Is The Current Price of Oil (High $20s) Sustainable?

TIE asked five distinguished experts.

JAMES SCHLESINGER

Senior Advisor, Lehman Brothers. The writer was also Secretary of Energy when the Shah fell, and Secretary of Defense during the Arab oil embargo.

Is the price of oil sustainable in the high $20s or low $30s for the next twelve months? Answer: unquestionably. Will the price of oil be so sustained over the next year? Answer: it is very dubious.

The key is inventories. Inventories are now at their lowest level for the last quarter century. As inventories shrink, prices rise -- and vice versa. In 1997, after the Asian financial crisis and the Organization of Petroleum Exporting Countries' (OPEC) subsequent "mistaken" decision to increase quotas, oil inventories swelled inordinately. By the end of 1998, prices had dropped to around $10 per barrel. Through a series of cuts, OPEC and its allies responded by pushing production below consumption. Accordingly, inventories have been falling rapidly, which is where we stand today. The OPEC powers were badly burned and have learned their lesson (at least temporarily).

Inventory levels remain a matter of dispute. Suitable inventory levels for consumer nations may be excessive to producers. But once burned, twice shy: The OPEC nations will be cautious about increasing supply so that theprice of oil does not slip back into the teens.

Today, only the Saudis have the requisite spare capacity to provide added supply for a robust world economy. The Saudis are keenly aware that a price in the high $20s is unsustainable in the long run since it will induce substitution, conservation, and, most importantly, an expansion of non-OPEC production. The Saudi Minister of Petroleum Ali al-Naimi has said that the appropriate price should be $20-$25. But the Saudis also wish to achieve consensus within OPEC. They are determined to avoid increasing supply to such an extent that prices slip back into the teens. And they want to avoid, as their partners do, the appearance of buckling under American pressure.

The upshot is a very cautious increase in production, one that is unlikely to bring prices down quickly -- so that prices could linger in the high $20s for a while. Discipline can, of course, always break down. But that remains the most probable outcome.

Nonetheless, it is likely that oil prices will be down in the low $20s by the end of next winter's heating season, if not earlier.

What can the United States do about it? Answer: little or nothing. We kid ourselves if we believe we have that much influence. Saddam Hussein continues to rail that producers must not yield to American pressure. The Kuwaitis, for one, are notoriously unsusceptible to pressure (save when their country's existence is at stake). And again, the Saudis would be embarrassed to be perceived as yielding to overt American pressure.

So until such time as additional capacity is developed or cartel discipline cracks or the international economy craters, we should get used to OPEC's renewed control of the oil price.

LUIS E. GIUSTI

Senior Advisor, The Center for Strategic and International Studies, and former Chairman and CEO, Petroleos de Venezuela, S.A.

Last year at this time, wildly inaccurate predictions ran rampant among analysts. Trying to control or predict the price of oil within a supply management system has proved to be slippery territory. The $30 per barrel price was an overshoot of the $20 to 25 per barrel target, resulting from the difficult assessment of elasticity within a managed supply. Contributing factors such as weather, economic cycles, and non-compliance of production agreements cannot be discounted in the future of price fluctuations.

The most recent challenge was to finalize the supply agreement without a big price fall. The 1.7 million barrels a day production increase announced in March by 0PEC, plus the 1.5 million barrels a day over-production beyond OPEC's quotas, seem to provide the recipe for meeting the $20-25 per barrel range. In the wider picture, we might conclude that increased price stability is helped both by intense dialogue between producers as well as by the active participation of consumer nations, as exemplified by U.S. Secretary of Energy Bill Richardson's efforts. Also, renewed relations between Iran and Saudi Arabia can add strength to the original triumvirate of Mexico, Saudi Arabia, and Venezuela.

The upper price ceiling, according to the traditional law of supply and demand, is set by the ever-present but elusive ghost of price driven substitution. Abundant statistical information indicates that if price is consistently above $25 per barrel (West Texas Crude), oil will begin dropping from its 40 percent market share. In addition, price stability is threatened when more expensive barrels enter the market, thereby increasing supply and pushing the prices down. While the possibility for substitution and loss of market share -- as well as the expansion plans and upstream opening projects announced by several countries -- suggest that prices will decline from $25-30 per barrel, low stocks, bad weather, strong economic growth, and the uncertain future of Iraq's Oil for Food program could help sustain these prices for some time.

DANIEL YERGIN and ANN-LOUISE HITTLE

Daniel Yergin is Chairman of Cambridge Energy Research Associates (CERA) and author of the Pulitzer winning The Prize. Ann-Louise Hittle is CERA's Senior Director for World Oil and chief author of World Oil Scenarios to 2020.

Over the last year, the oil exporting nations were much more successful at boosting oil prices than they themselves had expected. Worldwide petroleum in ventories fell from overflowing to below traditional "minimum operating levels." But prices went in the other direction, rising from as low as $10 per barrel to as high as $34 per barrel.

Now the oil exporting nations face the challenge of redefining success away from squeezing down inventories to...