March 19 , 2003
This past week, stock values
of companies owning oil reserves reached a 52 week low while the price of a
barrel of oil reached a 52 week high. Is
the world going crazy, and what does this mean for economic growth in the next
I will not vouch for the
sanity of the world, but most oil producers are convinced that war with Iraq
will create a temporary shortage of crude oil.
"Temporary" means there is little incentive to increase
exploration, as a new field will not be delivering until well after war is
over and the oil fires, if any, are out
that oil refineries and distribution systems (including gas stations) will
suffer higher costs long before customers can be acclimated to commensurately
higher prices. In other words,
oil companies probably will lose money in those ventures.
While I certainly think that
the 52 week low for oil stocks is overdone, and I would be buying oil service
investments at this time, this disparity between refining and exploration
certainly explains why profit concerns exist in the oil patch.
Remember, 55 percent of the crude is purchased from foreign suppliers,
while most of the refining and almost all of the distribution is done by
shortages are not good for economic activity.
The three great world recessions following World War II (1973-74,
1980-82, and 1990-91) all were spawned by "temporary shortages" of
Those television interviews
of people pumping gas into their vehicles and declaring that
"they must pay the price because they need to get to work"
explains some of the problem. In
the short run, we are located a certain distance from our jobs, have autos of
some degree of fuel efficiency, and work in environments whose energy
efficiency is already built in.
Because energy costs are
small relative to the job locations, auto prices, and buildings, we change
very little when prices rise. Yet,
a shortage requires that something must change.
Thus, oil product prices rise so high that the ability to buy other
goods and services is impacted. This
leaves goods on the shelves and service providers without sufficient work.
Some lose their jobs, so they no longer need to drive to a job that no
longer is there.
Eventually, the job losses
and reduced economic activity eliminate the shortages.
In the meantime, we begin to change locations, alter the fuel
efficiency of our vehicles , change our driving behavior, and make our
buildings more fuel efficient. By
the time the temporary shortages are over, the changing behavior begins to
generate a glut of petroleum, and petroleum prices fall sharply.
Is there a shortage of oil
A slowing in world economic
growth and an increase in production from Russia, Colombia, and a few other
locations would suggest that the answer is no.
However, a decline in energy content per dollar of GDP that began in
1973 has been halted by the explosion of sport utility use, especially in the
United States. Also, China has
increased its rural highways from less than 100 miles a decade ago to more
than 12,000 miles today. The land
of the bicycle is motorizing.
The world is growing more
slowly and production is increasing, but energy needs per unit of growth now
are increasing. Adding to energy
use is an unusually cold winter. Three
great lakes are frozen for the first time in 9 years.
Ice skaters have returned to almost all the canals in the Netherlands.
More to the point, energy output jumped 2.5 percent in February while
energy material inventories plummeted to the lowest levels in nearly three
I once estimated that the
U.S. needs about 250 million barrels of oil and product to keep its pipelines
operating efficiently. Last week,
that inventory had fallen to less than 270 million barrels.
Natural gas inventories fell 13 percent in a single week in late
February and are now at only one trillion cubic feet.
To be sure, spring is coming. (It is busting out all over in the South but snow still
blankets most of the large Northern and Midwestern cities.) This will allow natural gas supplies to rebuild.
Indeed, those prices have fallen more than $2 per thousand cubic feet
in the past two weeks.
However, OPEC indicates that
it is producing at only a million barrels less than capacity outside of
Venezuela. (The Venezuela
production numbers are under dispute because of the ongoing political unrest
in that country). With Iraq
currently producing at 1.7 million barrels per day, a war might mean real
shortages that can be intensified if other Mideast production is disrupted.
The United States uses well
over 6 billion barrels of oil per year. With
prices up $17 per barrel from a year ago and little of that gain being
returned in the form of new exploration, President Bush's tax cuts pale in
comparison to the drain on the economy created by higher oil prices.