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Supply, demand imbalance causing oil price spike
San Francisco Chronicle


May 27, 2008

Call it a failure of economics. Even as the cost of crude oil has soared in recent years, the amount pumped from the ground hasn't.

Since the start of 2004, oil's price has quadrupled, from $33 per barrel to $132. Production, meanwhile, has risen just 1.8 percent, to 84.6 million barrels per day.

That's not enough to keep pace with the world's growing thirst for oil, which has increased 3.7 percent during the same time.

The imbalance -- one of the main reasons gasoline now costs more than $4 per gallon -- isn't the way economics is supposed to work.

When a product is in short supply, the price rises, and the companies that make it usually produce more so they can cash in. Supply eventually outstrips demand and the price goes down.

Faced with rising global demand and record prices, the oil companies in theory have a powerful incentive to find, pump and sell as much crude as they can.

But in reality, they're having a hard time keeping their output level -- much less expanding it.

That's because hitting the geological jackpot --big, untapped oil fields known as "elephants" in industry parlance -- is getting harder and harder.

"There aren't many elephants or super-fields left," said Ken Medlock, an energy research fellow at Rice University's Baker Institute for Public Policy. "The major (companies) are looking for places to make large investments, but they haven't found many."

The Organization of the Petroleum Exporting Countries, meanwhile, refuses to pump more oil, saying there's enough on the market. But that refusal may mask problems within the cartel, analysts say.

While some OPEC countries could increase production if they chose, others, such as Iran and Venezuela, haven't invested enough money in their oil fields and have seen their production decline as a result.

Stagnant production over the past few years makes some wonder whether the dreaded moment of "peak oil" has arrived. That refers to the theory that because oil is a finite supply, it will become increasingly scarce after production reaches a peak.

No one knows when that moment will hit. It's the kind of milestone that can only be seen in retrospect, after years of falling production.

But the fact that oil companies have not yet been able to ramp up their output to capitalize on today's prices alarms people who believe peak oil is upon us.

"It's a strong signal that global oil production is probably peaking about now," said Richard Heinberg, senior fellow at the Post Carbon Institute think tank in Sebastopol. Heinberg has popularized the notion of peak oil in a series of books.

Many if not most oil industry analysts disagree. A few even argue that enough new wells will be drilled in the next few years to create an oil glut and lower prices.

"We're projecting by the end of 2009 we may actually be in a surplus," said Frank Verrastro, director of the energy program at the Center for Strategic and International Studies.

But even if the glut materializes, it won't last long, he said. Demand is rising too quickly for that, in such places as China, India and the Middle East.

Another complication is the fact that there's a lag between high prices and increased production. Oil fields take years to find and develop, and the contracts to pump and market their oil can last for decades.

Oil companies often hesitate to commit themselves when prices first start rising, because the increase could prove to be short-lived. If that happens, then their costly initial investment might not be recouped over time.

The last time oil prices hit a historic high -- in 1981, after oil industry deregulation and the start of the Iran-Iraq War -- production didn't rise for the next five years. By the end of the decade, the market was swamped with crude, leading to years of low prices for both oil and gasoline.


E-mail David R. Baker at
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