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Demand-driven energy market promises more high fuel prices

A “long, mild fall” could help ease oil prices back from current post-Katrina/Rita levels. But odds are that little can be done to return U.S. gasoline, diesel and natural gas prices to the ranges farmers and consumers were paying a year ago.

Energy analysts estimate that Hurricane Katrina disabled 7 percent of U.S. oil refining capacity when it struck the Gulf Coast on Aug. 29. On the Friday before Hurricane Rita hit the Louisiana-Texas coast on Sept. 24, 35 percent of U.S. refining capacity was shut down.

But, with all the attention those events have brought to the energy markets, they are the effects, not the causes of tighter energy supplies, according to Matt Roberts, an energy economist with Ohio State University Extension Service.

“If Hurricane Katrina had hit four or five years ago, it would have been a $4 or $5 per barrel event, not a $10 to $15 per barrel event,” said Roberts. “The difference is we're now in a fundamentally very tight, demand-driven scenario in the world energy markets.”

Speaking at the 2005 Southern Region Agricultural Outlook Conference in Atlanta, Roberts said much of the tightness in the world energy markets can be summed up in one or two words: China and India.

“China had 9.1 percent GDP growth (gross domestic product) in 2004 and is projected to grow at 9.3 percent in 2005,” he said. “Since 1990, China's economic growth has averaged more than 5 percent annually. In 1990, China was a net oil exporter, now it's the second largest importer behind the United States.

“But what you have to remember about developing countries like China and India is that what's driving their growth has been manufacturing, and manufacturing is much, much more energy intensive than the service and knowledge-based economy that we have in the United States.”

Thus, while their economic growth may have been as high as 9.1 percent or 9.3 percent in recent years, their energy growth has been much greater than that, said Roberts.

Compete for oil

Not only have China and India been competing for more oil, other countries have been getting in the mix as well. Total global economic growth reached 4.1 percent in 2004 and is projected at 4.3 percent in 2005 compared to 3.6 percent in the United States this year.

“World oil demand is estimated to have been 3.3 percent higher in 2004 than it was in 2003 and 2.2 percent higher in 2005 than in 2004,” he said. “And, if you plot this on out, you can see that oil use is likely to continue tracking closely with world economic growth.

Some critics have been trying to blame the consortium of oil producing and exporting countries for holding back on oil production and causing higher prices in the United States. Such criticism is unjustified, says Roberts.

“OPEC is pumping more oil now than at any time in its existence,” he notes. “The OPEC countries are almost at full capacity. The balance — what they're not pumping — is not desirable because it is high-sulfur oil and not the low-sulfur or “sweet” crude that everyone wants these days.”

With the increased pumping, U.S. oil stocks are the highest they've been in five years, running around 330 million barrels between April and July of this year before dropping to around 310 million barrels in recent weeks.

“The problem is demand has strengthened so much that production can't keep up,” he said. “We need $50 per barrel oil to keep our stocks at levels that used to apply at $10 per barrel. It truly is a different scenario.”

The weaker dollar has also added to the “sticker shock” of high gasoline prices. “One of the reasons we have progressively more expensive oil in this country is that we have a progressively cheaper dollar,” he says. “Don't let the currency values get in the way of the fact that we're just exchanging goods. The real price will stay the same.”

Dollar/euro prices

Over the last two-and-a-half years, the price of oil in dollars has gone up 110 percent, he said, while the price of oil in euros, the currency of the European Union, has gone up 80 percent, which is a difference of about $10 per barrel. (Saudi Arabia is now considering pricing its oil in euros, according to reports.)

Roberts, who was a commodities broker in the energy markets before he went back to school to get a Ph. D., says two factors could help reduce oil prices significantly (“below $40 per barrel”): weaker global economic growth or a stronger U.S. dollar.

“But you have to ask yourself if those really are worth the trade-off,” he said, noting a stronger dollar would exacerbate the trade deficit and slower economic growth could bring on a worldwide recession. “I'm not sure they are.”

In the next year, two factors will determine the direction of U.S. oil prices: Restoration of Gulf of Mexico production (about 900,000 barrels per day or 18 percent of U.S. production remained offline from Katrina when he spoke on Sept. 26) and potential foreign supply disruptions in Nigeria, Venezuela and Iraq.

“Any disruptions in these countries will have very significant price impact,” he said. “Given these challenges, it's unlikely that additional production can significantly affect prices in the next one to two years. With continually strengthening demand and no clearly visible way for supplies to catch up, effectively, a bidding has broken out, it's simple supply and demand.”

Eventually, the higher demand and resulting higher prices for oil will become “self-equilibrating;” that is, enough oil will be pumped and use will be restricted to the point that supply and demand will come back into closer balance, he says.

Roberts says he frequently hears complaints that part of the reason for higher gasoline prices is that the United States does not have enough refining capacity since no new oil refineries have been built here in the last 30 years.

“That's true,” he says. “However, our oil refining capacity has increased by 30 percent in those 30 years with fewer refineries.”

Refining margins

If the United States had a shortage of refining capacity, refining margins would be increasing. But until this summer, that wasn't happening, said Roberts, displaying a graph of refining margins for the past four years.

“We can import gasoline just like we do crude oil, so we don't care if we have enough refining capacity in the United States. What we care about is whether there is enough capacity in the world.”

Why did refining margins increase this summer? The United States actually started the summer of 2005 in “pretty good shape” on gasoline stocks, said Roberts. But consumption rose 3 percent this past summer over consumption in 2004 and gasoline stocks plummeted.

“Now some of this stocks situation was due to the hurricanes in August and September, but a big part of it was an awful lot of people driving an awful lot of miles in awfully big vehicles — awfully fast,” said Roberts.

In contrast to 2004 when Hurricane Ivan caused disruptions in supplies, U.S. diesel stocks currently are much higher than gasoline stocks going into the winter, he noted. With no sharp spikes in demand or further disruptions in supply this winter, the United States should be in good shape for diesel fuels and heating oil.

“If we could have a long, mild fall, we could see diesel fuel prices fall so that I'm not getting calls every other day about what affect diesel prices will have on ag profitability.”

Roberts told the southeastern university and Extension economists attending the conference that they could take the tightness on oil supplies and multiply that by a factor of four to come up with the supply/demand situation for natural gas.

“Production of natural gas has been gaining by about 1 percent per year, but consumption is growing at the rate of 3 percent per year,” he said. “New electrical power plants are being built to run on natural gas, and that's also increasing the demand.”

Congress authorized funding for a new natural gas pipeline from Alaska in the recently passed energy bill, but supplies of natural gas aren't expected to be delivered via the pipeline until 2012.

“The Department of Energy is projecting higher imports of liquefied natural gas or LNG to close the gap between supply and demand,” Roberts notes. “But LNG is costly and difficult to move around. The United States has three import terminals for LNG and would need to build 12 more to handle the needed imports. These would be very expensive.”

Katrina forced the shut down of about 6 percent of U.S. natural gas production and another 9 percent was closed down in advance of Rita, he said. Despite the disruption, natural gas inventories actually increased during the week of Sept. 9-16.

“Much will depend on the fall weather,” says Roberts. “With some luck, natural gas prices may move back to the $11 range (from current levels of $14 to $15 per 1,000 cubic feet) for February delivery.”

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