The Fuel Conundrum

Could an overabundance of oil be behind the recent explosion in diesel fuel prices?With diesel engines roaring and air horns blaring, more than 170 independent truckers and owner-operators rolled into Washington, D.C., last March to protect the skyrocketing cost of diesel fuel. With signs taped to their rigs saying "Will Work for Fuel," the second large-scale rally in two months in front of Capitol

Could an overabundance of oil be behind the recent explosion in diesel fuel prices?

With diesel engines roaring and air horns blaring, more than 170 independent truckers and owner-operators rolled into Washington, D.C., last March to protect the skyrocketing cost of diesel fuel. With signs taped to their rigs saying "Will Work for Fuel," the second large-scale rally in two months in front of Capitol Hill sought to draw attention to a fuel price crisis that still grips the trucking industry.

"Fuel price increases are really squeezing small business operators like me," said Irvin Wells, a 12-year veteran owner-operator from Dallas, at the rally. "You know as well as I do that fuel is one of our main expenses. Right now, I am spending an average of $140 more per trip than what I was spending last year at this time. I don't have enough money coming in to offset those kinds of expenses."

From lows of about 90 cents/gal. last year, the cost of diesel fuel shot up to over $1.56 this year. Prices soared to nearly $3/gal. in parts of the Northeast this winter as a frigid cold snap drove up demand for heating oil, which is produced from the same distillates diesel stocks rely upon.

Paying more at the pump for fuel, however, threatens more than just the wallets of truckers.

"Fuel price increases and other increases, such as insurance rates, are literally running us out of business," said Doug Danbury, owner of a two-truck fleet out of Michigan, at the Washington rally, sponsored by the Owner-Operator Independent Drivers Assn. (OOIDA). "Things are really rough - we're surviving pretty much day-to-day right now."

What's behind the high fuel prices? At first glance, the cause seems simple enough. The Organization of Petroleum Exporting Countries (OPEC) engineered major oil production cuts last year, agreed to not only among its 11 members but by non-OPEC oil producing nations as well.

Reducing the world's oil supply by 4-million barrels a day in the face of growing demand had its intended effect: raising the price of oil from lows of $10/barrel in 1999 to this year's high of $30/barrel.

Yet that's only half the story. At the heart of the fuel crisis in the United States - and, indeed, for the rest of the world - is a more fundamental problem: too much oil to go around.

What's driving the recent price hikes in diesel, gasoline, heating oil, and other petroleum products, argue Amy Myers Jaffe and Robert A. Manning in their essay, "The Shocks of a World of Cheap Oil," is an "embarrassment of oil riches."

"Contrary to much received wisdom, the energy problem looming in the early 21st century is neither skyrocketing prices nor shortages," they said. "Instead, the danger is precisely the opposite: long-term trends point to a prolonged oil surplus and low oil prices over the next decade."

Jaffe, director of the Energy Research program at the James A. Baker III Institute for Public Policy at Rice University, and Manning, senior fellow and director of Asian studies at the Council on Foreign Relations, say that current price hikes are the result of "engineered cutbacks."

Formed in 1960, OPEC resorted to such tactics for a simple reason: The cost of exploring and producing oil has dropped almost 80% over the last two decades. According to James Schlesinger, former U.S. secretary of defense and energy in the 1970s, that means most oil production today remains profitable even at margins down to $7-$8/barrel.

"Technological advances - including computer-assisted, three-dimensional imaging that let's geologists 'see' underground oil pockets - have slashed the cost for developing hard-to-tap reserves and improved the chances for new discoveries of oil," said Jaffe and Manning. "Moreover, better platform designs and drilling methods have also let companies recover more of the oil that they find. These technological gains have dramatically lowered the cost of finding and producing oil and natural gas, and given energy consumers ample, inexpensive supplies just at the time that earlier forecasts had predicted a shortage."

