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01/13/2000

The Future of Energy Prices, Part II

Last week we had the bull''s case for higher oil prices in the future
as enunciated by Daniel Yergin. This week it''s time for the bear''s
projections.

But first, a quick update on the current price environment. As of
1/12, oil (as represented by W. Texas Intermediate) was trading
back above $26 per barrel. It now seems clear that OPEC, as
well as key non-OPEC producers like Mexico, are looking to
keep the current production quotas in place. The producers are
concerned about factors like unused inventories as a result of
Y2K hoarding as well as the warm start to the winter in the
United States. This is raising questions about demand. So when
OPEC meets in March (ironically, the same date, 3/26, as the
Russian presidential election), they will opt to maintain the
production cuts they established early in 1999. No one expected
discipline in the ranks to last as long as it has.

Amy Myers Jaffe and Robert Manning wrote an article in the
Jan./Feb. issue of "Foreign Affairs." In it they state, "The energy
problem looming in the early 21st century is neither skyrocketing
prices nor shortages that herald the beginning of the end of the oil
age. Instead, the damage is precisely the opposite; long-term
trends point to a prolonged oil surplus and low oil prices over the
next two decades." And, they add, this scenario could destabilize
the oil-producing states, especially those from the Persian Gulf to
Russia.

According to the authors, the "sky-is-falling" school of oil
forecasting has been systematically wrong for more than a
generation. Back in 1972, a respected group of oil experts
known as the Club of Rome wrote that only 550 billion barrels of
oil remained and that the world would run out by 1990. In fact,
the world consumed 600 billion barrels of oil between 1970 and
1990, and there are today more than a trillion barrels of proven
reserves. And this figure is likely to rise as global consumption
exceeds the current 73 million barrels a day. The International
Energy Agency says that there are some 2.3 trillion barrels in
ultimate recoverable reserves.

So, under this scenario, the world''s problem is thus not scarcity
but glut, despite the Saudi-engineered production cuts. Jaffe and
Manning state that, "The political reverberations of a sustained oil
glut should not be underestimated. Many of the Gulf states,
Russia, the former Soviet republics and such key Latin American
countries as Venezuela, Mexico and Colombia - count heavily on
oil revenues to calm restive populations. Without higher prices
many of these nations would see heightened political instability,
social unrest or even civil wars. Such instability could trigger the
next oil shocks in the form of short-term disruptions."

The technology revolution has taken the oil and gas business by
storm, helping to make international crude-oil markets
increasingly global and transparent - a trend eased by the advent
of the oil futures and derivatives markets. Oil pricing is no longer
a secret process. Today it''s out in the open.

Other developments the authors foresee:

In the coming decade, the U.S. will increasingly rely on oil from
the western hemisphere and the Atlantic basin. It is East Asia''s
dependence on Middle Eastern oil that is rising substantially, not
America''s.

The transport sector''s use of oil is expected to account for more
than half of future oil-industry growth but here you have to look
at technology like new direct-injection engines that may
eventually curb the boom in demand for gasoline.

Trends in the Middle East also bode well for lower oil prices,
particularly as U.S.-led sanctions against Iraq, Iran and Libya
begin to erode.

But here is where the issue gets dicey. Decades of oil in the $12
to $20 range will lead to tremendous instability. [ If you''ve been
reading my "Week in Reviews" you know how I feel about
Venezuela, for example. Their flagging economy in ''98 helped
elect Chavez, ushering in a period of political turmoil.]

In the Gulf, succession crises may erupt as a generation of aging
leaders passes. The under 25 population is exploding, foretelling
problems in education and employment as well as increased
strains on resources such as food, water, health and electric
power. And oil has been no panacea. Since 1982, Saudi Arabia
has gone from $140 billion in surplus revenues to run up a
national debt of almost $130 billion.

As the Gulf economies shrink, job opportunities are becoming
increasingly scarce. Unemployment of 20-30% in the largest
cities is the norm and the large idle class of students is favoring
religious studies, this could become a major constituency for
Islamist opposition movements.

Violent internal disruptions could become a problem with
sabotage of one''s own oil installations a new potential challenge.

And finally, Jaffe and Manning advise the U.S. to be very wary of
ties to the Caspian oil basin and the authoritarian regimes therein.
We could find ourselves in a ton of local conflicts in which energy
and strategic interests are marginal.

Of course, as to this last point that is exactly what the U.S. is
doing by spending a lot of political capital in the new Caspian oil
pipeline project. Jaffe and Manning aren''t the first ones to say
that the energy interests are marginal...and, by extension, our
strategic interests are marginal as well.

So there you have it...the two sides of the oil game. Next week,
the 1967 Arab-Israeli War.

