03-24-03

OIL -- IRAQ AND AFTER

Daniel Yergin, chairman of Cambridge Energy Research Associates, received the Pulitzer Prize for his book "The Prize: The Epic Quest for Oil, Money and Power." His new television series, "Commanding Heights: The Battle for the World Economy," based on the book of the same name, is now being broadcast on television network around the world.

By Daniel Yergin

WASHINGTON -- Until things are settled in Iraq, the oil market will be turbulent. Yet the fundamentals of supply and demand have changed dramatically in just a few weeks, putting in place a foundation of stability that was missing this past winter. This also enables us to look out beyond the current war.

What was a very tight market in February has given way to one that appears, at least right now, able to accommodate the cessation of supplies out of Iraq. This is what the dramatic fall in price from the late February high of almost $40 a barrel is telling us. Of course, the price can bounce right back up again if there are difficulties in the war, or if there are other disruptions -- whether war-related in the Gulf region or for other reasons, such as the kind of tribal conflict that is shutting down some of Nigeria's production right now.

With that said, the market has changed quickly. What had made it so tight was a combination of factors. For several weeks, production in Venezuela, a larger producer than Iraq, was shut down by a quasi-civil war. Weather was cold. Inventories were low. And a "fear premium" entered the price as war with Iraq became increasingly likely. On top of everything else, the OPEC countries had been slow to increase output. All of this pushed oil prices above $30 a barrel -- a big negative for world economic growth.

Now, however, a good part of Venezuelan production has returned. Meanwhile, a number of other exporters, led by Saudi Arabia, have stepped up their production -- first to make up for the lost Venezuelan oil and then to prepare for the shutdown of Iraqi production. And, as winter gives way to spring, oil demand drops by 2 million barrels per day -- a volume about equal to what has been Iraq's recent level of exports. Indications that the U.S. Strategic Petroleum Reserve and the strategic reserves of other countries would be used -- "if necessary " -- helped further to calm the market.

Attention is now turning, with some concentration, to what happens in the future, both in terms of Iraqi and world oil. For a "new" Iraq, petroleum will be very important -- a major source of revenues for rebuilding the country. This means that job No. 1 will be to rehabilitate the existing industry, whose capacity has dropped by 20 percent over the last decade. To bring it back to its former capacity could well take two to three years and $5 billion or more -- even if there is very little war destruction.

The second task will be to double production. But here realism is required. Iraq currently is an important but second-tier oil-exporting country -- at about the same level as Nigeria. To double production could take six to 10 years and upward of $30 billion. That is why a new government is likely to seek foreign investment. It's probably going to look for a diversified group of companies, representing a number of different nationalities.

But Iraq also has to be seen in a bigger context. It does have large, untapped reserves. It's often said to have the "second largest proven reserves in the world." But all the Persian Gulf countries suddenly increased their reserves by 50 percent in the mid-1980s, and Iraq's current level of reserves are, in fact, very much on the same level of those of Kuwait, Iran and the United Arab Emirates.

Iraq -- which produces just about 3 percent of total world demand of 77 million barrels per day -- also needs to be seen within the framework of a much larger and more diversified network of global oil production. The supply picture has become much more varied since the oil-crisis years of the 1970s. Both the North Sea and Alaska came into the picture only in the late 1970s. West Africa is currently growing in importance. But the most dynamic growth right now is in the Caspian Sea region and in Russia, where output has surged by 25 percent in the last three years.

When we at Cambridge Energy (CERA) look out to the year 2010, we see Russia and the Caspian, on one side, and the Middle East (including Iraq) on the other, in a race to supply the new barrels needed to meet growing world demand. At this point, it looks pretty close, with each poised to add between 4 and 5 million barrels of oil per day. Critical for the Russian industry, however, will be new pipelines that will take Russian oil east to China or to Japan and north to the ice-free port of Murmansk.

Another key factor is technology. Every era of oil is punctuated by the introduction of new technologies that expand horizons. In the view of Cambridge Energy, a new technological revolution is unfolding. We call it DOFF -- the digital oil field of the future. This integrates a host of information, measurement and control technologies that will make exploration and production much more efficient and exact -- and thus lower costs.

We believe that DOFF could, over a period five years or so, add 125 billion barrels of oil that previously were not economic to produce. This is greater than the entire proven reserves of Iraq. Ironically, a new Iraq, reconnecting with the world economy, could be among the beneficiaries of DOFF, along with other oil-producing countries. But the biggest beneficiaries will be consumers -- most notably, the people of countries like China and India. For DOFF will add to the availability of the moderately priced oil that they so critically need for their continued economic growth.

(c) 2003, Global Economic Viewpoint. Distributed by Tribune Media Services International.
For immediate release (Distributed 3/24/03)