Oil Prices Becoming Decoupled

"Oil prices are becoming increasingly decoupled from the fundamentals of supply and demand," Dr. Daniel Yergin, chairman of Cambridge Energy Research Associates (CERA), said today in Washington D.C. "With prices over $90 a barrel and strong anticipation of $100, the oil market is showing signs of high fever, stoked by fears of clashes in the Middle East and resulting disruptions of supply. A weakening dollar and anticipation of further weakness add further fuel to the fever," he said.

Dr. Yergin spoke at a symposium on "The Economics and Geopolitics of Russian Energy" at Georgetown University, sponsored by the university's Center for Eurasian, Russian and East European Studies.

"What we're seeing in the oil market today is rooted more in the cauldrons of geopolitics and the impact of financial markets, expectations, and psychology than in supply and demand," he said, "but these are real factors." He pointed to major impact over the last two weeks of tougher rhetoric over Iran's nuclear program and heightened tension between Turkey and Iraq.

"The oil market may be only one or two events away from $100-plus oil," he said, "and there is much momentum in that direction. The major offset would be in the economic sphere – in terms of a slowing economy and slowing demand growth. But the timing of those effects would not unfold with the drama of events in the Middle East."

Dr. Yergin cited the overall importance of Russia in global energy markets, as well as its key impact this decade.

"While there has been so much attention around the world to the rapid increase in Chinese oil consumption, the growth in Russian oil production between 2000 and 2006 -- 2.9 million barrels per day – exceeded the 2.5 million barrel per day increase in Chinese oil demand over the same period," he said. "But while Chinese consumption continues to go up, Russia's increase in output is flattening out rapidly owing to swiftly rising costs and very high government taxes on oil production.

"Although publics and governments around the world are focused on prices, one of the most important factors in the world oil industry is the rapid rise in costs owing to shortages of people, equipment and skills," he told the Georgetown University conference.

Citing the IHS/CERA Upstream Capital Cost Index, he said that a new oil project today would be priced at 70 percent more than a project that was launched just three years ago. "The increased costs are leading to delays and postponements of oil and gas projects," he said, "which is affecting the timing of future supply."

Dr. Yergin observed that natural gas has become "arguably the most contentious issue" between Europe and Russia, which is the world's largest producer of natural gas and the major exporter to Europe. He commented that CERA's new study, Securing the Future: Making Russian-European Gas Interdependence Work, shows that there are "structural reasons" for the tension, owing to the major changes in Russia, Europe and the international gas market itself over the last decades.

He also pointed to the estimates of the U.S. National Petroleum Council that world energy consumption is likely to increase by 50 to 60 percent over the next quarter century. "Meeting that demand in an environmentally-sound way will be a very major challenge for all energy-producing countries, including both Russia and the United States," he said. "And the results will have a decisive impact on how nations define their energy security and what they do about it."