Wednesday, May 03, 2006

This week's Political Spaghetti: Blame the oil companies, but not for the reason you think

(updated below)

I've posted previously on effect that violence in the oil-rich Niger Delta of Nigeria is having on the price of gas at the pump. Violence in the Delta is not a new thing -- since the corporate predecessors of Shell and BP discovered oil in the town of Oloibiri in Bayelsa State in 1956, the environmental and social damage done to the region has been so severe that only the most alienated (or bought off) could fail to find sympathy. Spills are frequent, polluting the "creeks" that flow to and from the principal Niger River tributary, and the natural gas byproduct of extracting the high-quality light, sweet crude from the Delta is disposed of in permanent gas flares that scar the horizon, destroying not only crops and marketable trees, but also public health. And the locals get next to nothing for their trouble.

Nigeria is not the biggest oil producer in the world -- in 2004, it was ranked 8th amongst the world's leading oil producers (with 2.19 mbpd, or million barrels per day, versus Saudi Arabia's 8.73 mbpd). However, as of early September 2004, the capacity of the world's oil producing nations to exceed current demand had fallen precipitously to about 0.5-1.0 mbpd -- nearly all of it in the Persian Gulf -- which is much less than the export capacity of many, smaller exporting countries, like Venezuela or Nigeria. As such, even the slightest disturbance in oil supply in those countries can strangle the oil market.

Things were not always this way. According to an industry newsletter, WTRG Economics [emphasis mine]:
In mid 2002, there was over 6 million barrels per day of excess production capacity, but by mid 2003 the excess was below 2 million. During much of 2004 and 2005 the spare capacity to produce oil has been under one million barrels per day. A million barrels per day is not enough spare capacity to cover an interruption of supply from almost any OPEC producer. In a world that consumes over 80 million barrels per day of petroleum products that adds a significant risk premium to crude oil price and is largely responsible for prices in excess of $40 per barrel.
What happened just before mid 2003? Three things. A December, 2002, strike in Venezuela, called by political leaders in opposition to President Hugo Chavez, led millions to walk off the job, including workers at Venezuela's state-owned oil company PDVSA. Production plummeted, and it has never really recovered. It is still 0.9 mbpd below pre-strike levels. In the meantime, the US economy began to gain speed, increasing demand, while US inventories remained low (a problem that Hurricane Katrina did not solve). And we invaded Iraq.

The Iraq War's single most important economic impact (aside from a long-term total cost of as much as $2 trillion by some estimates) was to contribute to the drop in excess production capacity to below 2 mbpd (click on image to right). Since the Iraq War, export from the country has only declined. In January, the Iraqi Oil Minister, Bahr al-Uloum resigned after oil exports dropped 0.5 mbpd in just two months from a post-war average of 1.6 mbpd. He attributed this drop to bad weather and a shortage of electricity for pumping oil (thanks, President Bush). Ahmad Chalabi has taken his place. The war itself led to a 1.5 mbpd drop in production.

This might not have been a serious problem, except that starting in 2004 the world's two most populous nations, China and India, rapidly expanded their petroleum consumption rates.

With a tighter oil market, OPEC is no longer the force it once was. Prior to 2003, an increase in demand typically would prompt OPEC to raise their quotas -- their excess capacity made this possible. Today, raising quotas can do little to increase actual production, since most Persian Gulf states are at maximum production capacity. Suddenly, this buffer is gone, and world oil markets become strongly dependent upon small variations in supply in peripheral oil exporting nations. The strike in Venezuela elevated Hugo Chavez to "stardom" among international oil traders (Pat Robertson has publicly stated that assassinating him wouldn't be such a bad idea). In 2004, his country exported about 2.36 mbpd -- all he has to do is lower production by a few hundred thousand barrels per day, and crude prices get perky. But don't worry -- if he did that, Robertson might get his wish, and anyway with prices this high, Chavez has little incentive to cut production and let other countries rake in the profits.

So we have something of a trifecta: Iraq War, increased Asian demand, and the threat of local crises in peripheral oil-exporting countries due to OPEC's reduced capacity to keep production capacity well above demand.

That's why Bush's nuclear saber-rattling date with Iran, a country that exports even more oil than Venezuela, gives commodities markets a heavy dose of methamphetamines. Violence in the Niger Delta has the same effect. In March, as a result of militant violence, the kidnapping of several foreign oil workers, and the destruction of capital equipment, Nigerian oil production capacity dropped by over 25%. For a nation that exports most of its 2.51 mbpd oil production, this was a huge blow. A reduction of global capacity on the order of 0.5 mbpd cuts very close to strangling the excess that the Persian Gulf is able to supply.

This is not what we hear from the media or from Congress. The debate is so off base, in fact, that it borders on the surreal. According to Democrats, the oil companies are the problem, gouging consumers at the pump while reaping massive profits. Of course, this can't be the whole truth, not by a long shot. If the price of crude oil is rising, profits will naturally increase. Sure, it's a great time to be in the oil business, but not because of an active choice on their part to raise prices. In fact, they can't change prices except by changing production (something for which OPEC once regularly made the news when oversupply was a problem). Now, there's no room to lower production. The oil corporations are maxing out and riding high -- and presenting a convenient scapegoat.

