Why the World Is One Storm Away
From Energy Crisis
from WSJ
With Demand at Record Level,
Disturbances Take Toll;
Refining Capacity Stalls
Oil Workers Evacuate for Rita
By CHIP CUMMINS in London, BHUSHAN BAHREE in New York and JEFFREY BALL in Dallas
Staff Reporters of THE WALL STREET JOURNAL
September 24, 2005
As Hurricane Rita barrels through the heart of the U.S. oil industry, the world once again finds itself just a storm away from an energy crisis.
Whether or not Rita is that storm -- it was downgraded to a Category 3 hurricane yesterday afternoon -- it and Hurricane Katrina have driven home a hard lesson: In a world straining at the limits of oil supply, even relatively small disruptions can drive prices haywire and ricochet among consumers and companies. That has long-term implications for consumer and corporate spending and U.S. energy policy.
• Oil refineries at risk
As devastating as Katrina's human toll was, the storm should have been a relatively small disruption for the global petroleum system. Though Katrina sank more than 50 oil and natural-gas production platforms in the Gulf of Mexico and knocked out about 1.5 million barrels of daily oil production, the storm was only 10th on a list of 11 top shocks of recent decades, according to the International Energy Agency.
Yet Katrina had a wide impact because it hit at a time when markets for crude oil are the most stretched they've been in a generation. The global energy system that has powered the world economy for 25 years is severely strained. Demand for oil is growing faster than supply, thanks to America's love of sport-utility vehicles and China's booming economy and embrace of the passenger car.
Globally, producers today have at most 1.5 million barrels of spare crude-pumping capacity to tap in a crunch -- about the same amount currently shut down by Katrina and Rita. A cushion of at least 4% of demand, or roughly 3.5 million barrels these days, is needed to really insulate consumers from supply shocks.
That in part explains the worries that surrounded Rita as it swept across the Gulf of Mexico this week. As of late yesterday, the storm was expected to make landfall early this morning in eastern Texas. (See related article.)
Together, the summer storms have stoked growing unease that the world is vulnerable to even minor supply shocks. And there isn't a quick way to square the circle -- beyond, perhaps, a permanent increase in prices that would chill demand.
"There is no magic bullet," says John Browne, the chief executive of BP PLC. "You can't just fix one thing."
Ultimately, the prospect of an energy crisis depends on a few big factors: whether the industry can develop fresh crude supplies fast enough, whether demand can be tamed and whether the global refining bottleneck can be broken.
On the supply front, the outlook for quick relief is bad. The cheap gas prices of the 1990s prompted oil producers to cut costs, limit investment on exploration and production and consolidate through mergers. They also began using high-tech management systems to reduce their stockpiles of crude oil and gasoline, mirroring the just-in-time technology that Dell Inc. and others used to cut costs.
That approach has left much less cushion when a disaster knocks out fuel production. Gasoline inventories for the first six months of 2005 averaged 23.9 days of demand, down from 27.8 days in the first six months of 1995, according to the Energy Information Administration.
With oil demand soaring, investment in new production has been picking up again. Today, tiny Qatar is expected to unveil a $110 billion project-finance deal which is to fund, among other things, a $50 billion slate of new oil and gas projects. Saudi Arabia has said it will spend $50 billion to boost its pumping capacity by 1.5 million barrels a day and to build other petroleum facilities, including refineries.
Oil companies are investing heavily, too. Chevron CEO David O'Reilly said this week his company and other big oil majors are set to invest $250 billion in new projects in the coming three years.
But because it takes up to a decade to bring a big new oil project on line, it's unclear when this investment can bring relief -- especially if demand keeps soaring. While global demand for oil grew by 2.9 million barrels a day last year, Thierry Desmarest, chief executive of French giant Total SA, estimates oil producers can realistically provide at most 1.5 million to 2 million barrels a day of extra oil each year.
"More than that is not possible," Mr. Desmarest said in an interview this month. Because of production declines in existing fields, Mr. Desmarest said, the oil industry now faces a "difficult challenge" even if world demand moderates.
