Hoping for higher oil prices? Be careful what you wish for.
Longtime oil industry observer Roger Herrera is convinced that high oil prices, though often omitted in current economic and political debate, actually drove the global economy into recession in 2008.
Moreover, the direction crude prices take in the near future will play a major role in determining what happens with the economy, Herrera told Petroleum News in an Aug. 10 interview.
“It’s clear to me that $150-a-barrel oil was the trigger for the recession,” said Herrera, who has spent more than 40 years observing oil prices, initially as a petroleum industry geologist who started his career in Alaska, and then worked around the world, in places such as Peru, East and West Africa, Greece, Canada’s Arctic Islands, Colombia, Papua-New Guinea, Libya and Barbados before returning to Alaska in 1975, where he became increasingly involved in the federal politics of operating in the northernmost state.
Herera spent a lot of time in Washington, D.C., on issues such as offshore exploration and opening the 1002 area of the Arctic National Wildlife Refuge to energy exploration.
From time to time in the last decade and a half he has been interviewed by Petroleum News. Each time, he has accurately predicted the direction of oil prices.
“The prices put extreme stress on the economy — on the airlines, trucking companies, even consumer’s pockets,” Herrera said in the Aug. 10 interview. “And if you look at the economic pattern in the past, you’ll see that when the price of oil goes up, recession follows.”
The sharply higher oil prices, “without any shadow of doubt,” pushed the economy over the edge into recession, Herrera said.
Little has changed in his ongoing forecast for medium and long term oil prices. They will surely keep climbing, back to $150 a barrel and likely beyond in the long term, he said.
Why? Because of a number of factors, including the fact that hydrocarbons comprise 85 percent of world energy consumption and world oil reserves have either hit their peak or slipped past it into decline. In addition, a growing world population is bringing its increasing thirst for oil into play, while alternative energy sources and transportation fuels are doing little to close the gap between supplies and demand. Add to this energy market speculation, which is exacerbating already intense upward pressure on oil prices.
Changing fundamentals
Oil industry analyst and “Twilight in the Desert” author, Matthew R. Simmons, dubbed 2008 oil’s “annus horribilis” in a presentation earlier this year.
An investment banker specializing in the energy industry and one of the world’s leading experts on peak oil, Simmons said prices spiked last year, climbing from $96 to $147 a barrel by early July, before tumbling 74 percent during the last three months of the year. He said the highest oil prices reflected a 15-fold increase from under $10 per barrel in 1998, and the three-month plunge late in 2008 took prices back to November 2003 levels.
On Aug. 18, Bloomberg reported oil was $69 a barrel, crude having “advanced 55 percent this year.”
Simmons, who has an MBA from Harvard and was an energy advisor to U.S. President George W. Bush, attributed the sharp jump in oil prices over the past decade to a change in underlying industry fundamentals. He said oil demand grew by 12.7 million barrels per day, while crude supply increased only 7.3 million barrels a day. Numerous other factors also affected oil markets, but overall, crude supply grew more slowly than demand in recent years.
Part of the problem may be that no one seems to have a firm notion of what constitutes a fair price for oil, Simmons said. As examples, he cited BP’s Lord John Browne’s comment in October 2004 that “$27 barrel oil price is fair,” Shell’s John Huffmeister Jan. 6, 2008, saying that “$30-45 barrel oil price is fair,” and King Abdullah of Saudi Aramco saying in December 2008 that “$75 barrel oil price is fair.”
Murky short-term outlook
What will happen to oil prices in the short term? The answer is extremely difficult to predict, Herrera said.
The variability in oil prices will continue, but the when and how “is incomprehensible,” he said.
“The economy is even incomprehensible. We have a world recession to deal with. If the next three to four years is the short term and the next eight to 10 years is the medium term, then beyond that is the long term. The real question is when oil prices creep up again, at what stage do they trigger another collapse in the economy,” Herrera said.
If the recession ends soon, demand for crude will put pressure on prices, which would precipitate a relatively quick jump to higher levels, likely followed by an even bigger economic crash, he said.
However, if the economy staggers on for another three to four years, slowly rebounding from the recession, prices will be manageable until industrial growth can re-establish itself, especially in the United States, Herrera said.
Climate change worries
Other variables could affect the timing, if not the actual outcome of oil price increases, including public policy, investment in oil production and conservation.
“The only thing that worries me is that governments get paranoid and politicians will do something silly in response to this notion that greenhouse gases will destroy the atmosphere,” the analyst said.
This happened around 1999 when European countries put curbs on CO2 production. “It’s been a decade, and those policies haven’t made an impact on CO2 emissions in Europe. In fact, CO2 emissions have gone up,” Herrera said.
The analyst said he can envision U.S. politicians doing something similar such as imposing huge taxes on business in hopes of curbing CO2 emissions and ending up curbing critically needed industrial growth.
“The extremists say we’re going to burn up because of greenhouse gases, but geologically that argument makes no sense. The earth has been much hotter and the atmosphere much thinner in the past and the earth has survived. Climate change is a natural ongoing phenomenon since the dawn of man and before,” Herrera said.
Industry investment impact
Another concern is a decrease in oil field investment during the past two to three years. Herrera said oil fields, especially in foreign countries, have essentially been left to run themselves in recent years and as a result, production likely has suffered.
“When we come out of recession, we will find production down, and it will take substantially more investment for it to go up again,” he said.
However, conventional oil and gas production will continue to decline and unconventional hydrocarbon sources, which are being used to replace traditional production sources, will come with higher costs and inherent problems that preclude them offsetting the decrease long term, said Simmons.
While “sustainability” is an industry buzzword now being applied to oil and gas, Simmons told an industry audience in June that “it isn’t clear that oil and gas production is sustainable and it’s not clear that the world works if the industry plan is not sustainable.”
Simmons believes world oil reserves have already peaked and are now declining. He said hard data shows the peak occurred in 2005.
It’s too late
Whether peak oil is in the recent past or near future, the decline of world oil supplies is imminent and inevitable, Herrera said.
“It’s too late for huge oil discoveries to delay peak oil,” he said. “The only thing that can help now is conservation — at least it can make a difference in the short term.”
A very slow recovery from the recession would not stimulate demand for oil to a great degree and put pressure on prices. Instead, it would result in stable oil supply/demand conditions, Herrera said.
If this happens, “it will string out the peaking of oil,” he said. “Prices would be affected only by inflation plus the impact of moderate growth, and they could remain under $100 a barrel for a decade.”
Editor’s note: On Aug. 12, after a two-day meeting, the Federal Reserve’s policy-making committee announced the recession had ended and issued its most optimistic assessment in more than a year by saying the economy appeared to have hit bottom and was slowly stabilizing, emphasizing inflation would remain “subdued for some time.”
