Thursday, June 26, 2008

Cheap Gasoline?

Did I get your attention with the title of this posting? I'm guessing that I have. After all, for months now, the cost of gasoline has been all the chatter, as well as the lead story on many news programs and in all sorts of publications.

In any case, please read the following 1999 article, which the Washington Post reposted at the recent request of the author of a letter to the editor of the newspaper:
Where Cheap Gas Takes Us: The Threat Abroad in That Bargain Fill Up
By Teresa Wyszomierski

Mar. 7, 1999

With gasoline prices at less than a dollar a gallon--an all-time low--it's getting easy for Americans to fill up their gas-guzzling Pathfinders or Tahoes without a twinge of worry. But the same low fuel prices have also set two trends in motion overseas that could prove disastrous for the economy of the Middle East, the fortunes of Western oil companies and, ultimately, the pocketbooks of those same American consumers.

First, profit-hungry U.S. energy companies, which aggressively pursued alternative sources of oil after the 1973 Arab oil embargo, are now beginning to seek out cheap investment opportunities in the Persian Gulf. If the trend continues, America could once again become overly dependent on oil from the Middle East. Second, the region's growing economic instability, prompted by the low fuel prices, is fomenting scattered social and political unrest. This could leave Americans more vulnerable to disruptions in supply, such as physical attacks on pipelines and other oil installations.

Despite some attempts to diversify, most Middle Eastern countries have remained "petrodollar" economies, deriving most of their foreign exchange earnings from oil exports. The United Arab Emirates, for example, derives 60 percent of its income from oil sales. In both Yemen and Iran, oil accounts for more than 80 percent of total exports. In Saudi Arabia, oil income has risen steadily since 1993 as a percentage of government revenue, and oil sales now account for 35 to 40 percent of its GDP.

The drop in crude oil prices, due in part to falling demand from the battered economies of Asia and in part to an excessive buildup of oil production, has already had an impact on both Middle Eastern economies and Western oil company profits. Throughout the Persian Gulf, budget deficits have widened dramatically, necessitating both tax increases and significant cuts in government spending.

Iranian ministries have received less than half of their proposed budgets this year. The Yemeni government, which lost half its income, has cut 55 percent from its budget since 1998 and raised taxes significantly despite fierce opposition in parliament. The Saudi government, which lost one-third of its revenues last year and is now $13 billion in the red, has adopted an austerity budget for 1999 that includes cutting state spending by almost 16 percent.

In the West, oil company revenues have also been eroded by a season of economic crises in Asia and several mild winters in North America, creating lower demand for heating oil and gasoline, and thus making it impossible to charge consumers higher retail prices. Chevron's and Texaco's reported incomes declined by between 40 and 50 percent in 1998. Corporate balance sheets have been damaged as well, with petroleum inventories being adjusted to reflect lower and lower market values. And because oil prices are not expected to recover soon, near-term profitability and long-term survival are assured only to those producers that can lower their production costs.

As these financial problems continue, Middle Eastern crude will soon become the preferred choice of multinational oil companies, because the Arab world controls about two-thirds of all known oil reserves and has the lowest extraction costs. This would reverse the trend of the 1980s and early 1990s, when U.S. oil companies shifted away from the Gulf region and focused their investments on high-tech production techniques for existing wells, as well as on developing hot spots for exploration such as Kazakhstan and Turkmenistan in Central Asia.

Moreover, cash-strapped Gulf countries have, of necessity, become more receptive to foreign investment. Only 20 years ago, U.S. oil companies were expelled from Saudi fields in a wave of nationalization and resentment against U.S. support for Israel. Five months ago, in contrast, Saudi Crown Prince Abdullah ibn Abdulaziz and his oil minister traveled to Virginia to meet with U.S. oil executives and discuss the possibility of their investing in exploration and crude oil production.

In turn, Energy Secretary Bill Richardson visited Saudi Arabia last month, the first such trip by an American official since 1990. And although the Saudi oil minister ruled out foreign ownership in lucrative ventures such as oil exploration at this time, he expressed an interest in obtaining foreign investment for less profitable areas, such as refining and petrochemical production. U.S. oil firms, in response, have rushed to submit proposals to develop all areas of Saudi Arabia's energy industry.

Yet these seemingly attractive investment prospects could ultimately backfire if social unrest continues to grow in the Middle East. Indeed, physical disruption of oil production and delivery could spread if oil prices remain low and the region's royal governments do nothing to address several potentially explosive sources of popular discontent.

