It's Still Too Early To Panic At The Pump

Oil may have reached $30 a barrel, but few in the industry think it will stay that high for long

Oil prices are on the front burner in the U.S. for the first time in a decade. In the Northeast, domestic heating-oil prices rose 40% in a month. Gasoline prices are the highest since the Persian Gulf War, and analysts say they'll be even higher by the summer driving season if world production doesn't rise soon. With the industry benchmark--light sweet crude--exceeding $30 per barrel on the New York Mercantile Exchange for the first time since 1991, Energy Secretary Bill Richardson is embarking on visits to Saudi Arabia, Kuwait, and Mexico in hopes of persuading them to put more of their oil on the market.

You might think that the big oil producers would turn U.S. entreaties down flat while they enjoy their gusher of petrodollars. Not at all. In fact, signs are increasing that many of the major producers are alarmed by how high oil prices have gotten. The clearest signal yet came on Feb. 16, when Saudi Arabian Oil Minister Ali bin Ibrahim al-Naimi told reporters in Tokyo that "a price similar to the levels experienced during the last six months is a reasonable one." The six-month average of prices is about $4 per barrel below the current level.

One reason: The spike has OPEC worried that if prices stay high for too long, the big multinationals like Exxon Mobil Corp. will increase exploration and production and permanently gain market share. If $25 to $30 oil prevails for more than a few months, "all sorts of projects from West Africa to the Caspian will be set in motion that can't be turned off," says Adam E. Sieminski, oil strategist for Deutsche Bank Alex. Brown in Baltimore.

On top of that, big oil producers can't afford to pitch their customers into recession by raising prices too much. "These countries all have a stake--not only in the oil price--but in the health of the world economy and the U.S. stock market," says Daniel Yergin, chairman of consultants Cambridge Energy Research Associates. Indeed, for some producers, good relations with the U.S. are essential. Mexico, which has called for a "soft landing" in prices, ships 90% of its exports to the U.S. And the Saudi kingdom needs U.S. military protection.

The challenge for big exporters over the next weeks will be to find a formula that avoids the dangers of not doing enough to increase supplies, or triggering a price collapse by overproduction. The OPEC target may now be $22 to $25, says Petroleum Finance Co., a Washington-based consulting firm.

UNUSUAL DISCIPLINE. In the runup to OPEC's next meeting on Mar. 27 in Vienna, expect a behind-the-scenes battle between hawks such as Iran, Algeria, and Libya, and Saudi Arabia, which favors an easing. Moreover, the Saudis aren't just talking. According to Roger Diwan, a Petroleum Finance analyst, they have quietly ramped up their production to half a million barrels above the quota set for them last March. Publicly, the kingdom's policymakers continue to pledge allegiance to last March's agreement. They are wary of spoiling their recent good relations with Iran. And they have not wanted to risk hurting the chances of the supporters of moderate Iranian President Ali Mohammed Khatami in parliamentary elections. But after that Feb. 18 vote, the Saudis may be more strident about the virtues of producing more oil.

Some analysts say that OPEC's unusual discipline could dissolve once its members get embroiled in allocating new production quotas. "You will see discipline deteriorate quite quickly," predicts Fergus MacLeod, a British oil analyst. MacLeod thinks that a fall of about $10 per barrel may be in the offing. Futures traders also expect a quick drop in prices. The NYMEX contract for June delivery of crude oil is at $27 and the November contract is at $24.

For customers, an OPEC easing can't come too soon. Oil inventories in the U.S. are at their lowest level in 23 years. One reason is improved efficiency: Refiners have discovered just-in-time inventory management. But another factor is that oil buyers are hoping to wait out OPEC and replenish supplies after prices fall. If OPEC outwaits them, buyers could end up paying even more for oil in a classic squeeze.

COLD COMFORT. Already, tight markets have sent heating oil prices soaring--and brought pressure on the Clinton Administration to release oil from the Strategic Petroleum Reserve (sidebar). Ruth Collins, 61, who lives in a large, Victorian-style house in Roxbury, Mass., says she's been keeping the thermostat below 60 degrees. Close by in Chelsea, Annie L. Adams, 66, wonders where she will get the money to refill her tank at $1.96 a gallon. She has already turned down the heat and scrapped spending on such items as orthopedic shoes. Says Adams: "I'm afraid of dying in bed."

For most of the U.S., the biggest bite is coming from more costly gasoline. Retail gas prices rose to an average of $1.356 a gallon by mid-February, up 48% in the past year and the highest since late 1990, according to the Energy Dept. And things won't turn around quickly even if OPEC does ease up, because it takes a while for oil to be pumped, transported, and refined into products such as gasoline.

Despite those dislocations, however, oil prices are unlikely to knock the economy off track. The world is less dependent on oil than it once was, thanks to increased energy efficiency, the growing importance of service industries, and the rising use of natural gas. In the U.S. last year, consumer prices rose just 2.7% even though oil prices more than doubled.

With so much else going right in the global economy, companies are managing to absorb much of the oil price hikes rather than passing them along. Southwest Airlines Co. says recent fare increases of $2 to $4 one-way will recoup only $10 million to $20 million of a $75 million increase in fuel prices in the first quarter. But Chief Financial Officer Gary C. Kelly says the company expects to stay "nicely profitable" in the first quarter and predicts that fuel costs will soon head back down.

Even when OPEC does get its act together, it isn't the terror it was in the 1970s. Still, a lot of customers will breathe easier when the big producers open their spigots a little wider.

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