Monday, August 07, 2006

How Soon Will Oil Hit $80?

I woke up this morning, turned on the radio, and learned that BP had begun a shutdown of the Prudhoe Bay oil field in Alaska, which will take 400,000 barrels per day off the market. It wasn't long before the phone started ringing. MSNBC wanted me to comment, and so did Here & Now, a radio program out of Boston that airs nationally on NPR.

Here's my take on the situation: Just a few short years ago, 400,000 barrels per day would have had virtually no impact on the market price of oil. That's because there was plenty of slack in the system. If you shut down production in one part of the world, some other country could easily make it up.

These days, there isn't as much slack. Oil prices have gone through the roof because of increased anxieties caused by falling slack and rising demand. In addition, many of the major producing nations are anything but stable. Iraq isn't producing anywhere near its potential, oil workers in Nigeria are constantly under attack, Venezuela's president is actively seeking ways to hurt the U.S. economy, and Iran is hinting it may use oil as a weapon in response to economic sanctions relating to its nuclear enrichment program.

Iran has also threatened to retaliate if Israel attacks Syria. One form of retaliation may be to restrict the flow of oil out of the Persian Gulf. When traders have this much to worry about already, the sudden and unexpected loss of 400,000 barrels per day of production is enough to push prices considerably higher.

OPEC says it has plenty of spare capacity to make up for Prudhoe Bay's loss. Even today, Saudi Arabia could easily make up the difference alone. The Saudis are probably producing about 9 million barrels per day, and could probably push that up to 11 if they had to. But the Saudis can't produce much more than that without significant investments.

Nonetheless, I have to wonder if OPEC sincerely wants to bring oil prices back down. OPEC officially expresses concern about elevated oil prices and how they may harm global economic growth and oil demand, yet member countries certainly don't seem to mind drowning in the flood of cash these high prices are bringing them.

As for the Strategic Petroleum Reserve, it's holding about 690 million barrels of oil. It takes about 13 days for that oil to reach market once President Bush gives the order to release it. If he's thinking of doing it, he should do it soon.

Losing 400,000 barrels per day of production will not cause any shortages. But it will cause oil traders to bid up the price. We are getting very close to $80 per barrel. That translates to about $3.20 per gallon for the national average retail price of gasoline, which is already at $3.04 according to the AAA.