Feb 20 - $100 oil may be just the start

Feb 20 - $100 oil may be just the start
$100 oil may be just the start

It’s getting harder and more expensive to find new oil deposits, and global demand is growing. But there’s so much speculation in crude oil that a bubble may be forming.

Crude oil hit $100 a barrel for the first time Wednesday, and the odds are that it will keep climbing – with major consequences.

If crude stays above $100 a barrel for an extended period, “you could see gasoline prices at $3.60 or $4 a gallon, which is absolutely frightening,” Paul Ashworth, senior U.S. economist at Capital Economics, a London research firm, told The Wall Street Journal on Wednesday. “It’s going to have a fairly devastating impact.”

And that’s on top of a lot of pain already. At the end of 2007, estimates analyst Peter Beutel of Cameron Hanover, American consumers and businesses were paying $370 million more for gasoline each day than they had been a year earlier.

The fact is that no one knows how much higher oil will go. But the forces behind the increase are the ones that pushed oil up 57% in the last year:

  • Rapid global demand, especially from China and India, that’s outstripping supplies. Iran and Venezuela have resisted calls for the Organization of Petroleum Exporting Countries to boost production, ostensibly because they don’t want to help the United States. The real reason is that both are having trouble meeting their current production quotas.

  • A falling U.S. dollar. Crude oil is priced around the world in dollars, so if the currency loses value, sellers want compensation. Last year the dollar fell nearly 10% against the euro, 6% against the Japanese yen and 14% against the Canadian dollar.

  • Falling global inventories. Oil companies are taking advantage of high prices to sell crude as fast as they can because they expect prices to fall later on.

  • Lower interest rates. Traders see the Federal Reserve’s willingness to cut rates, perhaps substantially, to stave off a housing-related recession as a guarantee that domestic demand will remain strong. A slowdown or even a recession would dampen U.S. demand and knock prices lower.

  • Betting on ever-higher crude prices. People who have experience with oil suggest that prices are out of touch with reality. “Prices have outrun the fundamentals,” says Daniel Yergin, chairman of Cambridge Energy Research Associates, a global energy consulting firm.

The run-up is likely to ripple through the U.S. and other economies. Asia’s rapidly developing nations have flush cash reserves to continue subsidizing fuel for their populations. But China’s 10% rise in government-controlled fuel prices shows higher oil costs are putting a greater strain on Asian nations. China reportedly already has been experiencing spot shortages of motor fuels.

India, which imports 70% of its oil, subsidizes some of its fuels, especially those used for cooking, and may face shortages unless it can pass some of the costs on to consumers.

If all this sounds like the early 1980s, it is. Except for one important difference: There seems to be little or no slack in the oil and gas industry around the world. There are fears, as MSN Money’s Jim Jubak has noted, that Saudi Arabia’s oil fields aren’t as productive as before. Iraq, which has the world’s third-biggest oil reserves, is mired in violence.

High prices will encourage plans for new – and very expensive – drilling projects for new supplies. But the chances of making a find like the North Slope of Alaska aren’t great. There is one exciting prospect off the coast of Brazil that has boosted the rank of its known reserves from 22nd-largest in the world to ninth.

But, as oil expert Charles Maxwell has noted, 6% to 7% more oil must be found and made available annually to meet the 2% annual growth in global demand.

Meanwhile the cost of bringing new supplies to market has exploded in the last year or so, says Cambridge Energy’s Yergin. It’s not just drilling costs but also enormous costs in building new refineries as well.

Maxwell says crude could stay above $100 for several years.

Others believe the speculative fever is so out of control that a bust could occur like the 1986 and 1998 busts that saw crude collapse to around $10 a barrel each time.

For one thing, says Fadel Gheit, senior energy analyst at Oppenheimer & Co. in New York, OPEC has increased production despite the opposition from Iran and Venezuela. “All in all, there hasn’t been any significant change in supply or demand to justify a 50% jump in oil prices since August.”

At some point, consumers will cry uncle about rising gasoline prices, Cameron Hanover’s Beutel says. When they do, gasoline prices will drop and should pull oil prices down as well.

“It’s a bubble,” Oppenheimer’s Gheit has said repeatedly for months. “The $64,000 question is, when will the bubble burst?”

By Charley Blaine and Elizabeth Strott, MSN Money