Image: Waves pound oil facilities
Erik J. Russell  /  Reuters
Waves pound oil facilities in the Bahamas
By John W. Schoen Senior producer
msnbc.com
updated 10/1/2004 9:41:46 PM ET 2004-10-02T01:41:46

The reasons for the recent relentless rise in crude oil prices are pretty straightforward — including a record string of hurricanes slowing shipments and closing oil rigs in the Gulf of Mexico. The list also includes political instability in oil producing regions from Iraq to Nigeria. But with oil prices rolling toward all-time highs, the longer-term forecast for oil prices is much less certain.

Crude oil topped $50 per barrel Tuesday, pushing past the psychological milestone for the first time then surging further to new record levels likely to unsettle oil-consuming nations.

While consumers have been conditioned to believe that each oil price spike is eventually met with a drop to lower levels, some analysts believe that the latest rise may have established a new, long-term "floor" for the price of crude.

"The Saudis made that pretty clear a few months ago when prices started to drift back down below $35," said Raymond James oil analyst Marshall Adkins. "They said, 'Alright, we’re not going to put in the production increase that we originally intended because oil prices have come back. That to me says we’ve got a pretty good floor."

The central cause of the run toward $50 a barrel is simple: For the first time in the history of the modern oil industry, global demand continues to rise faster than the world’s capacity to produce more crude. That's very differnt than the last major “oil shocks” of the 1970s, which were the result of a decision by the newly-formed Organization of Petroleum Countries to withhold supplies to drive up prices. But with prices now nearing $50, OPEC producers are pumping as fast as they can — and just barely keeping up with the current global demand of roughly 82 million barrels per day.


“We have an incredibly tight oil market,” said Daniel Yergin, chairman of Cambridge Energy Research Associates. “And that means the market is vulnerable to any kind of shock or semi-shock because there is hardly any give in the supply.”

Those shocks have been coming fast and furious in the past few months. Escalating attacks on Iraqi oil pipelines have repeatedly crimped output from what was once one of OPEC’s biggest producers. I

In just the past two weeks, those hurricane-related disruptions have cut the U.S. supply of crude by 16 million barrels to less than 270 million barrels — well below the average level for this time of year, according to the Energy Department. (The next weekly report on inventories is due Wednesday.)

Oil Squeeze - Inventories of crude oil have fallen below their 5-year average range, pushing prices higher.

To help cushion the blow of storm-related interruptions, the Bush administration last week drew down about 1.7 million barrels of crude from the U.S. Strategic Petroleum Reserves and lent it to refiners whose supplies. Once those storm-delayed shipments reach shore, that oil will be pumped back into the reserve, which is approaching its full 727-million-barrel capacity. Video: Pain at the pump

The White House says it remains committed to its position of not selling that oil on the open market to try to drive down prices.

"Obviously, it's always something that we keep a close eye on, in terms of the (oil) price," White House spokesman Scott McClellan told reporters aboard Air Force One en route to a campaign event Monday. "But if you're talking about the Strategic Petroleum Reserve, that should not be used to manipulate prices or for political purposes. It's for national emergencies or physical disruptions in the supply."

Hardest hit
Industries that rely heavily on energy have been hit hard. In the airline industry, major carriers already buffeted by competition from low-cost competitors are bleeding even more cash to pay for higher jet fuel. While some rail and trucking companies have managed to pass along higher fuel costs, many are also seeing profits squeezed.

But economists say the overall U.S. economy is in much better shape to weather the shock of high oil prices than it was in the 1970s, when a spike in crude prices lit a fire under inflation that took years to extinguish. Part of the reason is that, even at current prices, oil is still selling for less than its inflation-adjusted peak of about $80 a barrel in the late 1970s.


What's more, the U.S. economy today is better able to withstand the recent rise in oil prices because most businesses and consumers are less dependent on oil, in part because of conservation measures undertaken after the 1970s oil shock. As a result, the U.S. economy today uses about half as much oil to produce a dollar in gross domestic products than it did 30 years ago. Still, the recent price run-up will likely shave a few tenths of a percent off the GDP, according to UBS Investment Research chief economist Maury Harris.

From the field“If you have $50 (oil) instead of $35 (oil) on a sustained basis, you could go a couple of years where you’re three-tenths (GDP) less than otherwise,” he said. “Now that’s something that the economy can handle, but it certainly at that point starts to makes a difference.”

In theory, higher oil prices should spur production, bringing more supplies on line to ease the crunch. But so far, major U.S. oil companies have been slow to ramp up exploration and production. Many analysts believe that’s because memories are still fresh of the 1990s oil boom, when prices crashed to $10 a barrel by 1998.

“Executives that are now in place at most of these major firms have not made their careers out of sticking their necks out when commodity prices bounced up,” said Adkins. “They made their careers by basically making sure your costs didn’t get out of control.”

Even if Western oil producers invested billions today, the oil markets wouldn’t see significant new supplies in the short term. For one thing, it takes years to bring new production on line. And if world demand continues to grow at the current annual rate of about 2.5 million barrels a day, non-OPEC producers just don't have enough in proved reserve. So much of the increase in supply will have to come from OPEC and other national oil companies, said Adkins.

“The scary thing about that is supply cannot go up another 2.5 million next year. The oil isn’t there,” he said. “So if the global economy tries to grow at the same pace next year that it is this year, you’ve got a real problem.”

If oil supplies can’t keep up with demand, some of the world's economies will fare better than others. In general, developed countries are better prepared to weather another oil squeeze because their economies have become more efficient. The United Kingdom, for example, produces some $2,800 in GDP for every barrel of oil consumed, while China produces less than $700 for each barrel.

Even if the global economy slows and production capacity increases, some oil exporters say that sharply higher oil prices are here to stay. A long-simmering debate in the oil industry over the long-term outlook for oil production is heating up with every fresh rise in the price of crude.

One camp believes that while short-term disruptions will continue to produce price spikes, the world still has plenty of oil. But the other camp argues that oil production is near — or at — peak levels, and total global output will soon begin a gradual decline just as it did in the United States when oil production peaked in 1970. Though alternative fuels and gains in efficiency may ultimately wean the world off oil, proponents of “peak oil” theory say that the transition might not happen quickly enough. If it doesn't, they warn, the result could be extremely painful.

“We really are close enough to the edge to have no excess capacity. Demand growth shows no sign of slowing and now it seems to be accelerating,” said Matt Simmons, a Houston-based investment banker. “It’s really important to know what the real story is — as bad as it may be.”

              Next: Why high oil prices haven't cut demand

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