tracts offered in OCS Lease Sale No. 181, and producers have not fully developed onshore and offshore leases they already have. "This psychological effect idea is a specious argument. We really can't affect world prices with our geology," she said.

"Oil is a global commodity, influenced by supply, demand and events. How you affect these elements is on the fringe unless you make a massive effort. It would be false, as some people suggest, to think that opening up the OCS today would reduce prices tomorrow," added Robert Menendez (D-N.J.).

But the two witnesses called for expansion of federal oil and gas leasing on the OCS. "Responsible development of part of the OCS should be part of the picture. The sense of new prospective territories becoming available and moving toward exploration would be very beneficial," Yergin said. "Many people have said that the United States needs to increase its supplies. I don't think it's fair to ask other countries to do it if we're not willing to do something ourselves," Diwan said.

When Lisa Murkowski (R-Ak.) suggested that crude oil prices dropped by $9/bbl in the two days after US President George W. Bush lifted the executive withdrawal of US OCS tracts on July 14, however, they suggested that other factors might have been at work. Speculators might have sold oil positions to pay off losses in other markets, Diwan said. A US decision to negotiate directly with Iran may have had the most positive impact, he added. "There also could have been pessimism about the weakening US economy and its impact on future demand," said Yergin.

OPEC's spare capacity

The two witnesses emphasized that a wide variety of conditions over a long period led to 2008's dramatic oil price increases. A combination of supply and demand shocks from 1985 to 2005 wiped out the Organization of Petroleum Exporting Countries' spare capacity, which left markets without any down-side risk, Diwan said. Sluggish supply growth outside OPEC has fed the future scarcity narrative, which attracted financial players to oil commodity markets, he said.

Yergin added that from 1998 through 2000, major oil companies downsized dramatically to survive because oil and gas prices were so weak. Investments were not made in new equipment or in training new engineers, both witnesses said. "It's clear we're in an oil shock now. The fact that it coincides with a financial crisis means people are talking about stagflation for the first time since the 1970s. Changes in the makeup of the oil commodity markets are definitely a factor. So are the declining dollar and US relations with other countries," said Yergin.

"In the last 25 years, the United States has encouraged consumption and discouraged production. That needs to be changed. It took us 20 years to get to a truly tight market. It will take a long time for us to unwind it. The problem is not only access but building facilities to produce from new fields," Diwan said.

Strong worldwide economic growth ignited energy demand in China, India and other countries, they noted, adding that these countries could embrace conservation next. "I think it's striking that the Chinese have put efficiency at the top of their energy list. China and India both need to feel that the energy security system built around the International Energy Agency will work for them too," Yergin said.

"If we put aside the geopolitical questions, I think the energy supply response has begun. Oil is not going to have as dominant a position five years from now," he maintained.

Contact Nick Snow at nicks@pennwell.com

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