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This Time, It's Different
Global Pressures Have Converged to Forge a New Oil Reality

By Steven Mufson
Washington Post Staff Writer
Sunday, July 27, 2008

The two events, half a world apart, went largely unheralded.

Early this month, Valero Energy in Texas got the unwelcome news that Mexico would be cutting supplies to one of the company's Gulf Coast refineries by up to 15 percent. Mexico's state-owned oil enterprise is one of Valero's main sources of crude, but oil output from Mexican fields, including the giant Cantarell field, is drying up. Mexican sales of crude oil to the United States have plunged to their lowest level in more than a dozen years.

The same week, India's Tata Motors announced it was expanding its plans to begin producing a new $2,500 "people's car" called the Nano in the fall. The company hopes that by making automobiles affordable for people in India and elsewhere, it could eventually sell 1 million of them a year.

Although neither development made headlines, together they were emblematic of the larger forces of supply and demand that have sent world oil prices bursting through one record level after another. And while the cost of crude has surged before, this oil shock is different. There is little prospect that drivers will ever again see gas prices retreat to the levels they enjoyed for much of the last generation.

Unlike the two short, sharp oil jolts of the 1970s, the latest run-up has been accelerating over several years as ample supplies of crude oil have proven elusive and the thirst for petroleum products has grown. The average price of a barrel of oil produced by the Organization of the Petroleum Exporting Countries doubled from 2001 to 2005, doubled again by March this year and jumped as much as 40 percent more after that.

For American motorists, a full tank of gas costs nearly twice what it did at the start of last year, racing past the $4-a-gallon mark, and has begun cutting into other household spending.

"What can you do? You need gas," said Barry Modeste, a construction worker who stopped his van at a Shell station in Takoma Park one recent morning to add $15 worth. It was enough, he said, to get him to a cheaper station in Rockville. "If you don't have gas, you can't get to work. And if you can't get to work, you don't get paid. And if you don't get paid, you can't buy food. We're at their mercy."

Last month, 51 percent of the respondents in a Washington Post poll said rising gas prices were causing a serious financial hardship for them or others in their household. It was the first time a majority had said that since the poll began posing that question eight years ago.

The rising prices are also adding to inflation, aggravating the U.S. trade deficit -- oil now accounts for about half of it -- and taking a toll on businesses already struggling with the economic slowdown caused by the housing and financial crises.

"I'm a very small businessman. If I get any smaller, I'll be out of business," said independent trucker Lee Klass, who was driving through the Texas Panhandle this month with a 33,000-pound load of plastic containers bound for Colorado. Klass had just paid $636 for fuel, enough for the trip but no more. Filling the tank would cost nearly twice that much.

Abroad, riots shook India after the government trimmed fuel subsidies. Truckers in Britain, France, Spain and South Korea have clogged the roads to protest rising fuel prices. In the Philippines, soaring prices for oil and petroleum-based fertilizer have derailed the economy and ignited calls for a cut in the tax on oil imports. With her popularity at a record low, President Gloria Macapagal Arroyo is expected to confront the issue in a nationally televised speech scheduled for tomorrow.

Even after oil prices have tumbled more than $24 in the past two weeks, largely as the result of easing tensions in the Middle East and slowing U.S. economic activity, crude is still trading near historic highs.

In a series of articles starting today, The Washington Post examines the economic forces that have unhinged oil prices from their longtime cyclical patterns, propelling fuel costs to once unimaginable levels that are now both fraying the lifestyles of our recent past and speeding the search for an energy source of the future.

* * *

Earlier oil shocks have had obvious causes. In October 1973, OPEC raised prices and declared an oil embargo against the United States and other countries that had supported Israel in its war earlier that month against its Arab neighbors. The embargo ended in March 1974, but pricing power had shifted from the oil companies to the producing countries. In 1979, prices soared again after the Iranian Revolution curtailed output and consumers and oil companies went on a spree of panic buying.

Now, however, there is no one culprit and no single international crisis to blame. Instead, world demand has been increasing faster than supply, steadily squeezing oil markets.

This in turn has signaled to investors that prices are inevitably heading higher. Financial players, such as Wall Street banks and hedge funds, have bet just that, investing tens of billions of dollars in oil futures. Critics on Capitol Hill and elsewhere say this speculation has turbo-charged the market, helping lift prices even more.

The tightening of the oil market reflects decisions made a decade ago, when conditions looked radically different. Regular unleaded gas was less than a dollar a gallon. Oil was little more than $10 a barrel. And the Economist magazine, predicting prices could soon be half that, ran a cover story with the headline: "Drowning in Oil."

Those low prices sent the wrong signals to consumers and oil companies alike.

Demand for oil jumped as U.S. sales of gas-guzzling cars soared and China's breakneck economic expansion picked up pace.

Daniel Yergin, a historian of the oil business and head of Cambridge Energy Research Associates, said that over the five years from 1998 to 2002, world oil demand grew 1.1 percent annually, raising daily consumption by 4.2 million barrels. But in the following five years from 2003 to 2007, world oil demand grew 2.1 percent annually, boosting consumption by about 8.2 million barrels per day.

