Wall Street Journal
March 27, 2000
Why Oil Price Tripled in 15 MonthsBy STEVE LIESMAN and JOHN J. FIALKA
Even as Nations Strove to Limit It
Staff Reporters of THE WALL STREET JOURNAL
Last October, Mexico's energy secretary said he couldn't see the price of oil reaching $30 a barrel. Forecasts didn't point that way, and the oil-producing nations didn't want it to go that high.
In November, the U.S. Energy Department's chief oil expert scoured the data for evidence that U.S. oil supplies were shrinking, but found little. Supplies appeared to be within a normal range.
Yet by late December, oil prices were zooming past $25 a barrel, on their way to $34 early this month. U.S. inventories of oil and gasoline suddenly were near record lows. The result, spiking gasoline prices and fears of spot shortages this summer, was something that neither consuming nor producing nations wanted -- not the consumers, for obvious reasons, but not the producers either, because they want to avoid a political and economic backlash.
So how did it happen? How did the world go from $11 oil to $34 oil in 15 months, despite efforts on all sides to avoid the boom-and-bust cycles of the past? The question is particularly relevant as the Organization of Petroleum Exporting Countries meets Monday in Vienna for another crack at getting it right.
A look at the markets and their managers over recent months shows that, for reasons ranging from uncertain data to year-2000 fears to millions of barrels of mysteriously "missing" crude oil, both OPEC oil ministers and Washington policy makers guessed wrong at key junctures.
As a result of this week's meeting, OPEC and non-OPEC producing countries are expected to restore about one million barrels of daily production from the 5.2 million barrels that they cut in 1998 and 1999. (Another million has already come back through quota-cheating by members.) In anticipation of the meeting, crude-oil prices have eased in recent days, closing Friday at $28.02 a barrel for West Texas Intermediate. Some OPEC officials say that if they can bring prices back down to $25 a barrel soon, their way of running the market will be vindicated. "It would be shame on us not to do the proper thing," says a Saudi official, who favors an agreement that would raise output and lower prices in a way that keeps producers unified and customers happy.
But disagreement remained on the eve of the meeting. And there's little escaping the conclusion that markets for a time spun out of OPEC's control, making oil once again a political issue, to some oil countries' dismay. "There is a sense now within Saudi Arabia that oil needs not to be politicized," the Saudi official says.
Now, some analysts believe that spot gasoline shortages in the Northeast and California are possible this summer no matter where OPEC sets production. "There are going to have to be some fairly heroic refinery runs because our stocks are so low," says Jay Hakes, who heads the U.S. Energy Department's Energy Information Administration.
The problems began with what OPEC ministers now derisively refer to as the disaster in Jakarta. Meeting in Indonesia in November 1997, oil ministers decided to increase crude-oil production, a decision that stemmed in part from a bitter marketshare battle among Mexico, Saudi Arabia and Venezuela, as well as from forecasts of higher demand. It turned out the boost came just as Asia's financial storm was gathering force. Asia's troubles soon cut demand sharply. An oil glut was born.
Burned by this blunder, OPEC now insists it will act only in response to market realities, not projections. It's a key policy change, one that will tend to limit how big a boost the ministers are willing to approve this week, and that could prompt them to revisit their decision in June.
Where's the Oil?
As prices began to sink soon after the 1997 Jakarta meeting, an anomaly in oil supply emerged. The Paris-based International Energy Agency, formed in the 1970s by industrialized nations to monitor world oil markets, noticed that oil production was significantly higher than the sum of oil consumption and inventories, which ought to roughly equal production. At one point, some analysts estimated that 300 million or even 500 million barrels of oil had been produced but couldn't be accounted for, almost seven days of world oil supply.
These estimates affected both prices and OPEC's future actions. They affected prices because traders, thinking the barrels were around somewhere, pushed prices lower. Then, facing a price downturn, Saudi Arabia, Venezuela and Mexico formed a troika to try to manage world oil markets. In that climate, this meant trying to curb production.
