An Easily Threatened Oil Industry
A Storm or Terrorist Attack Anywhere Could Disrupt Supplies Globally

By Justin Blum
Washington Post Staff Writer
Wednesday, September 21, 2005

First, Hurricane Katrina battered oil platforms and refineries, shuttering production and causing gasoline prices to soar. Yesterday, Hurricane Rita was bearing down on the Gulf Coast, threatening more damage to the country's strained oil operations.

A decade ago, such hurricanes may not have rattled the oil industry or pushed prices sharply higher at the pump.

But in the past few years, as global oil demand has increased, the industry has become increasingly vulnerable. A powerful storm or terrorist attack threatens to turn the oil industry inside out and send gasoline prices to record highs.

"When the market is running tight, anything -- whether it's a hurricane, or war, or revolution, or terrorism -- can precipitate a crisis," said Robert J. Lieber, a professor of government and international affairs at Georgetown University and author of "The Oil Decade."

Some recent books have even stoked fears that the world's oil production is peaking, a prelude to an era when wells will run dry. Industry officials say plenty of oil remains in the ground -- it's just a matter of producing it.

But surging global demand -- coupled with production and refining that have not kept pace -- virtually wiped away spare capacity that could be tapped if operations halted in some part of the world.

Katrina dramatically showed the impact of a sudden disruption. After soaring to records, oil and gasoline prices have retreated a bit. But Katrina has left the world -- and particularly the United States -- even more vulnerable to problems developing in the oil supply chain in the coming weeks and months. Some oil production and refining capacity remains off-line in the Gulf of Mexico and on the coast, eating away at the narrow cushion that keeps demand from overwhelming supply.

"This was a big reminder of how tight the system is," said Roger Diwan, a managing director at PFC Energy, a District-based consulting firm. "And what Katrina did is make the system even tighter going forward."

This situation is fundamentally different from price spikes in the 1970s, when oil-producing countries deliberately took supplies off the market.

Without the ability to pump much more oil, the Organization of the Petroleum Exporting Countries has been unable to guide prices lower. The cartel, concerned that high prices ultimately could dampen demand and cut into the revenue of its member countries, yesterday offered to make available to the market the little spare oil it can produce. But similar offers have been rebuffed in the past because there is little global refining capacity to turn those grades of oil into gasoline and other needed products.

The world's thirst for oil has been increasing steadily, largely because of economic growth in the United States, China and elsewhere. Global oil demand this year is estimated at 83.5 million barrels a day, up from 69.8 million a decade ago, according to the Paris-based International Energy Agency. That would represent an increase of nearly 20 percent.

Industry analysts and national security specialists are increasingly concerned about terrorist attacks on oil facilities, particularly in Saudi Arabia, the world's dominant oil-producing country. But less significant events -- such as strikes, political strife or mechanical failures -- could spark similar problems.

Such disruptions could be felt around the world, including in the United States, whether or not it relies on the affected country for oil supplies. Oil is traded globally, and without a safety net of spare production, a decrease in supplies coming from any country pushes up prices around the world.

The industry had more flexibility to adjust to disruptions when it was able to produce more oil than the world demanded.

For instance, before the war with Iraq in early 2003, the world could pump about 4 million barrels of oil a day more from the ground than it already was producing, analysts said.

When the war began, prices spiked as Iraq's production of 2 million barrels a day -- then about 3 percent of the world's oil supply -- was shut down. But then Saudi Arabia, Venezuela, Russia and other producers increased production by more than the amount taken off the market, causing prices to fall.

But when Katrina struck the Gulf Coast earlier this month, the margin was far narrower. U.S. energy officials estimated that the world could produce only 900,000 to 1.4 million barrels a day more than it was already pumping.

When the storm hit, knocking out about 1.4 million barrels a day of oil production in the Gulf, other producers did not make up the difference. There was no demand for the additional supplies held by OPEC countries because of limited refining capacity for the grades available. Instead, the industrialized countries that make up the International Energy Agency released oil from their emergency reserves. Some countries also released emergency supplies of gasoline. That helped ease prices.

Refiners have been hesitant to significantly expand capacity. No refinery has been built in the United States for about 30 years, though the industry has been adding on to existing operations. A series of mergerspromptedconsumer advocates to contend that refiners are less competitive and less likely to expand. For its part, the industry says concerns about regulatory barriers and profitability have inhibited the construction of new refineries.

The government offered incentives a couple of decades ago that spurred new refinery construction, leading to a surplus of capacity in the early 1980s. Profit margins fell. Refiners, complaining they were not making enough money, shuttered facilities.

As demand for gasoline has grown in recent years -- and refining capacity has not kept pace -- the United States has had to rely on imported gasoline supplies. Even before Katrina, 40 million gallons of the country's daily 380 million-gallon gasoline consumption came from overseas.

Katrina had such a big impact partly because it struck an area where U.S. oil operations are increasingly concentrated. As onshore oil production has declined, the industry has drilled more wells in the deep waters of the Gulf of Mexico, directly in the path of hurricanes. A huge amount of refining capacity is located in the Gulf region.

Countries that rely on oil imports complain that not enough money is being spent to explore and develop new oil fields. At the same time, environmentalists complain that the United States, the world's biggest oil consumer, has not taken any significant steps to reduce its thirst. Lawmakers in the United States have repeatedly rejected measures requiring that cars and trucks get better gasoline mileage, citing concerns about safety and the loss of domestic auto manufacturing jobs.

Oil companies have ramped up their spending in the past year, analysts said. But many of those projects will take years to complete and cannot immediately ease the tight supplies.

The industry should be investing $160 billion in 2005 to meet demand, said Fatih Birol, chief economist for the International Energy Agency, whose members include the United States and 25 other industrialized countries. But the agency forecasts investment at $140 billion to $145 billion.

"We are seeing now some moves both in the international oil companies and national oil companies to invest more in the oil sector," Birol said. "But we came to the conclusion that there's a need to increase the efforts at least by 20 percent."

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