Oil Supply Less Supple This Time
As far as oil markets are concerned, this war against Iraq is nothing like the last one.
Back then, adequate supplies were swiftly secured, and prices plummeted from record heights, even with two major exporters offline, Kuwaiti oil wells on fire and tankers slowed to a crawl in risky shipping lanes. Saudi Arabia and other nations had so much spare capacity that they could crank the valves wide open and calm oil traders’ frayed nerves.
Crude prices that shot up to $40.42 a barrel in the wake of Iraq’s August 1990 invasion of Kuwait dropped more than $10 the day after the U.S. began bombing Iraq in January 1991. They returned to the economically comfortable $20 range a week later.
Fast-forward to 2003, and to another war with Iraq. Crude prices rose before the bombing started 19 days ago, to just under $40 a barrel, then fell once the fighting began, settling at $28.62 a barrel Friday as U.S. troops closed in on Baghdad.
Glancing at prices, the two war scenarios might seem similar, said Amy Myers Jaffe, senior energy advisor at Rice University’s Baker Institute in Houston. “But there are actually some huge differences that could come back to bite us.”
The most critical: This time around, there isn’t much give in the global supply network. Any misstep can upset the supply-demand balance that holds prices steady.
Thirteen years ago, the market was overloaded with oil. The Organization of the Petroleum Exporting Countries was trying to shore up prices by holding down output by members, whose surplus production capacity at the time was a rich 5 million barrels a day.
U.S. storage tanks were filled to the brim, at a historic peak of 392 million barrels -- a 23-day supply at the time -- less than a week before Iraq invaded Kuwait. U.S. wells were producing enough to satisfy nearly 60% of U.S. demand.
Today, rarely used government stockpiles are ample, but commercial inventories in industrialized nations are at a 25-year low, able to meet about 50 days of demand, compared with 1990’s 87-day cache. OPEC’s extra oil production capacity has shrunk to between 700,000 and 1.2 million barrels a day by one estimate, at least 76% below what it was the summer of 1990.
U.S. inventories are in record-low territory, holding only about 14 days worth of consumption. What’s more, gasoline stocks are well below normal levels as the nation heads into the summer driving season. And output from domestic wells covers just 47% of what the country consumes.
Worldwide, “we’re living check to check right now,” said Phil Flynn, senior market analyst at Alaron Trading.
“We’re just one disaster away from a major price spike ... and it doesn’t even have to be a big disaster,” he said.
What changed between the first war and the second?
For one thing, refiners decided to cut costs by keeping less petroleum in storage. And oil companies and oil-rich countries “are more careful about their capital, and therefore don’t build spare capacity” like they used to, said Steve Chazen, Occidental Petroleum Corp. chief financial officer and executive vice president for corporate development.
“That creates more volatility, so a cold winter -- or a revolution in Venezuela or some other place -- will have a bigger effect than it would have 10 or 15 years ago,” Chazen said.
Meanwhile, the growing thirst for oil outpaced the discovery of oil reserves. Global consumption is 15% higher than in the summer of 1990, while proven reserves are 2% larger.
There hasn’t been an oil shortage -- buyers have been able to get all they want, though they have sometimes had to pay a premium. Consumers paid one in California, where the prewar runup in crude values, along with stunted gasoline supplies from misfiring refineries, sent prices at the pump zipping to a record-high average of $2.14 a gallon in mid-March.
To be sure, analysts say there has been a psychological “war premium” inflating prices. But there are also physical reasons for oil to be more expensive than it was a few months ago.
The invasion of Iraq eliminated the 1.7 million barrels a day that Baghdad had been exporting under a United Nations program, and the market is short another 1.3 million barrels a day or so because of civil unrest in Nigeria and underproduction in Venezuela.
The South American country is struggling to keep output at 2.5 million barrels a day, and aims to restore it to the more than 3 million barrels a day it was pumping before a nationwide strike in December crippled its oil industry.
Exports from Nigeria, which made up more than 5% of the United States’ crude oil imports last year, have fallen by 40% since ethnic fighting forced the shutdown of some oil facilities two weeks ago.
Others in OPEC -- Iraq, Nigeria and Venezuela are among its 11 members -- have stepped in to fill the gap, as they did when exports from Iraq and Kuwait were halted 13 years ago.
But many are producing at full-tilt, at a pace that Rice’s Jaffe says isn’t sustainable. Saudi Arabia, Kuwait, the United Arab Emirates and four other nations are pumping 2.9 million barrels a day more than they were four months ago, according to government estimates. They will get a break if the war ends soon and Iraq resumes exporting, even modestly.
“Things have been very fragile, which is why we’ve seen the prices where they’ve been,” said Daniel Yergin, chairman of Cambridge Energy Research Associates Inc., a Cambridge, Mass.-based research firm near Boston. “But if there are no further disruptions of supply from other countries, then we’ll see the supply-demand fundamentals improving week to week.”
No matter how long the war lasts, however, it could be months before Iraq is producing at its full pre-invasion rate of 2.5 million barrels a day; it could take longer to prod output back to the 1990 level of 3.1 million barrels a day. And it’s impossible to predict how production will fare in Venezuela and Nigeria, or whether war-fueled anti-American sentiment will surface in the world’s oil-rich nations.
With global consumption at 78 million barrels a day and growing, the pressure is greater now than in the summer of 1990 to find new resources.
“Oil is a depleting business,” said Occidental’s Chazen. “It’s not like a grocery store, where when you sell the groceries, you put some more in ... when you sell the oil, it’s sort of gone.”
There is huge potential in many places around the world, including Russia, West Africa and the Caspian Sea. “To replace some of the oil fields that are maturing, we are using technology that’s allowed us to explore in very deep water, where we couldn’t before,” said ChevronTexaco Corp. spokesman Fred Gorell. “That’s opened up new exploration opportunities all over the world, from West Africa to the Gulf of Mexico, Latin America and elsewhere.”
In the United States, it isn’t likely the steady decline in its oil output will be reversed; its big reserves were discovered and tapped long ago. Companies have diversified their nondomestic supplies, though, and today about 70% of imports come from countries outside the Persian Gulf, including Canada, Mexico, and the United Kingdom.
Still, relying so heavily on imported petroleum makes some in the industry uncomfortable. “Anytime you have to import products, whether it’s a computer made in China or gasoline made in China, your society’s more at risk,” said John DeWitt, chairman and owner of J.E. DeWitt Inc., an oil and gas distributor in South El Monte.
The economic risk is often checked by OPEC, whose members own 60% of the world’s proven reserves. The organization wants oil to be competitively priced, at between $22 and $28 a barrel, to keep alternative fuels from making inroads and ultimately reducing the world’s dependence on petroleum.
Much of the time, OPEC manages its production so that prices stay on a steady course. But who knows what the next 13 years will bring? Underdogs today could be oil giants tomorrow, and a resurgent Iraq could disrupt OPEC’s balancing act.
“One of the things about oil you can count on is that when everybody starts to get comfortable and they think they know what the future’s going to be,” Yergin said, “there comes a new surprise.”
