Untitled Document

OIL PRICES SOAR

Oil prices rose dramatically in 1999. OPEC production cuts and strong world demand caused the price of West Texas Intermediate crude to jump from about $13 per barrel in March to almost $27 per barrel in late November. OPEC discipline and the continued embargo against most Iraqi production were the main factors behind the high prices, but a strong US economy and recovery in Asia were also major contributors. Demand exceeded supply by 2.8 million barrels per day and stocks were drawn down. This year, the demand for oil is expected to grow by an additional 1.7 m/b/d; if not met by an increase in production, this will certainly drive prices higher. The way will be led by Asia, especially India, but US and European consumption will remain strong.

OPEC has the capacity to increase production, but it has expressed reluctance to do so until the current agreement expires in March 2000. Even if OPEC were to grant an early production increase to Venezuela (see below) and allow other members to increase production in March, oil prices are not likely to drop below $20 per barrel. Mexico, Norway and Russia were supposed to lower production and did not, but their ability to dramatically increase production is in doubt (especially in the case of Russia).

Iraq also plays an important role in the production question. The UN voted to extend the oil for food program for Iraq for a seventh phase, but Iraq refused to accept the offer to lift the $5.26 billion revenue ceiling. The markets will watch Iraqi exports in January to see if they are reduced to stay within these limits. The UN vote caused oil prices to recede a bit in early December, but Saddam Hussein will have a stronger card to play if OPEC keeps the lid on production in 2000.

The key Latin American producer is Venezuela. The US especially has become more dependent on its oil. Venezuela produces 3.3 million barrels per day (m/b/d) and exports 2.8 m/b/d. Exports to the US account for 1.7 m/b/d. The Venezuelan government has been instrumental in getting OPEC to adopt a more rigorous stance in cutting oil production. However, the production cut contributed to the expected 5% to 7% drop in Venezuela’s GDP and the country’s 15% to 20% unemployment rate in 1999. With much higher prices, 2000 looks to be a better year. Venezuela places any surplus over $9 per barrel into a stabilization fund (SF), allowing the government to maintain spending during future periods when the price of oil drops. In late December, the average price of Venezuelan crude oil was about $27 per barrel.

The tragic flooding and mud slides that hit the Caracas area in December caused Venezuela to seek changes in its quota to help the country deal with the crisis. Minister of Energy Ali Rodríguez told the press on December 29 that he would visit OPEC members in early 2000 to request an increase. Meanwhile, President Hugo Chávez said that his government would create 500,000 new jobs. He did not indicate whether this effort would be financed by dipping into the SF, but other financing of the magnitude required may not be available. Ultimately, while higher oil prices are good news for the Venezuelan economy, they detract from efforts to diversify the country’s exports.

The smaller exporters—Ecuador, Argentina, Bolivia and Colombia—have not cut their production significantly. Mexico reached an agreement with OPEC members to limit production, but while oil represents about 10% of Mexico’s total exports, it is not nearly as important for that economy as it is for Venezuela. The remaining countries of Latin America and the Caribbean are net importers of oil and the higher prices have a significant negative impact on their economies. Scarce foreign exchange must be used to maintain the level of oil imports, contributing to currency devaluation, budget deficits, inflation or slower growth for many of these countries.

The higher prices have meant more profits for oil companies, leading in turn to higher stock prices. This would normally encourage further exploration and drilling, but companies are reacting cautiously and no dramatic increases are planned. Just as OPEC is cautious about increasing supply, believing that oil prices might drop too sharply in response to an increase, so too the oil companies remain unconvinced of the wisdom of making a major effort to find new sources. This reluctance, combined with strong world demand, could affect the pocketbooks of US and most of the world’s consumers in 2000.

Economists point out that the US economy is not as dependent on oil as it was in the early 1970s. Nonetheless, the US imports huge quantities of oil and the impact on prices is evident in the CPI. The Federal Reserve has already raised the discount rate twice in response to the upturn in inflation. If pressure on prices continues, interest rates will undoubtedly increase further, slowing the economy.