That said, there could still be gouging (something the President has made the politically safe decision to investigate), but since both the price of gas at the pump and the price of crude oil have roughly doubled since 2003, gouging can't be the ultimate reason prices have risen as far as they have.

According to Republicans, the problem is that Clinton failed to allow oil exploration in the Alaska National Wildlife Refuge (ANWR). There are several problems with this claim. If drilling had been authorized in the mid-90s, initial production would have only started a couple of years ago, maybe. And if it were authorized today, production wouldn't ramp up until 2014 at the earliest. The Energy Information Administration (EIA) estimates that ANWR could yield 600 million barrels per year, for a daily rate of less than 2 mbpd, or about 1/10th of US daily oil consumption, but the same agency says this rate might be only half as large. If we did drill in ANWR, the benefit would be to reduce our dependence on foreign oil (but only marginally), and to slightly increase global excess petroleum production capacity.

But in the face of increased Asian demand, this would buy us only a couple of years before excess capacity dropped to nothing. In fact, getting down to brass tacks, if we really wanted a temporary fix for our current oil supply problems, a better decision than drilling in ANWR, one that would avoid environmental damage and cost fewer lives, would have been not to invade Iraq (which led to a 1-2 mbpd drop in excess petroleum production capacity).

Senators Maria Cantwell (D-Wash.) and Rick Santorum (R-Penn.) debated on the NewsHour with Jim Lehrer on Tuesday night the rather odd proposal by Senate Republicans to alleviate the crisis-of-the-pocketbook at the pump by delivering a $100 rebate to all American households. This was the most tangential and feckless debate ever to have graced the halls of Congress.

There are a number of long-term solutions to increased global demand that are frequently advanced that, of course, deserve our utmost attention: reducing our dependence on foreign oil (we are the biggest oil importer in the world) by incenting the development of alternative fuels, reducing our per capita demand by whatever means, and investing in forms of transportation that don't involve individuals driving an average of 30 miles per day, by themselves. At $75 per barrel, such investments will pay off a lot sooner than they would have just three years ago.

These are remedies that have been with us for years. What's changed? There was a time when we lived in a world with plenty of oil to go around. Not today. Once, we could avert our gaze from social and political crises in oil-exporting regions of the world, because OPEC was around to raise their quotas if supply dropped and crude prices got too high. Not today.

Now, barring the disappearance of India and China from the face of the Earth, the real crises are local and messy. So long as local problems persist, and so long as excess capacity remains as low as it is, expect to pay more at the pump. The secret to a fluid oil market 10 years ago was security and domination; today, the secret is stability, stability, stability. Indeed, the Iraq War, because of its timing, was perhaps exactly the wrong thing to do -- just as demand was increasing, we sent troops into the only part of the world with the capacity to generate excess production. In fact, I would bet that conflict anywhere in the world will now lead to a crisis in the oil markets on the same order as or worse than the current one.

War is no longer the answer. Neoconservativism was dead before it got out the door (the "door", in this case, being the invasion of Iraq).

I started off this post with violence in the Niger Delta for a reason. Today, even the smallest blip in oil production can send oil markets into the stratosphere. In this case, the "blip" is the direct result of oil exploration and extraction. The Movement for the Emancipation of the Niger Delta (MEND), now in on-again, off-again talks with the Nigerian government, seeks local control of their mineral resources. This is not an unjust struggle. Most Nigerians live on less than a $1 a day, but of all Nigerians, those that live in the Delta must suffer not only poverty, but environmental degradation and contamination, as well. And they must live with the knowledge that the land that is ancestrally theirs is under the control of oil companies and a government that do not see their well-being as a high priority.

Over 80% of Nigeria's federal revenues come from mineral extraction, and not surprisingly Nigeria represents one of the most stratified societies and corrupt governments on Earth. MEND wants a piece of the pie for the Ijaw and Ogoni tribespeople they represent, and justly so. Referring to President Olusegun Obasanjo's effort to extend his administration into a third term, Nigeria's (and Africa's) first Nobel Laureate, Wole Soyinka, says:
One thing which became clear in my contact with those rebels is that they just do not trust this government. And I've said openly, publicly in Nigeria. And now that same region wants illegally, unconstitutionally to prolong its stay using and bribery, coercion, and blackmail to try and twist the constitution around. What do you think those who've been waiting decades and decades for a government that will finally tackle their problems with a sense of justice, what do you think they feel towards that? [see here for another post on Soyinka]
It is for this that the oil companies should be blamed. In their natural quest for profit maximization, they have tried as hard as possible to ignore local problems. As I said, this was possible when excess capacity was in the 6 mbpd range. But now, the need for oil that automatically blinded us and them to all other concerns, such as the economic justice we afford to people from whose land we extract our wealth, is biting us in the ass.

So what do we do? First, we immediately abandon the abjectly stupid ANWR / oil companies-gouging-us-at-the-pump debate and start thinking seriously about how we can help alleviate the local crises that will plague us from here on out. Normalize our relationship with Chavez, and push Obasanjo to advance meaningful reforms in the Delta, right now. Stability, stability, stability.

