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The Sunday Times: The only way is up for oil prices

The Sunday Times: The only way is up for oil prices

 

By Dominic Rushe

May 23, 2004

 

ACROSS America the average price of regular petrol passed $2 (€1.66) a gallon last Monday. To outsiders, American fuel still looks laughably cheap. Aquafina, a popular bottled water, costs about $2.50 a gallon. But this is a big country with a bad train system where people and goods are transported long distances in big cars and trucks.

 

Pump prices have risen by 28% since January, and odds are they will keep rising. The consequences are far from funny. Expensive petrol is a national disaster. America’s motor industry is already feeling the pinch.

 

General Motors has raised discounts on its thirstiest sports utility vehicles (SUVs) twice this month. Some models come with up to $5,000 in discounts. After a record-breaking sales run for these monsters, the motor giants are now facing a colossal scrap pile of unsold pick-up trucks and SUVs. More lay-offs seem inevitable. And the longer petrol prices stay high, the more impact they will have on spending.

 

Wal-Mart, the world’s biggest retailer, has warned that its prices may have to rise because of increased transport costs. The retailer reckons customers could be spending $7 a week more on fuel because of the rises. Across the American media flower-delivery firms, truckers, caterers and mums can be heard counting the cost of rising prices.

 

There have been three big spikes in the price of oil in the past 50 years: after the Yom Kippur war 30 years ago; after the Iran-Iraq war in 1979; and after the previous Gulf war in 1991. Each time, recession followed close behind. This time, the real price of oil is not high by comparison, once inflation is taken into account. Adjusting for inflation, in today’s dollars, motorists were paying $2.92 per gallon in March 1981.

 

Oil buffs talk about Hubbert’s peak, a formula that says the cost of oil production follows a bell-shaped curve. Oil production increases rapidly in the early stages of a find as the easily accessible stuff is pumped out. Once it passes the peak, the cost of pumping oil rises sharply, production slows and the well rapidly becomes uneconomical. The cost of extracting the oil is greater than the value of what’s left in the ground.

 

The theory was created by M King Hubbert, a Shell geologist who predicted in 1956 that American oil production would peak in the early 1970s and then begin to decline. Hubbert was dismissed by experts inside and outside the oil industry until 1970, when US oil production peaked and started its long decline. Doom-mongers have it that the world is heading for Hubbert’s peak in the next few years.

 

As Shell has demonstrated, we don’t really know how much oil is out there. If we can’t trust Shell’s accounting, what about the Saudis? OPEC’s reserve figures have long been suspected of being subject to political inflation. We may not be sure how much is left but we do know we want to use more.

 

Globally it is estimated that the use of oil will rise by 50% in the next 20 years. Much of that extra demand will come from India and China. Just as America seems to be moving against gas guzzlers, new (sub) continents of consumers are coming on line.

 

The current crisis may be a good thing, ushering in a post-petrol age. In the meantime, watch out for shiploads of SUVs heading for China. The real issue now is whether prices are on the way up or down.

 

The oil futures market is betting oil prices will be lower next year at $35 a barrel, well below today’s $40 plus. In the short-term they are probably right, in the long term, it’s hard to argue for anyway but up.

 

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