Two decades ago, petroleum experts believed the world was on the verge of running out of oil. In 1972, a group known as the Club of Rome said that only 550-billion barrels of oil remained and that the world would run out by 1990, said Jaffe and Manning.

Instead, the opposite has occurred. The world actually consumed over 600-billion barrels of oil between 1970 and 1990. And according to the International Energy Agency (IEA) in Paris, cheaper drilling and recovery methods boosted the world's available oil supplies to over 1-trillion barrels of proved reserves (oil recoverable at current prices under current conditions).

Those reserves may actually exceed 2.3-trillion barrels, said the IEA, which means that even at current global consumption levels of 73-million barrels a day, the world has enough oil to last for at least another 70 years.

The wrath of low prices With better and cheaper technologies on hand, more and more countries have been able to locate and produce oil in greater quantities - both from new and old wells.

Jaffe and Manning explain that improved production techniques have allowed companies to double the amount of oil they can recover, in many cases from 20% to 30% up to between 50% and 60%. Exploration companies are now six times as successful at finding oil today as they were before 1973.

Now that finding and producing oil is cheaper and easier, more countries are getting into the act - reducing the stranglehold OPEC held for decades over the world's oil production, said Jaffe and Manning. They added that new oil reserves will soon come online in the waters off the Gulf of Mexico, eastern Canada, and western Africa, along with onshore regions in South America, central Africa, and regions of the former Soviet Union - areas outside OPEC's control.

Indeed, Canada has become the largest oil exporter to the U.S., providing 14.3% of the average 10.5-million barrels a day imported by the U.S., compared to 13.8% provided by Saudi Arabia.

Yet the rush by non-OPEC oil-producing countries such as Canada, Norway, the United Kingdom, Russia, and others to make money from their finds over the last two decades caused the price of oil to tumble dramatically. Cheap and plentiful oil knocked the price of oil down to $8 per barrel in 1998 - a 77-year record low. Though that proved a boon to truckers and motorists throughout the U.S. in 1998 and into 1999, it plunged oil-producing countries - especially ones mired in economic trouble, like Russia - into a crisis of their own.

"Although the economies of the United States and oil-importing nations would by and large benefit ... this scenario of plenty could de-stabilize oil-producing states, where regimes that count on healthy oil revenues for calming restive populations and assuaging social tensions," said Jaffe and Manning.

They pointed to countries in the Persian Gulf, Russia, the former Soviet republics, Mexico, Venezuela, and Colombia as prime examples. Russia, for instance, depends heavily on oil and gas exports for its hard-currency earnings - oil exports in 1996 alone earned that country $16.9 billion or 20% of its total export revenue - and low prices in 1998 worsened its already troubled economy.

"Without the salve of rising oil revenues, many of these nations can expect to see heightened political instability, social unrest, or even civil war," said Jaffe and Manning.

This explains why cheap and plentiful oil helped give new life to OPEC last year. The cartel convinced its members, as well as the non-OPEC countries, to adhere to new oil production quotas.

"Sheer fiscal terror revived OPEC," said James Placke, director of Middle East research for Cambridge Energy Research Assoc. "They were really looking over the edge of fiscal disaster."

Captive transportation Despite a world awash in cheap and plentiful oil, transportation in the U.S. remains uniquely vulnerable to any price fluctuations. While oil provides about 40% of the energy Americans consume, it represents 97% of transportation fuels, according to the American Petroleum Institute (API), based in Washington, D.C.

The trucking industry is even more susceptible because its primary fuel - diesel -is made from distillate fuel oil, the same oil by-product from which home heating oil is made.

According to API, some 10-million homes and 500,000 businesses rely on heating oil for heat during the winter months. That makes heating oil sales a weather-related commodity, which in turn can shrink the supply of diesel fuel during severe cold snaps.

For example, an unexpected frigid blast of air hit the Northeastern U.S. this past January and February, creating a spike in demand for home heating oil.

