Why Oil Prices Don’t Behave the Way They Used to

When the world is changing, ask why. War almost came again to the Middle East in the last two weeks, yet the price of oil went down.

For more than 20 years, whenever tensions rose in the oil-rich region, the price of crude oil, jet fuel, heating oil and gasoline also rose. But oil prices have fallen 33% in the last six months, from almost $23 a barrel to $15.35 today. And the decline gained momentum as a showdown with Iraq neared.

Yet the stock prices of major oil companies--such as Chevron, Exxon, British Petroleum, Mobil and others--have not declined much at all. Oil stocks always fell with oil prices before.

To be sure, stocks of the drillers and oil service companies--Halliburton, Baker Hughes, BJ Services, Varco International--are off 30% in the last six months. Dresser Industries was likewise sharply down until last week’s announcement of a merger agreement with Halliburton pushed it up. Wall Street reckons that oil companies will slash exploration budgets because of lower oil prices.

But Wall Street is largely wrong. Yes, there have been some production cutbacks in West Texas oil fields sensitive to the price of crude. But drilling around the world is going gangbusters, including in the Gulf of Mexico, where drill rigs are renting for up to $40,000 a day. A decade ago, when the price of oil was down, you couldn’t give rigs away.

Why is the price of oil declining and how long will it stay down? The economic slowdown in Asia is being blamed, but Asia is only partly responsible. More important is an argument within the Organization of Petroleum Exporting Countries and a profound shift in the world’s understanding about energy supplies and national security. And that’s not to mention changes in the oil industry.

Within OPEC, Venezuela has invited in U.S. oil companies--Conoco, Atlantic Richfield, Texaco and others--to help it develop formerly uneconomical reserves. It has increased production, angering Saudi Arabia, which has increased its outflow of oil to make Venezuela feel the pain of falling prices. The upshot is a global oil glut that now amounts to as much as 2 billion barrels a year of overproduction--one-third of the United States’ or Asia’s annual usage. No wonder gasoline is selling at 99 cents a gallon in Southern California.

And industry experts don’t see prices rising very much in the near future. Which is surprising, considering that the countries of Asia, which need oil and gas for electricity production, will double their imports of oil to 20 million barrels a day in the next decade. That’s an amount greater than total U.S. oil use today.

But there are increasing amounts of oil and gas around to feed that demand. Technology is unlocking previously uneconomic deposits in South America, the North Sea, southern Africa and the Middle East. The Caspian region of the former Soviet Union will commence production within five years.

“The price of oil will remain reasonable because there will be a constant battle among oil producers to get their share of oil consumer markets,” explains Vahan Zanoyan, head of Petroleum Finance Co., a Washington-based consulting firm.

Countries and companies have changed their understanding of oil. “We don’t base our plans on price, but on our own costs,” John Browne, British Petroleum’s chief executive, told financial analysts in London last year.

BP’s average cost of producing oil right now is $2.40 a barrel. Chevron’s “finding cost”--the total of exploration and development expenditure--is $3 a barrel on average. So it’s easy to see why $15-a-barrel oil doesn’t faze the major companies.

Where once oil companies argued with governments, now they work under contract to petroleum ministries who need their expertise. The opportunities are great, so the stock market accords premium prices to the major international companies. The demands are great, and Douglas Terreson, a Houston-based analyst at Morgan Stanley, sees mergers ahead making big companies larger and consolidating functions to achieve economies of scale. Shell and Texaco, for example, are combining their U.S. refining and marketing operations in a new company named Equilon.

Halliburton and Dresser are merging so the combined company will have the full range of oil-field services and the ability “to go in and manage a project for the oil companies anywhere in the world,” explains Houston-based analyst Matthew Conlan of Prudential Securities.

There will be more mergers to come in the oil service field, predicts Mark Siegel, chairman of UTI Energy, a company that owns drilling rigs.

More revealing than changes in the companies is the shift in attitudes of governments. Oil used to be seen--and still is seen to some extent--as a necessity of national salvation and a cause of war. In the 1970s, President Nixon declared self-sufficiency a national U.S. goal.

But two decades later, the U.S. has taken the different tack of diversifying its suppliers. Venezuela, Canada and Mexico are now principal suppliers of imported oil.

Private companies from the U.S., Britain and the Netherlands are using technology to help countries everywhere increase production of oil. International oil futures markets, trading 24 hours a day, are setting the price now--not governments.

And the world is taking a cue from all this. China is participating in markets and developing oil with others, reports Daniel Yergin, co-author of “Commanding Heights,” a new book on the shifting relationships between governments and the private sector. China National Petroleum has invested in Kazakhstan’s oil efforts and in exploration with Iranian National Oil. China and Russia are working out investments to bring Russian gas to Korea, Japan and China.

The point is interdependence for economic development, says Yergin, whose earlier book “The Prize” is a widely respected history of oil.

Now if economic development instead of political instability would spread to Iraq and other countries in the Middle East, the question of war and the price of oil might never come up again. But the world isn’t changing that fast yet.

“Political instability continues to hobble Iraq and now even Egypt,” says Joseph Jabbra, professor of Middle East studies at Loyola Marymount University. There are signs of hope also, Jabbra says. “Saudi Arabia is making progress in petrochemicals. Syria is encouraging modern economic development, and many countries are seeing agriculture as a possibility for development. This region, after all, fed the Roman Empire.”

So it did, and yet today the region is a cause for reflection on the wealth of nations. Two decades ago, the Middle East was seen as rich because it had the resource of oil. Learned experts predicted the decline of the U.S. because it didn’t produce all the oil it consumed.

Yet the successful economies of the intervening years, including the U.S.’, have been those based on innovation and the advance of knowledge--including the knowledge of how to develop more oil. The price of oil today, accounting for inflation, is roughly $3 a barrel--just what it was in 1973.