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01/06/2000
The Future of Energy Prices, Part I
Awhile back I had a two-part story on OPEC and its relation to
the U.S. equity market as part of my "Wall Street History" link.
The story was mostly about the oil shocks of the 1970s. But
recently I read an article in the Jan./Feb. issue of "Foreign
Affairs" magazine which gave me pause. The authors, Amy
Myers Jaffe and Robert Manning, are negative on the future of oil
prices. I then remembered a piece from the Mar./Apr., 1998 issue
of the same periodical which has proved, thus far, to be somewhat
prescient. You''ll recall that back in the spring of 1998, and
throughout that year, oil prices were tumbling, down to about the
$10-$11 level (as measured by W. Texas crude). It was early in
1999 that they began to climb and in virtually a straight line
throughout the year to finish at the $25.60 level (after hitting $27
late last fall).
The author of the 1998 piece was noted oil expert Daniel Yergin.
Yergin was bullish on the future long-term price of oil. So who is
going to be right over the next decade? Well, let''s examine each
side over the next two weeks and then you can make up your
own mind.
As I write this, oil is trading at the $25 level. The bullish case is
built around the feeling that the production cuts which OPEC
engineered last spring will hold. In addition, the bulls say that
world stockpiles (inventories) will continue to be drawn down,
primarily because the global economy is gaining strength. One
noted expert, Charles Maxwell, believes that over time oil will
continue to surprise to the upside. Morgan Stanley strategist
Byron Wien is also in agreement with Maxwell.
The bears on oil would argue that, to the contrary, OPEC doesn''t
have a chance at maintaining the discipline they have so far on the
production quotas. They never have in the past. The next
compliance data may also show that the bears may be right. It''s
possible that the production targets are only being met about 70%
of the time (as opposed to the 85-90% compliance throughout
1999). In addition, the bears believe that we still have a
worldwide glut of oil, particularly when you take into
consideration the non-OPEC production which has generally been
in an uptrend for some time. But, this week we will focus on
Yergin''s bullish scenario.
Yergin was writing his 1998 piece at the height of the Asian
financial crisis and his comments mostly deal with that continent.
Back then, he was expecting the Asian economies to rebound
fairly quickly (which they obviously have) and that after a pause,
Asian energy consumption would rise again in just 2-3 years (it
already is).
Yergin writes, "The reason (why demand will rise) is that there
really was an Asian economic miracle, and the conditions for high
growth - discipline, flexibility, high savings, rapid absorption of
technology, embrace of international markets, and strong
entrepreneurial networks - are still in place."
"The source of the economic crisis is in the badly regulated
private financial sector. Once Asia begins to recover, meeting the
region''s energy needs will again become a preoccupation - and an
anxiety."
It has always been felt by doom and gloomsters like yours truly
that the specter of increasing demand for energy in Asia would
produce tensions, competition and outright conflict between the
region''s larger nations. Yergin argues that these gloomy
scenarios of conflict are unlikely to materialize because "of a sea
change in the approaches to economics and conflict around the
world." He argues that market-based solutions will be the norm.
One impact of the slowing demand that was witnessed until the
later part of 1999 was that the pressure came off many of the
Asian governments to continue to implement energy planning.
After all, it should be remembered that during the period 1990-
95, the demand for oil increased about 5% a year. For example,
by 1993 China moved from being a net exporter of oil to a net
importer, representing a fundamental change in Asia''s energy
balance.
In the future, Asia''s export-driven industrialization and its
dramatic increase in the use of cars and other fossil fuel-powered
transportation, coupled with rapid urbanization and
electrification, will combine to increase energy demand at a
projected annual rate of 4-5% through 2010. Yergin says this is
in contrast to an annual global rise of about 2% during the same
period. Growing by 4% a year, Asia''s oil demand will account
for more than 50% of the global increase.
The net increase in oil imports up through 2010 will be 9 million
barrels per day or more. Yergin projects that Indonesia and
Malaysis will join China as net importers of oil over the next
decade. As Indonesia now provides about 20% of Asia''s total oil
production, by 2005 the current net oil exports could disappear
due to domestic demand. [Of course, the domestic strife that
continues to sweep the nation will have something to say about
the timetable.]
And if you''re wondering about the impact of new exploration in
the Asian region (like the South China Sea), Yergin believes that,
regardless, Asia is destined to import more than 20 million barrels
of oil per day, compared with 11-12 million today. [Again, these
figures are from an article now 2 years old so I added the "12th"
million based on the current expansion taking place].
As for China and the South China Sea, why won''t this strategic
waterway become a future battleground over 1) potential
exploration and 2) actual shipments of the black gold? Yergin
believes that China''s leadership is sensitive to the importance of
securing its own energy needs. By 2010 China could be
importing almost 50% of its total oil demand which must come
from the Middle East or Central Asia. The last thing they want is
turmoil in the region which would upset their formula for the
economic transformation of the country. So rather than conflict,
Yergin sees a growing "mutuality of interest, increasing reliance
on free markets, cross-border energy trade (especially when it
comes to natural gas) and cooperation with Middle East
producers."
Yes, it always comes down to the politics of oil. And in the
growth scenario that Yergin envisions, a $20 plus price for oil
would seem to be low given the projections on supply and
demand.
Next week, the other side....and why the U.S. is foolishly
pursuing the potential reserves from the Caspian basin.
*In the interest of full disclosure, I currently have a substantial
position in energy-related issues. I will, however, refrain from
issuing my own forecast.
Brian Trumbore
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