Their first two efforts, in 1998, fizzled amid widespread cheating on OPEC quotas. Prices slipped further. Only early last year, when the low prices began to seriously deplete the treasuries of oil-producing nations, did OPEC members finally stick to reduced production quotas. Together with non-OPEC producers (such as Mexico and Norway), they reduced daily world oil output by 6.5%.
Was this too much? Robert Mabro of the Oxford Institute for Energy Studies in Britain contends that estimates of "missing" oil were exaggerated and led OPEC to cut back its production too sharply. Whether or not those estimates were too high, by mid-1999 world oil markets clearly were tightening.
OPEC met again last September and could have moderated the production cutbacks, then only a few months old. But the Saudi official explains that September is a contentious time to adjust production because no one knows what the approaching winter's weather will do to demand. So when OPEC oil ministers gathered, they exchanged pleasantries, rubber-stamped their cutbacks and departed in one of the smoothest meetings in years.
But concern was growing in some circles. Sen. Charles E. Schumer says he ran into an oil trader at that time who predicted $30 crude by year-end. Sen. Schumer called some oil-trade experts and found that many agreed. From then to December, says the senator, a New York Democrat, "I lobbied the administration at a minimum every other week" to release supplies from the Strategic Petroleum Reserve and avert a $30 oil price. "First they said they didn't think it would happen," he says. "Later in the fall, I met with leaders in the Energy Department and they said, 'Well, OPEC always cracks' " -- that is, produces more than its quotas call for.
But OPEC's resolve on cutbacks was underestimated, both by the IEA and by experts at the Department of Energy, says the DOE's Mr. Hakes. "We felt there would be more noncompliance," he says. Instead, OPEC "had the highest compliance we've seen for a number of years."
One reason: the political leadership in Venezuela. It had elected a president, Hugo Chavez, who made a policy of bringing his country -- previously one of OPEC's most egregious cheaters on production quotas -- into line. Mr. Chavez decided that fighting Saudi Arabia for market share wasn't as productive as controlling prices through OPEC.
Oil ministers from the Mexico-Venezuela-Saudi Arabia troika got together in November, in what many thought would be a first step to loosen restrictions on output. But the data the ministers had to guide them suggested that oil stocks were resilient, so they took no action on the cutbacks.
At the time, the oil-inventory declines that would be expected to follow from lower OPEC production weren't showing up in statistics. One reason, the IEA suggests, was that all that missing oil had begun coming out of its storage tanks, wherever they were, to take advantage of a firming market.
Then Iraq and Y2K complicated the situation further. As the year 2000 approached, the Clinton administration urged producing nations to put more oil on ships heading to consuming nations. They complied. But then Saddam Hussein, displeased with United Nations, turned off Iraq's spigot for a few days. The chaotic oil movements confounded the data-gatherers at the IEA.
The agency reported that world inventories fell by 2.7 million barrels a day in December. The figure was wrong. It was revised by the IEA this month to show that inventories actually were falling 4.6 million barrels a day in December -- one of the agency's largest revisions ever.
For a while, the weather did its bit for price moderation. A warm December and early January in the Northeast eased fears of shortages. Crude-oil inventories didn't register expected declines. Although Asian demand was picking up and the IEA warned that "this is a thirsty oil market, waiting for more oil," OPEC was growing complacent.
In fact, in January, two officials from large producing nations said that given current circumstances, producers would probably extend their cutbacks beyond March 31. That hit the markets like a bombshell. Prices leapt, suddenly approaching $30 a barrel.
By this time, the oil price in the futures market was much higher for the nearest month than prices for delivery in later months, a situation known as "backwardation." This reduced the incentive for oil companies to build inventories: Producing companies were less eager to do so because crude would be worth less later, while refiners didn't want to build inventories because they believed they would be able to buy crude oil for less money later.
