Opinion: All I Want for Christmas Is Cheaper Oil

By Dan Lang

taff Reporter

If you are one of those who clapped for Tinker Bell, you’ll love this report by Bear, Stearns & Co. Equity Research.

One of its analysts concludes that crude oil will fall next year from its current roost in the $30-to-$35 a barrel range to between $17 and $18 a barrel — a price level not seen since June 1999. That forecast was presented to the Boston Security Analysts Society in November and discussed last week during the Transport Topics Management Outlook Forum.

Cheaper oil would be a really great Christmas gift — even if it arrives a little late — to the trucking industry, which has suffered from steadily climbing diesel fuel prices, up more than 50% since early 1999.

The forecast was developed by Frederick P. Leuffer, about whom a colleague at Bear Stearns said, “He sometimes seems to be way out in left field, but he has been on the money every time in the past.”

Maybe he is on the money this time, too. I certainly don’t want to be the kind of Grinch who roots against this kind of high expectation. But I can’t escape the little whisper of reality that keeps telling me there is something wrong with this analysis, elegant though it may be.

According to the report, technology has so improved the efficiency of oil production that major oil companies were achieving a healthy 16% rate of return on capital at a time when the average price of oil was only $16.24 a barrel.

At $20 a barrel, the reasoning goes, there should be plenty of incentive for exploration and development by producers outside the Organization of the Petroleum Exporting Countries.

In addition, it is said that the new technology has shortened the time needed to bring a well on line — meaning that a producer can react to an opportunity to get into the market with less fear that the price will fall before they can start earning.

But the part of this report that makes it truly elegant is its conclusion that Saudi Arabia and perhaps some other long-time OPEC producers can counter this new ability to react quickly to market opportunities by manipulating the price up and down.

Indeed, the report suggests that the Saudis, Kuwaitis and the United Arab Emirates, the OPEC members with the greatest capacity for production, were already chasing this strategy in 1997 when they overproduced so much as to force the price below $10 a barrel.

This means that the real motive for the production cuts that began in 1998 and 1999 was the introduction of “high-end” price volatility that would give the cartel members the revenue they need.

Thus, the next step would be to quickly bring the price down to below $20 a barrel so that no outside producers will enter the market.

The report asserts, as the OPEC members have, that production is already outstripping demand despite continued high prices and low inventories, especially in the United States.

The blame goes to the logistical system of moving oil around the world, which Bear Stearns says is complex and hard to trace.

Maybe.

But in explaining the glut of oil in 1997-98, the report ignores the severe recession in Asia, which suddenly reduced demand when production was increasing.

It also ignores Asia’s economic recovery, which has soaked up additional oil production and helped keep world demand strong.

Also ignored are the struggles of U.S. refineries to produce distillates — heating oil and diesel fuel — in the face of continued high demand for transportation and looming high demand for home heating during what is likely to be a colder-than-usual winter.

Finally, although the report deals in wholesale oil prices, the implication is that the price of fuel for transportation, heating and energy will drop. In that regard, it ignores the likelihood that the Environmental Protection Agency will mandate the production of ultra-low-sulfur diesel fuel.

If it does, warns the American Petroleum Institute, there will be severe shortages and substantially higher prices.

The problem with the Bear Stearns analysis — the thing that fills me with grinchiness — is that it seems to leave nothing to chance.

It stretches credulity to think that a three-year roller coaster ride from extremely low to extremely high oil prices was the result of a calculated scheme and not just miscalculation.

As my ol’ daddy used to say: “You’ve got to give people credit for being stupid.”

Actually my father would have hated being called “ol’ daddy.” But he might have said that.

Dan Lang covers fuel issues, trucking equipment and intermodal news for Transport Topics.