The low prices of the late 1990s also dampened the impetus for finding new supplies. Oil companies delayed exploration for new fields. Capital spending dropped 15 percent at the biggest oil companies in late 1998 and plunged as much as 70 percent at the smaller ones. Too few drilling rigs were built. And refineries weren't expanded or upgraded, making it hard for them to use the lower-quality crude oils that have become a larger portion of supplies or to produce the right balance of products as gasoline use is stagnating and diesel fuel use growing.

Investment slackened just as finding new supplies was becoming more difficult and costly. Most of the world's big, easy-to-tap fields have already been discovered and largely drained.

Some analysts argue that peak oil production has already been reached. Others say the peak remains a ways off but perhaps not very far. Though capital spending by big oil companies has again picked up pace in the past couple of years, spurred by higher prices, exploration is still falling short.

"It's not that we're going to run out of oil or hydrocarbons, but it's not going to become available as fast as uninhibited, unrestricted demand," said Sadad Husseini, a consultant and former petroleum geologist at Saudi Aramco.

Just two decades ago, the world could pump 15 percent more oil than it needed. Today, that spare production capacity has practically vanished -- it's now about 2 percent beyond the world's total daily consumption of 85.5 million barrels. That makes the market very sensitive to rumors about anything that might endanger existing production.

Earlier, oil-rich nations opened their spigots to prevent run-ups in prices. In the early 1980s, oil from the British and Norwegian North Sea started to flow in large volumes and helped push down prices even as war raged between Iran and Iraq, disrupting Mideast supplies. During the Persian Gulf War after Iraq invaded Kuwait in 1990, Saudi Arabia increased production to head off a spike in oil prices.

But now, the cushion is all but gone. And Saudi Arabia, which is home to what little spare capacity remains, has become reluctant to temper price increases by boosting production. Quite the reverse, the kingdom and its fellow OPEC members have trimmed production on those few occasions when prices showed signs of slipping, most recently in late 2006.

That has left the global oil market particularly vulnerable to threats as varied as hurricanes in the oil-rich Gulf of Mexico, the potential for war with Iran and pipeline attacks by small groups of insurgents in remote parts of the Niger Delta.

* * *

At the beginning of the pipeline, high oil prices have been a gusher of good news.

Any company that owns oil in the ground or a share of what's pumped out of it is swimming in profit. Exxon Mobil, the biggest of the independent oil giants, last year broke records for U.S. corporate profits, chalking up $40.6 billion. This year, it is on track to earn even more.

Thanks to the rapid and sustained rise in prices, oil-producing countries are also accumulating vast reservoirs of money in one of the most massive transfers of wealth in history. Every day, oil consumers pay $6 billion to $7.5 billion more for crude oil than they paid six years ago. At the current rate, they will pump more than $1.5 trillion a year into the coffers of OPEC, Russia and other oil exporting countries.

Some Middle Eastern countries are already on a shopping spree: indoor ski facilities on the edge of the desert, water-borne hotel complexes, new industrial cities.

The new balance of petro-power was evident at a meeting of oil producers and consumers in late June in Jeddah, Saudi Arabia. The body language and setting said it all.

Grim-faced, British Prime Minister Gordon Brown followed a half-step behind a smiling Saudi King Abdullah as they entered a palatial conference room with marble walls and glittering chandeliers.

Dignitaries in flowing robes and business suits from 35 nations, seven international agencies and 25 companies were seated in a horseshoe arrangement. The king, flanked by Brown and China's vice president, was perched on a dais in the center and politely listened to entreaties from U.S. Energy Secretary Samuel Bodman and others for higher oil output. In the end, Abdullah bestowed only modest assurances while admonishing consuming countries for "selfish interests, increased consumption."

This exercise in oil diplomacy did nothing to stop the relentless rise of petroleum prices. If anything, the summit showed the inability of consuming nations to change today's prices and the relative indifference of producing countries, who blame high prices on Western "speculators."

But Bodman insisted that high prices were a question of supply and demand, and he urged the Saudis to boost output. "I believe that most of us agree on one thing: Prices are too high at present," he said. "And unless we act, the situation will remain unsustainable."

* * *

What makes it unsustainable is that cheap oil has been a building block of the American economy and society, from big cars and big planes to interstate highways and commuters living in remote exurbs.

For the better part of a century, U.S. policy contributed to this pattern of development. Taxes on gasoline were set aside for highways, which opened up more vistas for new communities. This in turn promoted even more driving, more gasoline consumption and more tax revenue for highways. Today U.S. automobiles use more than 9 million barrels of gasoline a day, more than any other country.

The high price of oil has sparked recent efforts by technology experts, venture capitalists, alternative energy firms and even some oil companies to come up with ways to wean the world economy off its addiction.

Developing countries like China and India, however, are in no hurry to embrace this new vision. They want to join the ranks of economic powerhouses and question why they should be forced to temper their aspirations, why their oil use should be more constrained than those who came before.

A century after Henry Ford's Model T revolutionized American life, Tata's Nano could do the same for India. Unveiling his company's concept for the car early this year, Chairman Ratan Tata placed the Nano in a narrative of technological endeavors that led from bicycle to jet. He called it "a journey that embodies the human spirit of change . . . the drive to stretch the envelope . . . the quest to lead and the quest to conquer."

But in an era of scarce oil, the Nano could take the world down a rough and costly road.

Staff writer Simone Baribeau contributed to this report.

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