But don't get mad at the oil companies for gouging us at the pump -- even if they're doing it, it's not the real problem. Get mad at them, and our government, for ignoring real people, and for exacerbating the instabilities of Dutch Disease -- instabilities that, in the tighter oil market of today, many feel we must now manage with guns and threats. It is ironic that, in the absence of OPEC, the very saber-rattling that is meant to bring Iran in line instead has the effect of exagerating crude prices and raising revenue for Iran's nuclear ambitions.

Now, if you will allow me to put on my tin foil cap, consider that an Iraq War, subsequently high oil prices, and an administration that is closer to big oil than any in history, form a combination that might not serve the public good. Hey, I mean, one way to look at the War is that it was a good thing for big oil, whether we won or lost. If things had gone smoothly, big oil would have gained control of Iraq's oil fields. But by doing poorly, they have raked in record profits as excess oil production capacity dropped and OPEC became irrelevant.

The result: the tightest oil market ever -- and social justice is now in our best interest.

UPDATE: Andrew Sullivan was kind enough to link here, but I'm not entirely sure I agree with his desire to gouge us at the pumps to make us change our habits. While I want us to change our habits, according to James Mulva, the CEO of Conoco-Phillips, about $20 of the $75 currently paid per barrel for crude is a risk premium. That means that much of what we're paying at the pump -- what Sullivan thinks is needed to get us to change our habits -- is borne out of political instability and suffering elswhere. If this were purely a demand issue, then we would be paying $55 a barrel -- still a lot, but due only to increased demand in Asia and plateauing supply in the Gulf. I can't think of high gas prices as the deck is currently stacked as a "good" if they're due social injustice elsewhere.

Check out Mulva's interview with Jim Lehrer last night. He names three reasons gas prices are so high: increased Asian demand; local crises in Nigeria, Venezuela, and Iran; and limited refining capacity. No mention of Iraq, but then refining capacity is not a major factor in setting the price of crude since it does not affect production capacity. It's worth reading the transcript.


Anonymous said...

The oil companies take all of the risk in transporting the crude, refining it, then transporting it to the retail level, and all for a 10 percent profit margin.

While the greedy government wonks demand their pound of flesh , in excess of .50 per gallon....oil is a very plentiful, cheap commodity. Remove all of the government headaches and taxes , there is the solution.

Matt said...

Your prescription would cut the rug from under our entire interstate highway program. Unless you have another revenue source ...

Anonymous said...

Interesting article. However one point bothers me: on the one hand you say that Chavez cutting production by a few hundred thousand BPD will send markets into the stratosphere; then on the other you say the 2 MBPD (10 X more) from ANWR will have no effect on prices.

I agree with your other proposals. Then you go and say 'abjectly stupid ANWR' and it shows either an intentional desire to twist your own facts in order to support your position or a darned short memory span.

Matt said...

I was unclear. First, I called the current debate in congress "abjectly stupid," not the ANWR proposal.

That said, it's not clear that exploration alone in the medium to long-term, and in the face of rising demand, will reduce the political risk premium induced by Iran, Nigeria, and Venezuela. But these short term conflicts have a dramatic effect on crude prices that acts far faster than the long-term development of increased demand. I should have added a note that what's different between the effects of a crisis in Venezuela and opening ANWR is a matter of time scale.

Daniel said...

I heard this analogy the other day from Tom Freidman of the New York Times and it struck me as quite correct. He was discussing an article on “The First Law of Petropolitics”.

The U.S. Revolutionary War was started, partly on a principle of “No taxation without representation”, the current attitude in many Muslim, oil producing countries seems to be “No representation without taxation”. Since they have oil the government doesn’t need to tax their citizens and since they don’t tax them they don’t feel the need to listen to them or allow them any say in the government.

Is it a coincidence that one of the oldest and most thriving democracies in Africa is Botswana, a country without a drop of oil? That Lebanon, one of the only Arab states without any oil, is the only Arab state that has been a democracy since its birth?

Bahrain is the first Arab gulf state to be running out of oil, it is also the first Arab state to hold free and open elections in which women could vote, and run for office, and the first Arab gulf state to reform it’s labor laws to make it’s people less able to depend on foreign labor.

Taiwan is an island with no natural resources, but one of the most robust economies in the world. How? They have developed the “human” resources of the country and maximized the potential of the people thru an excellent education system. More difficult than just drilling another oil well, but in the long run a lot better for the people and the country.

Oil revenues could be used to develop a society and civilization that could become self reliant without the oil, but in almost every case oil revenue is used to keep those in power, in power, and to suppress any opposition. Keep the populace ignorant, so they believe what ever they’re told, and impoverished, so they’re dependent on the government to feed them, and they’re less likely to rise up and demand democratic representation.

The oil companies foster this phenomenon by their avaricious indifference, they couldn’t care less if their “sub-contractors” are using slave labor as long as they are getting their oil and making their record profits. Trying to influence governments to be responsible or do the right thing might impact their profits. If the oil companies had acted responsibly as good stewards we might not be paying $20 per barrel in risk premium.