BIKE: coupla observations

[Roger Baker]

With regard to Michael Zakes' earlier question about why gasoline is  
still strangely cheap at about $1.70 a gallon despite the rapid rise in  
oil prices this month, NPR had a good piece today explaining it as  
follows:

Just as Lane Wimberly noted, there is not only the price of oil to  
consider but other bottlenecks that can affect supply like tanker  
availability and refining capacity. In this case a lack of domestic  
refining capacity caused oil to be processed at foreign refineries and  
reshipped here as more expensive gasoline to meet the summer peak in  
domestic driving demand.

With the domestic refining bottleneck resolved temporarily, the price  
of oil itself is probably about to reassert itself as rises in gasoline  
and heating oil prices pretty soon.

Just below is a good piece on what is likely to happen next year.  As  
you can see, world oil production is likely to fall well short of world  
demand leading to a price rise big enough to slow world economic  
growth, worldwide next year. Below that is another excellent economic  
analysis by an Indian economist predicting much the same thing.  --  
Roger

                ***********************************************

http://news.bbc.co.uk/1/hi/business/3554462.stm

"...The IEA, set up thirty years ago to advise oil consuming nations,  
said world demand would rise by a further 1.8 million barrels next year  
to 84 million barrels a day.
It added that Opec's production capacity would rise by 400,000 barrels  
a day this year, and by a further 700,000 barrels a day in 2005. "The  
market is tight, production and infrastructure capacity is less than  
desired, and uncertainties continue to weigh on the market," the agency  
said... Last week, IEA chief economist Dr Fatih Birol told BBC News  
Online that economic growth would slow unless oil prices retreated from  
their current highs..."

              ************************

The Hindu Business Line : The coming global recession in 2005
Monday, Aug 16, 2004
http://www.thehindubusinessline.com/2004/08/16/stories/ 
2004081600110800.htm

V. Anantha Nageswaran

A recession may be looming especially with the unprecedented rise in  
world
oil prices, which have historically presaged every recession in  
America. But
on oil there is breathtaking complacency says V. Anantha Nageswaran, and
warns of the portends of faulty OPEC reserves and output data, the UK
turning a net fuel importer and the developments in West Asia.

THIS column has, in the last few weeks, commented on the unrealistic
optimism of the Federal Reserve chairman on the state of the American
economy. One smart commentator called upon those with a penchant for  
wishful
thinking to join the Fed or an investment bank, he should have added,  
for in
recent times, the Federal Reserve governor had begun to sound more like  
the
chief economist of a Wall Street investment bank.

Shockingly high American trade deficit in June

However, it was truly Friday the 13th for the American economy and for  
the
Fed because US trade deficit for June exploded. Not only was the trade
deficit for May revised higher from $46 billion to $46.9 billion, but  
also
that for June at $55.8 billion was well above consensus estimates.
University of Michigan consumer confidence was lower than expected and  
West
Texas Intermediate Crude Oil price closed at $46.58 a barrel. That is an
appreciation of more than 43 per cent from the end-2003 close of $32.52  
a
barrel.

This has been our refrain all along. Either the US economy loses  
momentum
and heightened interest rate expectations are unmet or the US economy
continues to sizzle and pushes the trade and current account deficit
relentlessly higher, placing even greater demand on global savings to
finance American consumption.

Dollar to be hurt by low yields and high deficits

In either case, the inevitable result is a much weaker dollar. That  
trend
has just resumed after a hiatus that was inspired by tales of an  
unlikely
rebound in a debt-laden American economy.

Interestingly, what is emerging is some combination of both of the  
above and
that is serious. America could be experiencing an economic slowdown  
and, at
the same time, see its imports surge because of high oil price. Egged  
on by
automobile producers to acquire more (fuel inefficient) vehicles that  
they
do not need, it is possible that the demand for gasoline (petrol) has  
become
less elastic in the US. Consequently, despite a slowing economy, imports
might remain high. Thus, potentially high trade deficit unsupported by
interest rates presages a significantly weaker dollar. However, the  
weakness
of the dollar will have to fall disproportionately, yet again, on the  
global
major currencies. Asian currencies are unlikely to make gain against the
dollar as their economies would be unable to cope with high crude oil  
price.
The Asian economic miracle, after the 1997-98 Asian crisis, remains a  
work
in progress, notwithstanding tall claims or hopes to the contrary  
expressed
by East Asian governments and their cheerleaders.

Complacency over oil

Generally, there has been breathtaking complacency about the impact of
higher crude oil price. Even the Fed, justifying its rate hike last  
week,
blithely expects high energy prices to moderate. Investment banks,  
relying
on demand and supply figures, expect prices to moderate. History is on  
their
side. High price for oil has invariably contributed to its own decline,  
as
demand is elastic, new supply comes on stream at higher prices and oil
extraction from rare fields becomes viable. However, there is only so  
much
driving that one can do by looking at the rear-view mirror.

The energy efficiency of the Western economies is often cited as the  
proof
of the resilience of global economy to high oil price. It may be  
partially
true. Previous oil shocks might have pushed back the threshold oil price
that hurts global activity. Hence, the impact of a high price for energy
would not be linear. But to dismiss it as irrelevant is dangerous folly.
Every recession in America has been preceded by a surge in oil price.  
This
year's high crude oil price might already presage one in 2005.  
Perversely,
the Fed is preparing for it now by raising rates so that it could lower  
them
next year!