Brian Trumbore


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01/13/2000

The Future of Energy Prices, Part II

Last week we had the bull''s case for higher oil prices in the future
as enunciated by Daniel Yergin. This week it''s time for the bear''s
projections.

But first, a quick update on the current price environment. As of
1/12, oil (as represented by W. Texas Intermediate) was trading
back above $26 per barrel. It now seems clear that OPEC, as
well as key non-OPEC producers like Mexico, are looking to
keep the current production quotas in place. The producers are
concerned about factors like unused inventories as a result of
Y2K hoarding as well as the warm start to the winter in the
United States. This is raising questions about demand. So when
OPEC meets in March (ironically, the same date, 3/26, as the
Russian presidential election), they will opt to maintain the
production cuts they established early in 1999. No one expected
discipline in the ranks to last as long as it has.

Amy Myers Jaffe and Robert Manning wrote an article in the
Jan./Feb. issue of "Foreign Affairs." In it they state, "The energy
problem looming in the early 21st century is neither skyrocketing
prices nor shortages that herald the beginning of the end of the oil
age. Instead, the damage is precisely the opposite; long-term
trends point to a prolonged oil surplus and low oil prices over the
next two decades." And, they add, this scenario could destabilize
the oil-producing states, especially those from the Persian Gulf to
Russia.

According to the authors, the "sky-is-falling" school of oil
forecasting has been systematically wrong for more than a
generation. Back in 1972, a respected group of oil experts
known as the Club of Rome wrote that only 550 billion barrels of
oil remained and that the world would run out by 1990. In fact,
the world consumed 600 billion barrels of oil between 1970 and
1990, and there are today more than a trillion barrels of proven
reserves. And this figure is likely to rise as global consumption
exceeds the current 73 million barrels a day. The International
Energy Agency says that there are some 2.3 trillion barrels in
ultimate recoverable reserves.

So, under this scenario, the world''s problem is thus not scarcity
but glut, despite the Saudi-engineered production cuts. Jaffe and
Manning state that, "The political reverberations of a sustained oil
glut should not be underestimated. Many of the Gulf states,
Russia, the former Soviet republics and such key Latin American
countries as Venezuela, Mexico and Colombia - count heavily on
oil revenues to calm restive populations. Without higher prices
many of these nations would see heightened political instability,
social unrest or even civil wars. Such instability could trigger the
next oil shocks in the form of short-term disruptions."

The technology revolution has taken the oil and gas business by
storm, helping to make international crude-oil markets
increasingly global and transparent - a trend eased by the advent
of the oil futures and derivatives markets. Oil pricing is no longer
a secret process. Today it''s out in the open.

Other developments the authors foresee:

In the coming decade, the U.S. will increasingly rely on oil from
the western hemisphere and the Atlantic basin. It is East Asia''s
dependence on Middle Eastern oil that is rising substantially, not
America''s.

The transport sector''s use of oil is expected to account for more
than half of future oil-industry growth but here you have to look
at technology like new direct-injection engines that may
eventually curb the boom in demand for gasoline.

Trends in the Middle East also bode well for lower oil prices,
particularly as U.S.-led sanctions against Iraq, Iran and Libya
begin to erode.

But here is where the issue gets dicey. Decades of oil in the $12
to $20 range will lead to tremendous instability. [ If you''ve been
reading my "Week in Reviews" you know how I feel about
Venezuela, for example. Their flagging economy in ''98 helped
elect Chavez, ushering in a period of political turmoil.]

In the Gulf, succession crises may erupt as a generation of aging
leaders passes. The under 25 population is exploding, foretelling
problems in education and employment as well as increased
strains on resources such as food, water, health and electric
power. And oil has been no panacea. Since 1982, Saudi Arabia
has gone from $140 billion in surplus revenues to run up a
national debt of almost $130 billion.

As the Gulf economies shrink, job opportunities are becoming
increasingly scarce. Unemployment of 20-30% in the largest
cities is the norm and the large idle class of students is favoring
religious studies, this could become a major constituency for
Islamist opposition movements.

Violent internal disruptions could become a problem with
sabotage of one''s own oil installations a new potential challenge.

And finally, Jaffe and Manning advise the U.S. to be very wary of
ties to the Caspian oil basin and the authoritarian regimes therein.
We could find ourselves in a ton of local conflicts in which energy
and strategic interests are marginal.

Of course, as to this last point that is exactly what the U.S. is
doing by spending a lot of political capital in the new Caspian oil
pipeline project. Jaffe and Manning aren''t the first ones to say
that the energy interests are marginal...and, by extension, our
strategic interests are marginal as well.

So there you have it...the two sides of the oil game. Next week,
the 1967 Arab-Israeli War.

Brian Trumbore