May 22, 2006

The Real Story of Pricey Oil
Since the mid-1970s the demand for petroluemn in Western Europe and Japan has been flat. In the United States it has doubled.
By Fareed Zakaria

In March 2005, when a young Goldman Sachs analyst, Arjun Murti, predicted a doubling in oil prices to $100 a barrel, some compared the projection with the exaggerated forecasts of the technology era. But with oil at $70 a barrel, Murti's idea doesn't look bubbly anymore. Now we're experiencing a different conventional wisdom, one that says high oil prices reflect simple economics and there's not much anyone can do about it. Demand is rising, supply can't keep up, so prices rise. But behind the economics lie two powerful political realities that are worth exploring-and that suggest that market fatalism is the wrong response to this looming crisis.

I don't know if the world is running out of oil, a subject of heated debate. Even oil experts really are just guessing. But what's clear is that supply is low because few producers are spending big chunks of money to find and develop new oilfields. Without massive long-term investments, supply cannot keep up with demand. Another Goldman analyst, Jeffrey Currie, estimates that it would take $3.5 trillion dollars (yes, trillion) in the next decade to keep up with rising demand. Actual investments are going to be a fraction of this number.

Why? Partly because oil companies are fighting the last war. Spooked by the 1980s, when oversupply caused prices to collapse, they have been underinvesting for a decade. But private oil companies-the so-called majors-have reversed course. The problem is that the majors are actually the minors now. Exxon, Chevron and BP are small in comparison with the real giants, the national companies of the major oil-producing countries. They-Saudi Aramco, Petróleos de Venezuela S.A.-control more than 70 percent of oil production. And mostly they are not investing for the long term. Why? It's politics, stupid.

There are really only five countries that matter in the world of oil: Saudi Arabia, Iran, Iraq, Russia and Venezuela. And in every one of these countries, the government has questionable legitimacy or competence. Thus political leaders use their oil money to buy political support. They provide vast handouts to their people-gas is 40 cents a gallon in Iran!-in hope of keeping them quiet.

Consider the lineup. Saudi Arabia is actually the best of the bunch. While it lavishes its population with benefits, it has also begun spending to build up its supplies. The others are much worse. Russian production was growing 5 to 10 percent a year in the 1990s but is now increasing at merely 2 to 3 percent. Iran is flat, Iraq is down and Venezuelan production has dropped by half since 2003. In order to build up real capacity, these governments would need to take their oil revenues and reinvest them in projects that would take five to 10 years to spout oil. Which of these countries has that level of stability, confidence or competence?

The second political reality is in the United States. For all the talk about China and India, America remains the gorilla of global gas. India consumes 2.5 million barrels of oil a day. America burns 10 times that amount. The single biggest shift in global demand over the past decade has not been the rise of China but the rise of SUVs. Since the mid-1970s the demand for petroleum in Western Europe and Japan has been flat. In the United States it has doubled.

This ever-rising economic demand in America is fueled by politics. Without a loophole in the law, SUVs would be banned. Without artificially low gas prices, Americans would not guzzle as much gas. The American government subsidizes gas in many different ways, big and small. As consumers, we do not pay for the enormous expense involved in policing the Middle East, an expense we would almost certainly not incur if its chief export was carrots. We do not pay for the environmental fallout from burning gasoline. We get free roads and a free ride. And it might get freer. American politicians are jumping all over themselves to provide tax relief because a gallon of gas might hit $4-while prices in Japan and Europe are close to $7. I understand why the Saudi regime keeps gas cheap to bribe its citizens. But must America do the same?

President Bush has set up an absurd investigation into price fixing and gouging, which at best will be an exercise in futility. But imagine if he set up a national commission on energy that explained to Americans why prices were high. If the president and Congress were to propose a powerful package of measures-higher gas taxes, fuel-efficiency standards starting at 30 and rising to 40 miles per gallon, tax credits for new technologies-it would begin to wean the United States off its addiction to oil. And, it would signal to the market that demand for oil in the United States was likely to slow and stabilize. The fear, uncertainty and speculation that is built into the price of oil right now would ease. I can see the headline now: government acts boldly; oil prices drop. That's not just good economics, it's good politics.