- The Washington Times - Tuesday, June 21, 2005

Unlike the upward spirals in the price of oil that occurred in the wake of the 1973 Mideast war and during and after the 1979 Iranian revolution, both of which were the result of supply shocks, today’s soaring price of oil is demand-driven. In fact, today’s supply-and-demand situation is so tight that even the hint of a supply disruption, no matter how minor relative to earlier declines, has sent the price of crude soaring. In the past month alone, oil prices have climbed $12 a barrel, closing in recent days near $60 per barrel.

In the first month following the start of the 1973 Arab-Israeli war in October, Arab oil producers slashed output by nearly 6 million barrels per day, sending the price of oil through the roof. The pre-war cost of Saudi Arabia’s benchmark oil virtually quadrupled the following year. When the shah of Iran was overthrown in 1979, Iranian oil output collapsed during the revolutionary turmoil, taking millions of barrels off the world market. The outbreak of war between Iran and Iraq in September 1980 complicated a very tight market. As a result, the 1978 price of oil nearly tripled by 1981, averaging more $35 per barrel.

By 1998, the world oil price had fallen to $10 per barrel. Even the removal of Iraq’s oil output from the world market for several years after the 1991 Persian Gulf War did not arrest the decline in the price of oil. That was then. Since 1998, the price of oil has increased by about 500 percent.

In recent years, the demand for oil has accelerated as global economic growth, fueled largely by the expansions in the United States and China, has strengthened. On top of a 2004 global growth rate of 5.1 percent, the International Monetary Fund is projecting world economic output to increase by 4.3 percent this year. In 2004, worldwide oil demand increased by 2.5 million barrels per day. Last year’s annualized rate of increase in demand for oil, 3.4 percent, was twice the average during the previous 10 years, according to BP Statistical Review. The International Energy Agency is forecasting that world demand for oil will increase this year by 1.8 million barrels per day. China and the United States alone are expected to account for 40 percent of the increase.

While demand has been relentlessly rising, output and refining capacities have not been keeping pace. Moreover, when OPEC announced last week that it would be increasing its output quota by 500,000 barrels per day to 28 million barrels, the markets shrugged off the news, knowing that virtually all OPEC members were already producing at their full capacity and exceeding their quotas. Prices continued to rise.

With no let up in demand on the horizon, markets are now anxiously reacting to mere hints of supply problems. The early arrival of hurricane season in the Gulf of Mexico, threats by terrorists to attack Nigerian targets and a possible strike by Norwegian oil workers have all contributed to the rising price of oil in recent days.

In the near term, imagine how scary the market would become if a combination of these events or other potential supply problems actually removed 2 million barrels from the market. In the long run, with the Department of Energy projecting that U.S. petroleum imports will increase by 8 million barrels per day (to nearly 20 million barrels) from 2003 to 2025, it is worth noting that 2025’s net-import level would be more than four times the level of U.S. petroleum imports the year before the 1973 Mideast war.

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