As refineries had less oil on hand, preferring to draw down existing inventories rather than purchase higher-priced crude, they began making more heating oil at the expense of diesel fuel. That's why the price per gallon of diesel topped $3 in the Northeast, while the national average hovered around $1.50.

That's also why trucking is so vulnerable to oil price fluctuations, said Walter McCormick, president of the American Trucking Assns.

"The national diesel fuel crisis has a direct and strong adverse impact on the American trucking industry, because trucks move most of America's freight and diesel moves most of America's trucks," he said in a letter earlier this year to President Clinton. "This cannot continue if America's economic health is to be preserved."

The vulnerability of the trucking industry to price shocks may even increase in the years ahead, as other nations increase their reliance on oil to fuel their transportation sectors.

According to the IEA, transportation is expected to consume about 60% of the world's oil by 2010 - up from 55% in 1995 and 43% in 1971. As demand grows for trucks and automobiles in the emerging economies of China, India, and other Asian nations, that percentage could climb even higher, the IEA said.

Depending on foreign oil There's been another by-product of cheap, plentiful oil in the U.S.: a greater reliance on oil imports. The U.S. Dept. of Energy estimates that 54% of the nation's daily oil consumption comes from outside the country - a number expected to increase to 65% by 2020.

Despite the growth of non-OPEC oil imports from countries such as Canada and Norway, fully 45% of America's oil imports come from OPEC members, with Persian Gulf nations such as Saudi Arabia and Kuwait providing 23%.

The reason for such high levels of imports is that low prices have stifled domestic production. Domestic oil reserves actually fell 7% last year, according to API, as low prices made it uneconomical for smaller domestic producers to keep wells open.

"Oil became too cheap a year ago, and when it gets too cheap, domestic producers get forced out of business," said Jim Johnston, president of OOIDA. "Even when the price of oil increases, like it has recently, their financial backers may be unwilling to invest more funds because they fear the price will come back down again."

With almost half of the oil America imports coming from OPEC sources, Johnston warned that truckers and motorists alike would continue to be adversely affected by OPEC's production and price policies.

"OPEC s whole strategy revolves around controlling oil prices," he said. "They have to keep us on the edge of a shortage all the time to get higher prices. That's a dangerous situation, and we're concerned about our nation's dependency on them."

The world is also relying more on OPEC oil and, in particular, oil from the Persian Gulf countries. According to Jaffe and Manning, the Persian Gulf's oil share of the current world market is at 24%, but will rise to more than 32% by 2010. Asia is predicted to obtain more than 90% of its imports from the Persian Gulf by 2010, they said, which will leave countries such as China and India - long self-sufficient in energy - exposed to the same price fluctuations experienced in the U.S.

"If China thinks it is more vulnerable in energy, it could become more assertive, particularly if U.S.-Chinese relations turn adversarial," warn Jaffe and Manning.

The troubles ahead What does the new reality of overabundant oil mean to truckers? Quite simply, that the pain at the pump this winter could be a foretaste of unpleasant things to come - on both a national and global scale.

"A world of persistently low oil prices will pose real challenges for U.S. national security," said Jaffe and Manning. "Not only is Washington unprepared to handle these problems, but current policies are likely to exacerbate them."

Scarcity is not the only scenario to fear, they add. That's why burden-sharing questions are better addressed sooner rather than later to lessen the chance of tensions among major oil consuming nations during a crisis.

"The lessons of the past century have taught us that politics, not geology, has ruled our oil-supply fate," they explained. "Politics and diplomacy brought the price of oil from $8/barrel to past $23 last year and even higher this year. The internal politics of the Persian Gulf have repeatedly disrupted U.S. oil supplies in the past and could do so again in the future."

Hide comments


  • Allowed HTML tags: <em> <strong> <blockquote> <br> <p>

Plain text

  • No HTML tags allowed.
  • Web page addresses and e-mail addresses turn into links automatically.
  • Lines and paragraphs break automatically.