www. ecomentary. com 1 Growth, Geopolitics & Oil Policy What Happened to Cheap Oil? 4/26/05

www. ecomentary. com 2 Crude oil prices since 1861 periodic volatility

www. ecomentary. com 3 “The Way We Were…” …has vanished ….forever? MARKETS AND GOVERNMENT DON’T KNOW WHAT TO EXPECT

www. ecomentary. com 4 WIDE FORECASTS IN AN UNCERTAIN AGE US EIA Forecast MID 40’s TO MID 60’s in 18 months

www. ecomentary. com 5 Is World Production Peaking? Campbell’s Dreary Forecast—1999. Could it come true?

www. ecomentary. com 6 What should we believe? courtesy BP

www. ecomentary. com : Year of Change

www. ecomentary. com 8 -$ 2.59 change on 4/27/05 $ /27/05 $57.27 on 4/01/05 MEASURES OF UNCERTAINTY

www. ecomentary. com 9 Demographics of New Oil Demand New Sources of oil demand growth include China and India See next slide China is responsible for some 40-50% of additional demand Other Asian Demand is also rising (India, Korea, etc) Oil demands include transportation fuels and space heating (or power generation). Oil demand in the emerging markets is highly income elastic and petroleum products are used less efficiently than in the developed countries These sources of new demand are likely to continue rising Oil price instability leads these governments to adopt State- run oil reserve holding (adding to demand) but undermining a market based solution

www. ecomentary. com 10 New Demands

www. ecomentary. com 11

www. ecomentary. com 12 Oil in the Post-Cold War Era The end of stability New sources of demand New sources of supply Unclear property rights Rising Environmentalism Long Period of U.S. economic growth

www. ecomentary. com 13 The Post Cold War Oil Market From the end of the first Iraq War until 1996, crude oil rises from about $20 to over $25 with a pit stop at $15 in 1993 The US economic “boom” begins after the Mexican Crisis (1994) and oil moves above $25 With the Asian Crisis of 1997, falling world aggregate demand conditions push oil downward toward $12/barrel, again undermining new capacity expansion. After the Russian default (September 1998), oil essentially triples to an unsustainable $37/barrel during the Tech Boom In the Bust of 2001, oil collapses once again, climaxing with the 9-11 attack driving down consumption, but the US recovery in 2002 moves oil up again, this time over $50

www. ecomentary. com 14 World Nominal Oil Price Chronology: Or maybe it’s ‘déjà vu all over again?’

www. ecomentary. com Oil prices decline sharply following the September 11, 2001 terrorist attacks on the United States, largely on increased fears of a sharper worldwide economic downturn (and therefore sharply lower oil demand). Prices then increase on oil production cuts by OPEC and non-OPEC at the beginning of 2002, plus unrest in the Middle East and the possibility of renewed conflict with Iraq. 63.OPEC oil production cuts, unrest in Venezuela, and rising tension in the Middle East contribute to a significant increase in oil prices between January and June. 64.A general strike in Venezuela, concern over a possible military conflict in Iraq, and cold winter weather all contribute to a sharp decline in U.S. oil inventories and cause oil prices to escalate further at the end of the year. 65.Continued unrest in Venezuela and oil traders' anticipation of imminent military action in Iraq causes prices to rise in January and February, Military action commences in Iraq on March 19, Iraqi oil fields are not destroyed as had been feared. Prices fall. 67.OPEC delegates agree to lower the cartel’s output ceiling by 1 million barrels per day, to 23.5 million barrels per day, effective April OPEC agrees to raise its crude oil production target by 500,000 barrels (2% of current OPEC production) by August 1—in an effort to moderate high crude oil prices. 69.Hurricane Ivan causes lasting damage to the energy infrastructure in the Gulf of Mexico and interrupts oil and natural gas supplies to the United States. U.S. Secretary of Energy Spencer Abraham agrees to release 1.7 million barrels of oil in the form of a loan from the Strategic Petroleum Reserve.

www. ecomentary. com 16 Why Are Prices More Volatile This Time? no spare capacity prices have upside volatility when excess capacity drops below a critical value (3mb/d). See slides financialization: futures are heavily influenced by traders and the marginal barrel is priced by the marginal buyer Financial optics attract bad politics

www. ecomentary. com 17 Excess Capacity Problem

www. ecomentary. com 18 Spare Capacity and Pricing

www. ecomentary. com 19 DESPITE ‘DEBATES’ PROBLEMS WILL REMAIN

www. ecomentary. com 20 Market Failure or Government Policy Some Recurrent Themes Oil demand is price inelastic and for fast growing economies, highly income elastic Over time, new sources of oil become harder to find and more costly to develop If oil were strictly a ‘market commodity,’ oil supply would be far more responsive to expanded demand conditions, but oil is a ‘strategic resource’ and new supplies limited by governments Sources of ‘cheap reserves’ are under government control, making it virtually impossible for private companies to ignore governmental policies regarding oil supply development The SPR undermines private incentives to hold private inventories (the law of unintended consequences) creating conditions for even more price volatility

www. ecomentary. com 21 Demand is for Products—not Crude Oil Refinery Capacity Is Stretched Insufficient Refining Capacity Mr. and Mrs. NIMBY will make your lives difficult!

www. ecomentary. com 22 New Oil Supply is a long run proposition subject to politics ( “all politics are local”) Alaskan North Slope Gulf of Mexico Territories of the Former Soviet Union West Africa Venezuela Brazil Libya PG countries including Iraq, Iran and Saudi Arabia Global Warming and the Green Movement

www. ecomentary. com 23 And what if….? The Saudi’s don’t make the investment to expand 5 mmbd? Russian becomes inhospitable? Non-OPEC doesn’t produce some big finds? Can American Politics live with $ per barrel oil?

www. ecomentary. com 24 “oil is a greasy business” Calouste Gulbenkian as quoted in The Seven Sisters Calouste Gulbenkian: “Mr. Five Percent,” long ago discovered a basic truth about oil. Oil generates a great deal of money. The “pen may be mightier than the sword,” but money trumps the pen! Jessup’s Law: politicians can’t handle the truth because they fear their electorates. The result is almost always an inferior solution to an energy dilemma The “CRIC”cycle (courtesy of Robert Feldman of Morgan Stanley) applies to Energy Policy in the US Crisis----the move to $50 Response----lots of talk Improvement---shake the Hand of the Prince…and pray Complacency---slowing growth will slow prices…for a while It will take a Crisis in the U.S. to produce meaningful energy policy Meanwhile the Beating goes on!