The fallout from Rita on supply will take days to assess. Investors were jittery earlier this week, but yesterday prices of crude oil and natural gas eased a bit as Rita was downgraded. (See related article.) Late yesterday, Transocean Inc. said one of its rigs, the Deepwater Nautilus, broke free of a towboat and was floating about 40 miles south of Grand Isle, La., in an area lashed by heavy winds and waves. (See related article.)
But even if damage is minimal, Rita already has caused a shudder. Oil production was shut across the Gulf in preparation for the storm. Sixteen refineries from Houston to Lake Charles, La., were closed, and thousands of oil-industry workers evacuated from the area. That meant that a quarter of U.S. capacity to turn crude oil into gasoline, diesel and other products wasn't working yesterday.
And oil is only one concern. The storms also have dealt a blow to natural-gas output likely to last well into this winter. More than two-thirds of all gas production in the Gulf -- about 20% of U.S. domestic gas output -- is shut down, and Rita traveled right through an offshore area that mostly produces natural gas and is filled with aging, vulnerable platforms. Used by millions to heat their homes, gas also fires a big chunk of the power plants across the nation.
Natural-gas inventories have dropped below those at this time last year, as prices have soared. And the U.S. can't easily remedy short domestic supplies with imported natural gas, since the nation has just four specialized terminals to receive liquefied natural gas imports and they already are importing as much as they can find. Instead, the U.S. depends on domestic production and Canadian imports for most needs.
On the demand side, the U.S. is the sight of the world's most dramatic battle. It represents 4% of the world's population but burns 25% of its oil -- half of it going to power cars and trucks.
Over the past two decades, the auto industry has aggressively marketed gas-guzzling SUVs and pickup trucks while Washington has flinched at consumption-curbing prescriptions, such as high gasoline taxes and increased mileage standards, that have checked demand in Europe and Japan.
As a result, the fuel economy of the average new vehicle sold in the U.S. has flat-lined at about 25 miles per gallon. Larry Goldstein, president of the Petroleum Industry Research Foundation, a New York-based group, estimates U.S. gasoline consumption would be 20% lower than it is now if Americans drove roughly the same-size cars they were buying a decade ago.
Recently, there have been signs Americans are growing more concerned about fuel economy. Sales of big SUVs have been declining, while auto makers report that fuel economy is registering as a rising priority in surveys. This week, Ford Motor Co. announced a major boost in its production of more efficient hybrid gasoline-and-electric vehicles.
But the Bush administration has taken only baby steps, such as raising the light-truck mileage standard to 22.2 miles per gallon in 2007, from the 20.7 that had prevailed since 1996. Federal gas taxes to discourage usage, meanwhile, remain a hot potato, especially with prices rising.
This week also highlighted the industry's aging and overstretched gasoline-refining system. All the crude oil being pumped out needs to be refined, but there's a bottleneck of plants to do that.
Oil companies have been loath to invest in new refineries to turn crude into gasoline, scared off by the massive capital investment required, constantly changing environmental rules and stiff opposition from local citizens groups and environmental organizations. It's been nearly 30 years since a new refinery was built in the U.S.
That has meant that a third of U.S. refining capacity is now concentrated on the Gulf Coast, where the economies of Texas, Louisiana and Mississippi are heavily dependent on oil. And even before the two recent storms, refineries were running flat out.
The industry doesn't expect the "not in my back yard" mentality to go away any time soon. At a conference at New York's Waldorf Astoria hotel in April of last year, Saudi Arabia's oil minister, Ali Naimi, proposed that his country build two giant refineries in the U.S. Each would process 500,000 barrels of crude a day -- roughly the amount of gasoline the U.S. imports.
"Whether we will be able to get permits is another question," Mr. Naimi told his audience, amid snickers from executives and officials.
"Good luck," said Kyle McSlarrow, at the time deputy U.S. Energy Secretary, who was sitting next to Mr. Naimi. "If you can figure out [how]," he said jokingly, "let us know how you did it."
--Thaddeus Herrick in Houston, Russell Gold in Austin, Texas and John J. Fialka in Washington contributed to this article.
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