For the royal families and surrounding elites who control oil ownership in the Gulf states, life continues as usual. Arab sheiks still indulge in conspicuous consumption, driving luxury cars and building palatial homes. Moreover, in countries such as Saudi Arabia, these elites also benefit from a variety of state perquisites, including free electrical power, mail service and domestic air travel.

The poor, on the other hand, have been hit hard. Throughout the Middle East, there have always been sharp disparities between urban wealth and rural poverty, with both incomes and infrastructure lagging far behind in rural areas. But over the past two years, those differences have become far more pronounced. In Saudi Arabia, many people cannot afford basic foodstuffs, and even the urban middle class complains that its standard of living is deteriorating as authorities raise the price of services that thousands of royal family members enjoy at no cost.

The Saudi government's recent move to generate revenue by allowing foreign participation in certain oil activities is a step in the right direction, but it may be too little to mitigate the sting of cutbacks in public services and subsidies. To placate a dissatisfied populace, officials may need to relinquish at least some control over domestic oil production to foreign companies. But Saudi royal families, who benefit from about $2 billion in annual stipends from oil revenues, share the reluctance of many Gulf rulers to give up control of such vital national assets.

Falling oil revenues have also led to rising unemployment, a problem exacerbated by rapid growth in the region's labor force. Today, joblessness in the region ranges from 15 to 40 percent. Most inhabitants of the Gulf states are under age 25; in Saudi Arabia, a startling 75 percent of the population is under 30. And because urban and middle-class inhabitants have come to expect an easy life subsidized by oil revenues, few have developed the skills to replace the foreign workers these desert kingdoms can no longer afford. Labor opportunities are already limited in the stagnant oil sector, and the petrodollar economies have failed to develop much of a non-oil private sector.

The explosive social effect of lost oil revenue became vividly clear last June, when riots erupted in several cities in Yemen after the government discontinued subsidies on bread and fuel. Economic desperation has also led native tribesmen to dramatically step up their long-simmering terrorist campaign against foreign oil companies, hoping to secure a larger proportion of dwindling national oil revenues. In 1998 alone, there were 18 attacks by Yemeni tribesmen against the pipeline that carries nearly half of Yemen's oil output and is operated by the U.S.-based Hunt Oil Co. Repairing damaged equipment has cost the company an average of $120,000 after each attack.

In Bahrain, economic stagnation has reinvigorated popular resentment against the ruling emir, who dissolved the parliament in 1975 and has been governing by decree ever since. Arson attacks on fuel tanks, foreign-owned stores and the police have become more frequent, and a growing political opposition movement is openly criticizing the country's repressive legal system. The conflicts can only increase if unemployment, already at about 15 percent, further cuts into the country's large service and banking sectors.

In 1973, when the Arab oil embargo crippled the U.S. economy, the United States was importing 36 percent of its oil. Today, it imports 56 percent. Unless Western oil companies and their customers exercise more vigilance, they could be in for another expensive lesson. Consumers need to stop topping off their gargantuan gas tanks as if there were no tomorrow. Oil company shareholders should question their firms' new push into Gulf investments, and company officials should continue to develop alternative energy sources and technologies. Otherwise, if they become blinded by the lure of cheap Middle Eastern oil, average Americans may find themselves footing the bill for the imprudent investments of Big Oil.
Of course, the cost of oil involves more than expenditure at the pump. Truckers have to pay higher prices for diesel fuel, and that higher price is reflected in a rise in shipping price for everything from food to the computer you're using right now. And lest gloating set in because you heat your home with electric power instead of oil, see this June 25, 2008 Washington Post article about the rise in the rates for electricity for residents of Virginia. Excerpt:
RICHMOND, June 24 -- State regulators indicated Tuesday that they would approve the biggest one-time jump in Dominion Virginia Power electricity rates in three decades, saying they have no choice but to allow what they acknowledged would be a hardship on many low-income residents.


According to Dominion, coal costs have risen by 95 percent in the past year, and oil and natural gas have also become more expensive. Prices have risen so sharply that the commission's analysts have warned that the increase requested by Dominion might in fact be too conservative....
Mark Twain famously said, "Everybody complains about the weather, but nobody does anything about it." As the pain at the pump and at every cash register continues, that little adage could be reworded: "Everybody complains about the cost of oil, but nobody does anything about it."

At what point will our leaders be willing to do something about the cost of oil and its ripple effects on our economy, even to our standard of living? Or should our leaders be waiting for a market correction? As ever, your comments are welcome.

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posted by Always On Watch @ 6/26/2008 07:22:00 AM