Entering a New Oil Era

By Amy Feldman

Oil prices have passed $50 a barrel, and fears abound that they're headed higher over the long term. What's next for oil, and what might higher prices mean for the global economy? To find out, AMY FELDMAN debriefed DANIEL YERGIN, one of the world's foremost oil experts. Yergin, 58, is chairman of Cambridge Energy Research Associates, a member of the Secretary of Energy's advisory board and author of the Pulitzer prizewinning book The Prize: The Epic Quest for Oil, Money and Power.

Q: Will oil prices remain this high?

A: We've entered a new era of oil prices. It sneaked up on people, but now it's all too evident. There is a new floor under the price of oil of around $40 a barrel. I'm struck that the oil market today is tighter than it was on the eve of the 1973 crisis. And with markets this tight, you'll see a lot more volatility, and you could see prices spike up as high as $65 to $80. How high they go depends on geopolitics and market psychology.

Q: To what extent is the U.S. economy at risk from higher oil prices?

A: Right now there's this accommodationist view of high oil prices. People are looking at global and U.S. growth and saying, "Well, these high prices are having less impact than might have been anticipated." And it's true that oil does not have as much leverage on our economy as it did in the '70s. We use half as much oil per unit of GDP as we did then. But when you have sustained prices of more than $50 a barrel, the economic impact will be larger than people have anticipated.

Q: Is it basically the China factor that's keeping prices so high?

A: Last year was the strongest oil-demand increase in a generation and the strongest economic growth in a generation. China's oil demand grew 17% last year, or almost 1 million bbl. a day. There have been only a few times in the history of oil that demand has grown by 1 million bbl. a day in a single country; the last was in 1977 when the U.S. was coming out of recession. What we are seeing with China, and with India behind it, is analogous to the European economic miracle of the 1950s and 1960s. A dozen years ago, China didn't even import oil. Today it is the second-largest oil market. What U.S. motorists are seeing at the pump reflects strong economic growth in China.

Q: Can China sustain that hot growth rate?

A: People have been asking that question ever since the era of reform began there in 1980. Yet China has continued to sustain 8%, 9%, 10% growth and even higher. Now they are trying to damp down the growth because they're concerned about overinvestment and inflation. We should never assume things will continue in a straight line. But as long as China and India are experiencing a strong economic growth rate, that translates into higher oil demand.

Q: How well has the oil industry dealt with this increased demand?

A: When markets are this tight, all the OPEC countries can do is try to run and keep up. Almost all are producing at capacity. And higher prices reduce the urgency to encourage investment. We really need investment in new production capacity. We do see significant growth in non-OPEC production, in countries like Azerbaijan, Angola, Kazakhstan and Russia. The Saudis have indicated they will increase capacity about 20% in the next five years, which would be significant.

Q: Can Iraq become a factor?

A: Even without the insurgency, it would have taken time for the Iraqis to sort out what they want to do with their oil industry. Right now Iraq is a second-tier exporter, and its exports are running below last year's. The Iraqi oil industry needs somewhere around $40 billion in investment to start to produce on a scale commensurate with its reserves. That takes not only time and money but also stability, security and some political consensus.

Q: With all this going on in the oil market, what's the big-picture view?

A: My next book will be about how intertwined oil and geopolitics are. There was a period in the '90s in which all these issues of security were brushed aside. Now we realize oil and the fates of nations are all very tied together.