Crude prices were also climbing faster than gasoline's pump prices, further prompting some refiners to limit the amount of fuel they turned out. U.S. refineries these days are running at 87% of capacity, down from a normal 91%.
As for production companies, their concern wasn't so much producing more oil as producing oil more profitably. Oil-company share prices were languishing, and executives were reluctant to break their vows of fiscal discipline and boost production. That restraint, in turn, relieved OPEC nations of any market-share motives to crank up their own output.
Then the weather turned. A chill hit the U.S. Northeast, freezing ports and keeping some heating oil from getting to distributors. On one day, home-heating-oil futures shot up to more than $2 a gallon in trading on the New York Mercantile Exchange. Homeowners saw the cost to fill a heating-oil tank climb to $400 from $250 earlier in the season, and some faced shortages.
Coming around the time of the New Hampshire primary, the price jumps helped make oil, after a 10-year dormancy, suddenly a political issue again. Yet ostensible U.S. allies such as Kuwait were offering hawkish rhetoric, to the effect that price levels didn't signal any need to increase production.
Road to Riyadh
Energy Secretary Bill Richardson set up meetings with the oil producers, first in Mexico City and then in Cairo, Kuwait City, Riyadh, London and Oslo, even at the risk of looking heavy-handed. "It was a balancing act that we had to attempt," says an administration official. "If we didn't make some effort, the Republicans would attack us for doing nothing in the face of this problem."
The pressure didn't play particularly well abroad. A Mexican official says Mr. Richardson's visit "actually damaged the situation" by raising his country's production to front-page political news.
In the Middle East, the Saudis and some others were skeptical of U.S. computer models predicting serious supply problems. After all, they were the same kinds of models that had wrongly predicted demand growth in 1997. So Mr. Richardson brought Mr. Hakes along to share data showing that inventories were skimpier than thought.
The Saudis argued that demand for oil traditionally drops in the U.S. in the spring, and the market should self-correct. Mr. Hakes responded that demand for crude oil doesn't slump, only the demand for refined products. Refiners are busy gobbling up oil to make gasoline for summer driving. Eventually, Mr. Hakes says, the Saudis saw his position.
U.S. politicians "have to be seen responding to the internal politics," a Saudi official says. But given Saudi Arabia's own appreciation of the risk in oil-price spikes, "it was really preaching to the pope." He adds that he finds America's position amusing. Only a year ago, independent U.S. oil-production companies alleged that Saudi Arabia and other foreign producers were dumping cheap oil. "Now the Americans want to penalize us for gouging," the Saudi official says. "That's what wonderful America is all about."
Iran, meanwhile, was opposed to an increase in OPEC production. But after a contentious meeting in Riyadh, Iran and Saudi Arabia issued a statement appearing to back higher output.
Did the Americans help? A U.S. official acknowledges that Washington has used back channels to get its pro-production message to Iran and Libya in recent weeks. But U.S. officials are adamant that recent decisions to re-evaluate the American travel ban to Libya and to lift a ban on luxury-good imports from Iran have nothing to do with the price of oil.
Since its statement with Saudi Arabia, Iran has waffled. With less extra production capacity than some other producers, Iran will benefit less from an output boost and is said to favor only a modest increase. The recent price fall to $28 a barrel helps Tehran make its case in Vienna to other producers.
Even if OPEC should reach unanimity on raising oil output, it might not be enough to fill the badly depleted U.S. gasoline tank. Saudi oil takes six weeks to reach the U.S. Oil from Venezuela or Mexico can take as long as four weeks.
When additional supplies arrive in late April or May, refiners will have to ramp up to 98% capacity and sustain that level well into the summer to avoid some shortages, says the Energy Department's Mr. Hakes. "It is not at all impossible," he says, but he adds that in areas such as California and New England, any unexpected shutdown of a refinery could cause severe supply problems.
Bob Slaughter, general counsel of a refiners' trade association, notes that three West Coast refineries had problems last summer. This year, he says, "there isn't going to be room for one of these events."