- The Washington Times - Tuesday, June 1, 2004

Irrespective of the publicized decisions by ministers from the Organization of Petroleum Exporting Countries (OPEC), who are meeting this week in Beirut, the world would do well to prepare for oil prices above $40 per barrel for the indefinite future. Indeed, the $40 level will probably represent a floor, not a ceiling. As the oil minister of Mexico, which is not a member of OPEC, recently told Expansion, the Financial Times’ Spanish sister newspaper, “The market is signaling that [OPEC’s official] price band between $22 and $28 was broken a long time ago.”

Several important factors need to be understood. When OPEC set the $22-$28 price band on March 30, 2000, a U.S. dollar was worth 1.04 euros. Today, that same dollar buys only 0.82 euros, reflecting a dollar depreciation of 21 percent since the band was established. Because the world oil price is set in dollars, OPEC would want to exercise any market power at its current disposal to raise the dollar price of its product to compensate for the dollar’s reduced purchasing power. That market power at the moment is quite extensive. In fact, the spare oil-production capacity in the world is lower today than it has been in three decades. Virtually all of that spare capacity is in the hands of Saudi Arabia, which, along with Iraq recently, has been the target of terrorists determined to stem the flow of both nations’ oil output. Most experts calculate that the so-called “terrorist premium” in today’s market amounts to $4-$8 per barrel, a level that is not likely to fall in the near term.

Now, it is true that today’s evident floor price in the range of $40 is nearly identical to OPEC’s record-level official ceiling price of $41, which was established in December 1980. Adjusted for inflation, however, that $41 per barrel translates into $90 per barrel today. Thus, when measured in constant dollars, oil prices today are much lower today than they were nearly 25 years ago. It is also true, moreover, that, relatively speaking, the U.S. economy is much less dependent upon oil today than it was in 1980. Thus, while petroleum demand in the United States has increased from 17 million barrels per day in 1980 to 20 million barrels per day now, today’s gross domestic product is more than twice the level of 1980’s. At the same time, however, America’s reliance imported petroleum products now averages 11.5 million barrels per day, more than 5 million barrels per day higher than imports in 1980.

Except for Saudi Arabia, which says it wants to increase its output by as much as 2.2 million barrels per day to meet rising demand (which is mostly fueled by China and other rapidly growing Asian nations), other OPEC and non-OPEC oil producers are already maximizing output. However, it is unlikely that Saudi Arabia’s ramped-up production will be sufficient to meet rising demand, which is projected to increase by nearly 4 million barrels per day by the end of this year. Thus, upward pressure on oil prices will likely remain for some time.

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