Yearend: Why the price of oil rose in 2004

WASHINGTON, Dec. 31 (UPI) -- The simple to answer to the question of why oil prices rose in 2004 is -- demand vs. availability.

More consumers were chasing slowly rising output; in particular, the rising market demands of India and China for the world's daily output of approximately 84.6 million barrels per day have meant that the traditional Western consuming societies of the United States and Japan suddenly found themselves competing with brash newcomers who will in the short term pay top dollar to keep their economies humming. While one of the traditional bugbears of higher oil prices is the Organization of Petroleum Exporting Countries, in fact they have recently tried to stabilize prices, in October boosting output by 150,000 barrels to 30.6 million barrels per day (bpd), its highest level in 25 years.

The rising global demand is outpacing output. Currently, the only "swing production" resides in Saudi Arabia and the United Arab Emirates, which can turn on the taps to increase output by 3 million bpd. While new global resources are slowly coming online, they are constrained by a number of factors, including investment, corruption and political instability. The leading potential rival to Saudi Arabia is Russia, which now produces more than 8.4 million barrels a day. On the surface Russia is a major player, as it consumes only 2.68 million barrels a day, leaving the remainder for export. Even more important for potential investors, Russia's oil reserves are conservatively estimated at 70 billion barrels, more than double U.S. reserves. The Kremlin has profited handsomely from the 2004 surge in oil prices; in October the State Duma approved a number of oil-based amendments to the 2004 budget, revising its estimated surplus up by more than 500 percent from the original figures.

Russia's problem is that it is exporting at flat-out capacity and is seeking massive foreign investment. Much of the physical plant dates from the later days of the Soviet Union and is elderly from the Transneft pipelines to oil export ports. Even worse for Russia, the former existing Soviet network was largely designed to supply the needs of the USSR and its Eastern European satellite states, producing an illogical network for serving the expanding Western market. Case in point -- Lithuania's Ventspils port, which was the major Soviet Baltic export port until Russia built the Primorsk facility. Kazakhstan, a rising Caspian oil exporter, still sends its exports via the Caspian Pipeline Consortium to the Russian Black Sea port of Novorossiisk, where it is loaded onto tankers for a voyage through the crowded Turkish Straits, a situation that makes Ankara deeply unhappy.

A similar situation applies to Azerbaijan, another former Soviet state. When Azerbaijan signed a series of hydrocarbon deals with Western companies in the early 1990s, known in Baku as the "deal of the century, its sole export pipeline ran from Baku to Novorossiisk, where Transneft charged the Azeris more than $15 for the privilege. Worse for the Azeris, Transneft was unable to "batch ship," which meant that higher-grade Azeri crude was admixed with poorer grades of Russian and Kazakh crude, resulting in a lower price. In 1999, Azerbaijan inaugurated a supplemental Baku-Supsa Black Sea line across neighboring energy-poor Georgia, which was grateful for a $3 tariff. The opening of the Baku-Tbilisi-Ceyhan pipeline next May should ameliorate the Turkish Straits bottle, as it ends in the Turkish Mediterranean deepwater port of Baku, but questions remain about the security of the route.

Last but not least, Russia's preemptive strike against Yukos, its major private oil exporter, has spooked both London and New York. Whatever the Kremlin's rationale for its actions, the reality is that in the short term it has cast a cloud over foreign investment in all Russian energy companies.

Politics also reverberate beyond Russian energy issues. Case in point - China. While the Bush administration is seeking via the United Nations Security Council strong action against the genocide in Darfur, Sudan, and Iran for its nuclear programs, the reality is that China will most likely veto any U.S. initiative, as it currently receives 14 percent of its energy exports from Sudan and an additional 8 percent from Iran. China's hunger for foreign energy is immense; in the first 10 months of 2004, according to China's General Administration of Customs, China imported 99.6 million tons of crude oil, nearly 9 million tons over 2003 imports. Last year China exceeded Japan as the world's second-largest energy importer, a trend that can only continue.

While additional sources of energy are under development, such as the Caspian and offshore Africa, they are very capital-intensive and will not have a significant impact for years. The reality is that for the foreseeable future the Middle East will provide the majority of the world's energy needs.

Nor is the long-term picture much better, as some specialists estimate that by 2030, global demand for energy will grow 60 percent from 2004, with China and India accounting for over 50 percent of that growth. Consuming societies with declining resources such as the United States and the European Union will be bidding for energy in an increasingly crowded market. EU countries currently depend on 60 percent energy imports. By the year 2030, as a result of many factors, including the decline of North Sea production, this dependence is projecting to grow to 80 percent.

The final wild card in this grim picture is the potential impact of terrorism; the purported message on Dec. 21 from al-Qaida to begin targeting Saudi oil facilities bodes ill for stable oil prices.

Predicting the future is a murky business at best, but it would seem that countries with increasing consumption rates would have to dig deeper into their pockets to ensure access to hydrocarbons. If there is a silver cloud lining to all this, is that sustained $40+ a barrel oil prices may well stimulate development of alternative forms of energy, from wind power to solar energy. For consumers, especially in the energy-hungry United States, trading in the gas guzzler and carpooling might be the only short-term answer to paying higher energy prices.