Soaring Global Demand for Oil Strains Production Capacity

OPEC Hits Limit for Crude Used in U.S. Gasoline;
Price Volatility May Rise 

BHUSHAN BAHREE / Wall Street Journal 22mar04

NEW YORK—Global demand is straining the world's ability to produce and deliver crude oil and gasoline, potentially adding to price volatility even as the cost of oil approaches 20-year highs.

The nations belonging to the Organization of Petroleum Exporting Countries are hitting their limit to produce light, sweet crude, the preferred grade of oil used to make gasoline, especially in the U.S. Capacity limits also plague the petroleum industry's so-called downstream end, which refines oil into essential consumer products such as gasoline. By one estimate, global refining capacity could fall behind world demand as early as this year.

Meanwhile, trade in crude oil and refined products has been made tougher as shipping capacity has become strained.

"The whole system is really stretched," says Roger Diwan, an analyst at PFC Energy, a Washington consulting firm. "That raises the risk of price spikes due to regional market dislocations."

The price of the U.S. benchmark light, sweet crude is approaching the psychologically important level of $40 a barrel. On Friday, oil for April delivery settled at $38.08 a barrel, up 15 cents, on the New York Mercantile Exchange, after trading as high as $38.50 a barrel. Barring a sudden drop, industry analysts expect the average price this month to be the highest since oil futures began trading on the Nymex in 1983. The current record of $35.92 a barrel was set in October 1990, two months after Iraq invaded Kuwait.

In rough terms, oil prices reached their modern-day high in 1979, when they spiked to about $44 a barrel. Of course, when inflation is considered, energy prices from that era are much greater. A $44 barrel in 1979 would fetch more than $100 at today's prices.

U.S. oil benchmark prices have risen in part because the nation's gasoline supplies are low and demand is high and rising. But that increase is being felt globally. U.S. crude values, along with North Sea-benchmark Brent crude oil—a comparable light crude also widely used to produce gasoline—are widely used to price oil produced and sold elsewhere. And the U.S. gasoline market, in turn, is being roiled by global forces such as China's growing thirst for oil.

A slowdown in demand growth could quickly damp oil prices. So, too, could a surprise decision by OPEC to pump more oil when the cartel meets late this month. So far, though, strong demand growth in the U.S., China and elsewhere is bringing the trillion-dollar-a-year global petroleum industry closer to the limits of its ability to supply, refine and transport oil.

OPEC can pump more oil. But cartel officials say members have hit the limit of their ability to pump light, sweet crude in particular. "We have more capacity, but it's not the right stuff," says a senior OPEC official. Light, sweet crude remains in many corners of the world, but the energy industry doesn't have the capacity to pump it.

The world is consuming about 80 million barrels a day of oil. Unused production capacity of some 2.5 million barrels a day, the cushion against supply shocks, is almost all in Saudi Arabia, the United Arab Emirates and Kuwait, countries with large streams of medium- and heavy-crude varieties. While refineries are being tweaked to consume heavier oil, their operations are complex both technically and economically and can't turn on a dime.

Industry executives said Asian refiners have been outbidding American buyers for light, sweet crudes from Africa, where OPEC countries such as Nigeria, Libya and Algeria are pumping at or near capacity.

The world's ability to refine crude oil into gasoline also is growing tight. Estimates by PFC Energy show that spare oil-refining capacity has narrowed markedly since January 1999, when global capacity showed a surplus over demand of 5.7 million barrels a day.

By the end of this year, PFC Energy expects average global demand to exceed refining capacity by about one million barrels a day. The reason: The industry hasn't built a large number of new refineries because low profit margins and other issues have discouraged investment. Even when they became economically attractive, refineries take years to build, though existing facilities constantly find ways to boost production.

Markets for oil products such as gasoline are more regional than for crude, due in part to a dizzying array of local product standards. But gasoline pricing is more global than generally thought, as key products do cross boundaries. The U.S. imports some 800,000 barrels a day of gasoline to meet demand of about 8.8 million barrels a day.

Another problem is that the industry is keeping crude and gasoline inventories tight in order to avoid tying up capital, leaving less of a cushion to make up for shortfalls. "Oil companies have opted to maintain operational stocks, but not discretionary stocks" as they once did, says Larry Goldstein, president of the Petroleum Industry Research Foundation in New York.

Transporting crude oil also has become more expensive, though tanker rates have declined from January peaks. Industry officials say the high cost of transport accounts for the increasing premium being paid for U.S. benchmark crude oil over North Sea Brent, a comparable light crude with high gasoline yields. Industry officials note that the world's tanker fleet now spends more time on the water to deliver rising volumes of crude oil to the U.S. and China from export ports in the Middle East and Africa. European safety rules requiring double hulls, and China's growing need for all sorts of commodities, have pushed up freight rates and reduced tanker availabilities.