Pain At The Pump

Ahh, summer. Time for some time off. With the dollar in the doldrums, interest rates soaring, and financial markets tanking, you certainly could use it. But after forking out as much as $1.50 a gallon to fill 'er up on the way to the beach, you realize there's one more item you need to worry about: higher oil prices.

That's the message the 13 OPEC oil ministers broadcast to world consumers as the cartel wound up its deliberations in Vienna on June 19. In the face of surprisingly high demand for oil, OPEC decided to cap its production at 24.5 million barrels a day until late in the year. The market's predictable reply: Oil futures contracts on the New York Mercantile Exchange shot up to $20.75 a barrel on June 20, their highest levels in 15 months.

OPEC alone is not to blame for what is a 30% runup in crude prices since January. Markets are worried about the Yemeni civil war and the possible ramifications of a nuclear standoff in North Korea. And expectations that the U.N. Security Council might lift its four-year embargo on Iraqi oil exports--flooding the market and dampening prices--have evaporated.

More important, for the first time since the gulf war, world oil demand is starting to perk up (chart), thanks to rebounding economies. Demand this year will rise by a healthy 500,000 to 600,000 barrels a day, to 67.3 million, predicts Cambridge Energy Research Associates Inc., an industry consultant. Demand from the former Soviet Union is still slumping. Rising energy needs in Asia and the U.S., though, mean that the rest of the world must come up with 1.3 million barrels a day in fresh supplies this year.

Meanwhile, supplies are being squeezed. Just about the only spare production capacity remaining is in OPEC's hands--and there isn't much of it. If the cartel were pumping at full throttle, it would produce only 27.5 million barrels a day, or 10% more than current production. "OPEC is operating at a higher capacity [utilization] than it was during the oil shocks of the 1970s," says Robin West of Petroleum Finance Co. a consulting firm in Washington. "The margins are now very, very narrow" between what's pumped and what the world is consuming.

IN MOTHBALLS. That's because, until recently, oil cost less in real terms than it did in 1970. The past three years of price weakness have beggared even the richest members of OPEC, including Saudi Arabia. The result: Billions of dollars of oil-patch investments have been mothballed, or canceled altogether. Thanks to the severe price slump following the gulf war, for example, Riyadh downsized costly plans by state-owned Saudi Aramco to increase output to 12 million barrels a day, stopping instead at the current 10 million. Even with higher prices, Aramco will be hard pressed to produce much more any time soon. Most of the major U.S. oil companies, moreover, aren't ramping up capital spending for new exploration.

Production relief could come eventually from Iraq, whose 3 million barrels a day can't be kept off the market forever. But surging demand in such rapidly industrializing Asian countries as China and India ensures that there will soon be a ready market for Iraqi oil--and much more. Asian oil demand, according to a study by Honolulu's East-West Center, is set to rise to 20 million barrels a day in 2000, up more than one-third from 14.7 million today. The higher consumption should keep upward pressure on prices through decade's end, at least.

With Asia set to supplant North America as the world's biggest oil market in the next few years, some worry that Persian Gulf producers could give Eastern buyers the preferential treatment Americans once commanded. "The U.S. could be vulnerable as oil goes east," says Peter Wildblood, chief executive of London's International Petroleum Exchange. Just one more thing to worry about as you gas up the car this summer.

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