Optimists who argue for lower prices may be overlooking two factors.  
One,
they assume that the figures on which they base their analyses are  
reliable
and, two, they may be overestimating demand elasticity. It is doubtful  
if
they could really model the emergence of nearly 2.0 billion people out  
of
poverty into lower and middle income classes and the resulting shift in
demand curve to the right: More quantity is demanded at all prices.
In India alone, casual observation would record the explosion in the  
number
of automobiles on the road and the chaotic way in which traffic is
organised. Both contribute to rising fuel consumption. Further, the  
policy
of subsidising passenger traffic with freight means there is larger  
movement
of goods through roads. This further enhances demand for hydrocarbon  
fuels.

Shrinking Supply
Faulty OPEC reserves and output data

Despite the OPEC (Organisation of Petroleum Exporting Countries)  
increasing
its output from August, crude oil price has continued to surge unabated.
Analysts are forced to conclude based on persistently high price that  
they
might have erred in estimating both demand and supply. In 1987, most  
OPEC
countries increased their estimation of reserves, overnight. That was
because production quotas were to be set in line with estimated  
reserves.
Since then, the reserves have stayed constant. That is possible only if  
new
discoveries matched production year after year. That is a statistical
impossibility.

Recently, a leading firm of Texas oil consultants backed by British
economists pointed to OPEC as the reason behind the current crude oil  
price
surge. They accused the cartel of deliberately exaggerating the real  
level
of its members' output. They calculate that OPEC members have been
exaggerating their oil output by up to 2 million barrels per day (bpd),  
more
than 7.5 per cent.

According to the official data, millions of barrels of oil are  
accumulating
in untraceable depots, a possibility that is dismissed as implausible  
by oil
and shipping analysts. This paradox, dubbed the "mystery of the missing
barrels", has now been solved, according to new research from Groppe,  
Long
and Littell, a long-established Texas-based oil consultant whose clients
have included Shell, ChevronTexaco and BP; and from Lombard Street  
Research
in London.

After analysing 30 years of data, focusing on import figures of all the  
main
oil consumers and adjusting them for the quality, type and weight of  
oil and
different measures used, Groppe and his team have uncovered  
discrepancies.
On average, the OPEC countries claim to produce between 1.25m bpd and  
2m bpd
more than their real output. Only half of all announced supply increases
actually materialise.

Groppe said: "There is no way to get accurate information on any OPEC
country's oil exports. The IEA is forced to rely uncritically on what  
it is
told by governments. The real level of Saudi production is one of the  
most
closely-guarded secrets in the world."

In a bid to hide the fact that they are not producing as much oil as  
they
claim, some OPEC countries are also over-reporting their consumption of  
oil.
Demand for oil from West Asia is officially set to hit 5.56m bpd this  
year,
almost as much as the 6.29m bpd from China. It is allegedly also greater
than the 4.82m bpd expected to be consumed by the whole of Latin America
this year.

UK is to become a net fuel importer soon

Among non-OPEC producers, the UK trade deficit, which swelled to 4.97
billion pounds ($8.9 billion) in June, is set to widen as North Sea oil
reserves that were first tapped in the 1970s become depleted, said Alex
Kemp, Britain's official oil historian.

The trade deficit widened in June from 4.8 billion pounds in May, the
government said in a report yesterday, as the surplus in oil declined  
to 22
million pounds, the lowest since August 1991. By volume, Britain  
imported
more oil than it exported in June. The UK, Europe's second-largest  
economy,
may become a net importer of oil and gas within three years, Kemp said.
By the end of 2002, the UK had produced a total of 32.9 billion barrels  
of
oil equivalent, which includes oil and gas, with remaining reserves  
possibly
as low as 13.6 billion barrels, the latest available government figures
show.

As early as next year, the UK, the world's fourth largest gas producer,  
will
become a net importer of the fuel, according to forecasts by Kemp and  
the UK
Offshore Operators' Association, an industry lobby group.

The case of Oman and its parallel for Saudi Arabia

The UK has joined Indonesia which, earlier this year, became a net oil
importer. An article by Bill Powers, Editor of Canadian Energy View  
Point
(http://www.financialsense.com/editorials/powers/2004/0801.html) argues  
that
some of the enhanced oil recovery techniques employed by Oman have  
resulted
in an accelerated decline in production and that similar techniques  
Arabia
have also been employed on the world's largest oil field, Saudi Arabia's
Ghawar. Horizontal drilling in Oman's Yibal field has led to a dramatic
increase in water production and an equally impressive decline in oil
production.

Matt Simmons, one of the US President, Mr George Bush's energy advisors,
believes that Ghawar field is about to head into terminal and  
irreversible
decline. Should that happen, the world would soon experience triple  
digit
oil prices.

He favours pricing crude oil at $182 a barrel so that demand could be
controlled and there would be time to find bridge fuels and fuels to  
fill
the gap between an oil economy and a renewable economy
(http://news.bbc.co.uk/2/hi/business/3777413.stm). Mr. Matt Simmons also
belongs to the Association for the Study of Peak Oil and Gas
(www.peakoil.net).

It would be useful to know if India, a heavy oil importer, has any  
strategic
thinking not only to counter short-term price spikes but also a  
long-term
fuel plan for a one billion strong economy. Neither this government nor  
any
in the past has displayed a comprehensive approach to energy security.  
The
previous government merely sanctioned the building up of a strategic oil
reserve. That is a short-term remedy.

For now, as Stephen Roach of Morgan Stanley puts it, there is a 40 per  
cent
chance of a global recession in 2005 and rising by the day.

With a marginal current account surplus, a lower fiscal deficit and a  
higher
starting point for cutting interest rates, Europe seems better placed  
than a
debt-laden America and an energy importing Asia, to tackle that.  
Investors
should know where to place their bets.

(The author is an economist based in Singapore. Please address feedback  
to
nageswar)



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