About four weeks ago, in an interview with the Financial Times before the recent meeting of the Organization of Petroleum Exporting Countries (OPEC) in Algiers, Dr. Purnomo Yusgiantoro, Secretary General of OPEC, made the comment that OPEC is producing at "near maximum capacity".  He was further quoted as saying "the price is too high.  We are already doing our best, our share, to stabilize the market".  OPEC subsequently cut its official quotas by one million barrels per day for the spring quarter and stated that they would stop producing at rates  above quotas to accommodate a normal spring seasonal drop in demand. 

This comment, a firm indication from OPEC that - despite the convenient spring respite, the world has no more surplus oil production capacity, that oil prices are too high and that not much can be done about it - presents a situation with profound negative implications for the world economy.  Dr. Purnomo, with two degrees from the Colorado School of Mines, is a technocratic type of politician; his comments are not to be taken lightly.  Not surprisingly, however, this comment has received little notice from the press or Congress who seem to consider Janet Jackson's right breast of much greater interest and threat to national well-being.  Even Chairman Greenspan, usually astutely concerned with energy matters, in the portion of his testimony I heard, did not mention it.

For the first time, growth of world demand for oil and world economic growth will be limited by the growth of world oil production capacity - and that is not a very high rate of growth, less than two percent. 

Large new supplies to alleviate this problem do not seem to be available, at least in the short term ( a few years ).  Russian production has reached the limit of their export infrastructure and new pipeline capacity is a few years away.  Iraq is still not awarding contracts for the development of new fields and probably will not in the near future.  Latin America, with economic and political problems in Venezuela, Argentina, and Colombia, is not attracting investment.  Libya is set to re-enter the game, but significant increases of its production are a few years away.  West African production will increase in the short term and Saudi Arabia has announced an $18 billion investment program over three years to develop new production.  These latter two sources will give some relief; they should offset production declines elsewhere (and in their own older fields) and hold worldwide production at least constant, perhaps with a small rate of increase, but probably not enough to maintain economic growth at current rates.  

If the total world economy cannot keep growing at current rates, several questions arise regarding economic adjustments.  What parts of the economy will continue to grow at the expense of others?  With globalization, can some parts continue to grow as others falter?  Who is going to take the hit?  So far no one seems concerned, but the effect on employment may relegate the current debate on job outsourcing to the back pages. 

When world demand approached productive capacity previously, respite was provided by a sudden drop of demand caused by the Asian financial crisis and the re-entry of Iraqi supply to the markets as sanctions against Iraqi production were lifted under the UN oil-for-food program.  With no significant shut-in production poised to re-enter the market, will the US initiate another foreign financial crisis to decrease demand and maintain oil price stability?  If so, who will it target and what will be the rebound effect on the US stock market and economy?   Or China?  Or Russia?  Or Europe?  Will that be better than just letting prices continue to rise?

The current situation is the result of trends that have been converging for years.  Congressional "energy bills" have become a debate on environmental issues and subsidies to corn farmers, offer no solution, and do not get passed.  The US oil industry was "outsourced" to foreigners many years ago.  No action has been taken to correct the inconsistencies, imbalances and tensions of the oil market and alleviate the effect of the now-imminent economic upheaval

So those inconsistencies, imbalances and tensions will now be imposed on the world economy in a disruptive manner.  Be ready for it; the proverbial sleeping giant is rolling over.

 

Dr. Charles A. Kohlhaas is a former Professor of Petroleum Engineering at the Colorado School of Mines and has worked for, founded, managed, and consults for, major and independent companies in the international oil and gas industry.