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Why oil prices will stay
high
By Jephraim P Gundzik
The recent decision by the Organization of
Petroleum Exporting Countries (OPEC) to reduce oil
production has crystallized the growing influence of
geopolitics on crude-oil supplies.
Despite
strong pressure from the administration of US President
George W Bush on OPEC to delay its planned production
cut, the position of Saudi Arabia - to reduce supplies -
prevailed. More important than the immediate impact on
oil prices, OPEC's action signals the depth to which US
foreign relations with Persian Gulf countries have
plunged in the year since the US invasion of Iraq. US
foreign relations with other key oil-producing
countries, including Russia and Venezuela, have also
weakened considerably over the past year. Increasing
antagonism between the world's largest oil producers and
the Bush administration will keep world oil supply lean
through at least the end of 2004. With supply
diminished, oil demand, particularly in Asia, will
remain strong, pushing international oil prices above
US$40 per barrel.
Saudi Arabia holds the world's
largest petroleum reserves and accounts for more than
one-third and one-half of total OPEC oil production and
spare production capacity, respectively. Its dominant
position in OPEC and importance to world oil supply has
made strong relations with Saudi Arabia a priority for
the US government over many administrations. In the
past, strong relations with Saudi Arabia gave the United
States considerable influence over OPEC, helping to
ensure that international oil prices remained at levels
acceptable to consuming countries. But over the past
three years, relations between the Bush administration
and Saudi Arabia have deteriorated substantially. The
role of Saudi nationals in the terrorist attacks against
the US in September 2001 instigated this deterioration.
The deterioration in relations advanced with the US
invasion of Iraq, which Saudi Arabia, along with many
other Gulf countries, opposed. These countries opposed
the war in Iraq specifically because they feared it
would strongly destabilize the entire region - a fear
that has been realized.
In addition to the
chaotic conditions accompanying the US occupation of
Iraq and growing instability there, terrorist attacks
have occurred in Saudi Arabia, Morocco and Turkey. The
conflict in the Palestinian Territories has escalated to
heights unimaginable two years ago and the Bush
administration continues to threaten Syria and Iran.
Washington has succeeded in alienating almost every
country in the Middle East. Against this background,
it's no great leap to infer that many of the region's
governments would be happy to see Bush defeated in this
year's presidential elections, potentially heralding a
change in US foreign policy and the return of stability
in the Middle East. While the Gulf countries have no
influence over US foreign policy, they do have modest
leverage over the US economy via their ability to
control oil supply and therefore international oil
prices. High oil prices will undermine the US economy,
threatening Bush's re-election.
Russia is the
world's largest crude-oil producer and its
second-largest oil exporter. Like Saudi Arabia, Russia
has strong influence over world oil supply and
international oil prices. Relations between the United
States and Russia, though seemingly strong after the
terrorist attacks in the US, have deteriorated sharply
over the past year. Russia also strongly opposed the US
invasion of Iraq. While Moscow was loath to see the
Middle East destabilize, it was even more concerned with
the potential of increased instability in Central Asia
and in Russia as a result of the war in Iraq. As in the
Middle East, an upsurge of terrorism has swept through
Central Asia and Russia over the past year. In addition
to increasing instability, the government of President
Vladimir Putin is also very concerned about US plans for
permanent military bases in Uzbekistan and Kyrgyzstan,
and Washington's influence over Georgia, a key transit
point in the Caspian oil pipeline.
Though Putin
and Bush may be "friends", it is unlikely that Putin
would be thrilled about a second term for Bush and the
implications this would have for instability around and
within Russia. Over the past year, the Putin government
has consolidated its command over the country's oil
companies, giving Moscow effective control over oil
production and exports. Like the Gulf countries, Russia
can also have modest influence over the US economy and
the outcome of the US presidential elections via its
ability to withhold oil supply, pushing international
oil prices higher.
President Hugo Chavez of
Venezuela is definitely not a friend of Bush.
Venezuela's government remains adamant that the Bush
administration covertly supported the coup that
attempted to topple Chavez in April 2002. Chavez has
suggested that the Bush administration also supported
the oil-sector strike in late 2002, as well as the
recent recall referendum in Venezuela. Chavez even
threatened to stop Venezuela's oil exports to the United
States if Washington continued to interfere in
Venezuela's highly fractured political morass. Venezuela
accounts for 14 percent of total US oil imports and 8
percent of OPEC oil production. Chavez would probably
relish the opportunity to undermine Bush's re-election
chances by restricting oil imports or oil production, or
both.
Even a minor decline of oil production, of
a further 1 million barrels per day, in Saudi Arabia,
Russia and Venezuela would push international oil prices
well above $40 per barrel. Reduced oil production in
these countries cannot be offset by increased production
in other countries. World spare oil production capacity
is estimated to be only about 2.5 million barrels per
day. Nearly one-half of this spare capacity is held by
Saudi Arabia, Russia and Venezuela. Because only a small
decline in production would have an inordinately large
impact on oil prices, these countries would all benefit
more from withholding production than increasing it.
Against the backdrop of tightening oil supply, demand is
expected to remain quite firm.
World oil demand
is expected to increase by about 2 percent in 2004.
Demand in both North America and Europe is expected to
increase by only about 1 percent. In contrast, oil
demand in Asia is expected to grow by 4 percent this
year, led by nearly 11 percent growth of oil demand in
China. This is very significant because China is the
world's second-largest consumer of crude oil after the
United States. China's crude-oil consumption was
equivalent to nearly 70 percent of the combined crude
oil consumption of France, Germany, Italy and the United
Kingdom last year. Though economic growth is expected to
slow marginally in China this year, oil demand growth is
expected to remain underpinned by the country's
insatiable energy demand.
The high degree of
energy price subsidization in China suggests that higher
international oil prices will not significantly impact
economic growth there. The main impact of continued high
international oil prices will be on China's fiscal
accounts. In the rest of Asia, the sustained strength of
international oil prices will restrain economic growth
by an average of about 0.5 percent this year.
Tightening world oil supplies and continued
strong demand for oil will push oil prices above $40 per
barrel (West Texas Intermediate basis) this year.
However, in the short term, oil prices could slide. In
addition to building oil stocks in the United States,
which recently reached a 19-month high, speculative long
positions in oil derivatives are very large. At some
point these speculative positions will shake out,
pushing prices lower.
Nonetheless, any downward
correction in prices will probably be short-lived. Only
significantly weaker-than-projected oil demand growth in
China could lead international oil prices on a sustained
down trend this year.
Jephraim P
Gundzik is president of Condor Advisers, Inc. Condor
Advisers provides emerging markets investment risk
analysis to individuals and institutions globally.
(Condor Advisers Inc)
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