GLOBAL AGENDA: The market works

All you need to know is that every dollar off the price of a barrel is a transfer from the pockets of the Saudis, the Iranians or the Russians to your pocket.

September 7, 2006 23:11
3 minute read.
GLOBAL AGENDA: The market works

oil barrel 88. (photo credit: )


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The best news recently for the world economy, not to mention the Israeli one, has been the steady decline in oil prices. By mid-week, they had slipped to around $67.50 a barrel, some $11 dollars below the latest peak, hit immediately after the Israel-Hizbullah war began in mid-July. To understand why this is good, all you need to know is that every dollar off the price of a barrel, or cent/agora off the price in the filling station, is a transfer from the pockets of the Saudis, the Iranians or the Russians to your pocket. Along the way, a chunk of what you pay goes to the Treasury and to the oil companies, so the same logic applies there as well. Of particular interest is why the price fell further this week. Of course, any number of reasons can be cited for every move, but the focus of the oil market has clearly changed. Instead of the familiar "reduced tensions in the Middle East" and "prospects for negotiations over the Iranian nuclear issue" - still important factors - the spotlight moved to the Gulf of Mexico. Two developments there have helped push prices lower. First, there have been no damaging hurricanes, at least so far, nearly halfway through the annual season. No hurricanes means no disruption, which means no supply problems. With ample supply, prices must fall. By the way, with last year's damage repaired, at least some Gulf installations have considerably boosted their output compared to pre-Katarina levels. But the big news this week from the Gulf came not from the atmosphere above the water, but from the bowels of the earth deep beneath. Three oil companies - US giant Chevron, the much smaller Devon Energy and the Norwegian Statoil - announced that a test well known as "Jack 2" had proven highly successful. The implications, as well as the drilling of the well, are earthshaking. Jack 2 is 175 miles offshore, in more than 7,000 feet of water and then more than 20,000 feet below the seafloor. By comparison, most of the current wells operating in the Gulf of Mexico are relatively close to shore and on a shelf that puts them in less than 1,700 feet of water. Merely drilling wells like Jack 2 is an extraordinary feat of engineering, but the big breakthrough is the fact that the test generated 6,000 barrels a day - in other words, oil can be extracted in these conditions in commercial quantities. That's great, but it's only a teaser. The real source of the excitement in the markets is that the area of the Gulf that has become commercially accessible is believed to contain reserves of between 3 billion and 15 billion barrels. When you remember that total proven US reserves currently stand at less than 30 billion barrels, the magnitude, and hence the importance, of the news becomes clear. No wonder, then, that this development is being hailed as the biggest breakthrough in US energy supplies since the Alaskan fields were opened up in the 1970s. Of course, it will be years until this oil reaches the market, so it can have no impact on the supply/demand balance in 2006 or even 2007. But that does not make it irrelevant. On the contrary, it has immediate impact on the market, as the price action this week showed, as well as on the economic, geopolitical and military strength of the US - and of other countries with potentially accessible reserves of this kind. But above all, it is testimony to the way the market - Adam Smith's "invisible hand" - works. Only the tripling of prices between 2003 and 2006 made the massive investment in Jack 2 economically feasible. By extension, that means that huge additional quantities of oil have become accessible all around the globe, so that the claim that "the world is running out of oil" can be put back in the freezer for another 30 years, until the next "oil shock". Granted, this is not good news for the greens, who would like to end our dependence on fossil fuels. However, their victory will come, if at all, through numerous incremental changes in technology of the sort being developed in greater numbers recently, thanks again to the great spur provided to research by the impact of high prices. Any way you look at it, time and the markets are working against the big oil producers who, as in the 1970s, will be the main victims of the boom/ bust cycle in oil prices.

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