High price of oil alarms even OPEC

Reasons for today's high oil prices are so numerous that levels above $60 per barrel seem almost inevitable: from rising global demand and new nationalism in Latin America to a tense standoff over Iran's nuclear program.

Those issues are all real enough. But behind them all is a bigger factor, so obvious it almost passes notice: the OPEC cartel. Without the supply constraints imposed over many years by the Organization of Petroleum Exporting Countries, the price of oil today would be far lower, analysts say.

"We live in a world where there's a functioning cartel in the oil market," says Amy Myers Jaffe, an energy expert at Rice University's Baker Institute for Public Policy in Houston. "If we had a functioning open market," she reckons, "the price of oil would be $15 [a barrel]."

That's a rough estimate, based on current production costs in the Middle East and the price levels of not so long ago. Other experts might pick a higher figure.

Still, the prevailing view among oil analysts is that prices have risen so much that oil-importers face an unusual level of uncertainty as they chart energy policies for the years ahead. Even OPEC is worried, they say.

"OPEC is a strongly anticompetitive force. There's no question that they have withheld oil from the market," says James Smith, an oil and gas management expert at Southern Methodist University in Dallas. But "I think they're quite alarmed at $60 or $70."

A too-high price poses two threats: It could tip a now-strong world economy toward slowdown or recession, and it could fuel a push by consuming nations to reduce their reliance on oil.

OPEC hardly has a perfect track record of imposing its will on the world market for oil. The member governments, including major players such as Saudi Arabia, Iran, Nigeria, and Venezuela, agree on quotas for production, not publicly announced price targets.

Many analysts believe that OPEC has sought to keep oil prices within a range of $22 to $28 per barrel, although that number may have ratcheted upward as member nations reap easy profits without pushing the world economy into recession.

Like all cartels, OPEC is a force as much for what it doesn't do as what it does.

Even as world demand has risen, the 11 cartel members produce barely the amount of oil now that they did in 1977, according to a congressional report prepared last year by economist Theodore Boll of Congress's Joint Economic Committee.

"Crude oil is an abundant resource," the report concludes. "Production cost in the Middle East is less than $5 per barrel, and even in higher cost areas is nowhere near today's price."

In a perfectly competitive marketplace, willing sellers would compete with one another to produce oil and sell it to willing buyers at a profit.

OPEC's long-standing policies, by constraining production capacity, have both raised the price and increased the volatility of prices. Today for instance, in the tight world market engineered largely by OPEC, neither cartel members nor other nations can quickly bring much new oil to the market.

That has pushed prices up.

Ms. Jaffe at Rice University bases her $15-a-barrel estimate on the prevailing costs of production for the world's biggest producers, and on the fact that prices have been there in the not-so-distant past. Crude oil hovered near that level often from the late 1980s through the 1990s.

Other nations have ramped up their production in recent years, but are wary of going too far, uncertain when OPEC might loosen its own spigots and send prices falling again.

Given today's tight market, with demand growing in Asia and elsewhere, some analysts say $60 per barrel is a logical price.

But with little spare capacity, a tight market also means one with little margin for error. Thus, buyers of oil have also priced in a "risk premium," based on the fear of possible supply disruptions related to weather, politics, or terrorism.

In a congressional hearing on oil prices last week, industry analyst Daniel Yergin, of Cambridge Energy Research Associates, put that risk premium at "somewhere between $10 and $15 a barrel."

That would account for prices surging above $70 recently, as global tensions over Iran's nuclear program heightened, and why the price fell early this week on news of a diplomatic overture by Iran to the US.

The risk premium comes on top of what might be called the "OPEC premium," the impact of cartel-managed output.

In addition to the production quotas set periodically at OPEC meetings, another competition-dampening force has risen along with oil prices: nationalism.

In Venezuela, oil prices have given leftist leader Hugo Chávez a vehicle for new assertiveness against the United States and for populist policies. He is using the "oil weapon" not as a stick but as a carrot, bestowing favorable prices on countries or groups to bring them into his ideological fold.

To garner a greater share of oil revenues, Venezuela last weekend announced a new tax on foreign oil companies. Meanwhile, Bolivia recently moved to nationalize its natural-gas sector.

"We don't have anyone controlling the market" for crude oil, says A.F. Alhajji, an oil economist at Ohio Northern University in Ada, Ohio.

But he says that various forms of government intervention, from taxes and regulation to outright control, partially thwart market forces.

Such policies are often popular, given oil's economic importance, its wealth-producing potential, and the environmental impacts involved.

If oil is destined to remain a political football, what could help the oil market function better? Experts see a range of possibilities.

"We need to think about what the ultimate diplomatic solution is" says Jaffe. She urges a kind of container-ship diplomacy. Oil-consuming nations could impose trade penalties against nations that don't allow a free flow of investment in their oil industries.

Other analysts say that if oil- consuming nations increase their public and private stockpiles of oil, it would create more of a cushion in the market - and perhaps reduce the risk premium built into oil prices.

Some environmental, consumer, and national-security advocates say the answer may be to wean America and the world increasingly off reliance on oil as the fuel for transportation.

"What would happen if the United States did something about demand?" asks Tyson Slocum, an energy expert at Public Citizen, a nonprofit public interest group based in Washington.

He says that just one new policy - hiking the average fuel economy of cars and light trucks to 40 miles per gallon - could cut US oil demand by 20 percent. Since the US accounts for 25 percent of world oil consumption, that shift could have a powerful impact on oil prices.

There's no certainty that today's $60-plus oil prices will stick. But if they do, the price hike alone will spur new supplies of energy - alternative fuels or hard-to-reach oil that are have in the past been too expensive to develop.

"We're going in that direction," he says.