www.techcentralstation.com By Arnold Kling 01/20/2003

E-Mail Bookmark Print SaveTCSMy instinct is to oppose any policy initiative that is touted to fight child pornography or the drug menace. It's not that I'm in favor of child porn or drug abuse. However, I am conditioned by experience to expect proposals supposedly aimed at those problems to turn out to be ineffectual while threatening damage to the Internet and/or the Constitution.

But the worst refuge of scoundrels, in my opinion, is the line that "we need to reduce our dependence on foreign oil in order to fight terrorism." When I hear that, my baloney-sandwich detector really starts vibrating. I am ready to reject whatever is on offer, whether it be oil drilling in Alaska, regulations on SUV's, or some new synthetic fuels program.

Oil Is Oil

I teach economics in high school. Here is a good question for an introductory course:

If the United States currently satisfies 10 percent of its demand for oil with imports from Saudi Arabia, by what percentage must the U.S. reduce its consumption in order to be 100 percent independent of Saudi oil?

If you answer "10 percent," you get an F. If we reduce oil consumption by 10 percent, then we will not cut 100 percent of our imports from Saudi Arabia. We cannot arrange to consume only American oil and no Saudi oil. Oil is oil. If we reduce demand by 10 percent, we probably will reduce our demand for Saudi oil by 10 percent, not by 100 percent.

(Actually, oil is not exactly the same everywhere. Saudi oil is somewhat cheaper to extract and refine than other oil. What this means is that if we reduce our demand for oil, the impact is likely to be felt somewhat more on other oil, and somewhat less on Saudi oil. Lowering our demand by 10 percent might not lower Saudi oil exports much at all. But we can leave that aside for now. Just keep in mind that oil is oil.)

But what if we passed a law against importing Saudi oil? In that case, the Saudis would export their oil to us via Venezuela. They might not physically use this channel, but if the Venezuelans sell more oil to the U.S. and the Saudis sell more to other customers no longer served by Venezuelans, it has the same effect.

I have received emails suggesting that I should switch brands of gasoline to a company that supposedly does not use Saudi oil. But if we all did that, then the brand that we switched to would run out of non-Saudi oil and have to start using Saudi oil.

The correct answer to the question of how much the United States would have to reduced oil consumption in order to drive our demand for Saudi oil to zero is 100 percent. Only if we stop using oil altogether can we be sure that we are not contributing to the demand for Saudi oil. Oil is oil, so that any demand for oil creates demand for Saudi oil

Once we recognize that oil is oil, it should be apparent how futile it is to try to reduce Saudi oil revenues by cutting back on our demand. True, if we reduce demand, then total world demand falls, and oil prices and revenues fall, but unless we take truly Draconian steps the effects are likely to be small.

How to Reduce Oil Consumption

I personally do not care much for SUV's, but the way I express my dislike for them is the same way that I express my dislike for cable television. I don't purchase those products. (One could argue that the fact that other people buy SUV's causes me some harm. For that matter, one could make the same argument about cable television. However, those effects are small, below what I would regard as the threshold that might justify regulation.)

As an economist, even if you told me that the policy objective is to reduce oil consumption, I would not opt for regulating the fuel economy of SUV's as my first choice. I would prefer a large gasoline tax (preferable phased in to give people time to adjust). This would give people a clear incentive to conserve, while allowing them to find the most efficient means to do so.

In contrast, regulating fuel economy of SUV's is inefficient. Old SUV's would be exempt from regulation, and they would tend to stay in the market longer. And new fuel-efficient SUV's would cost less per mile to drive at the margin, leading to more miles driven, which would cancel out some or all of the effect on gasoline consumption.

Of course, this still begs the question of why we should be reducing oil consumption below the natural level incented by the cost of oil in the market. One can argue that lower oil consumption would lead to lower pollution, but if fighting pollution is the objective then it is more efficient to tax or regulate pollution than to regulate fuel economy. From a pollution-fighting standpoint, it would be better to have a low-pollution car that gets 15 miles to the gallon than a high-pollution car that gets 40 miles to the gallon.

Just Take the Oil

The issue that leads people to suggest that we need to "reduce our dependence on foreign oil" is the apparent role of Saudi Arabia in funding terrorism. Someone who I love dearly but is a bit naive once said to me, "We've got a powerful army. The Saudis don't have bupkis. We should just take the oil!"

She is naive, because she is not sensitive to the issue of imperialism and world public opinion. To wage a war for oil would be to offend the sensibilities of large numbers of decent, well-educated people.

However, if Saudi funding for terrorism is the crux of the issue, then we have little choice but to confront the Saudis directly. The indirect approach of reducing oil demand is meaningless. Only a worldwide boycott of Saudi oil would effectively cut off their oil revenues. Yet such a boycott would be difficult to orchestrate and would itself be tantamount to war.

The problem with sponsoring terrorism is not that oil revenues are the source of funds. The problem with sponsoring terrorism is that it is grossly immoral. People introduce the connection with oil revenues as a red herring. As we have seen, trying to make a connection between fighting terrorism and regulating SUV's or drilling for Alaskan oil is a violation of Oil Econ 101. At best, it is a way to dodge the challenge posed by apparent Saudi support for terror. At worst, it is an attempt to advance another agenda using terrorism as an excuse.

The real issue is the alleged Saudi funding of terror. No matter how much demand we withdraw from the oil market, the Saudis will have revenue and we have to be concerned with how they use it.

If cutting off funding is critical to winning the war on terror, then we must press the Saudis on that point. We should tell them that we respect their rights as a sovereign nation, but they owe it to the community of nations to not fund terrorists. If that approach does not work, then it is a waste of time to wring our hands over our "dependence on foreign oil." The only fallback position is the one suggested by my wife: just take the oil.

money.cnn.com January 20, 2003: 6:03 AM EST

LONDON (Reuters) - Oil prices ticked higher Monday as top U.N. weapons inspectors spent a second day in Iraq and the United States said time was running out for Baghdad to prove compliance with disarmament resolutions.

London Brent blend in early trade added 19 cents to $30.73 a barrel. U.S. crude, closed on Monday for Martin Luther King day, set a new two-year high of $34 a barrel on Friday.

Washington on Sunday issued one of its clearest warnings yet to Iraqi President Saddam Hussein that non-cooperation with U.N. inspectors could be deemed a trigger for a war in the absence of a "smoking gun," or hard evidence of weapons of mass destruction -- and that a decision could be just weeks away.

"The test is, is Saddam Hussein cooperating?" said U.S. Defense Secretary Donald Rumsfeld on weekend television. "He's not doing that."

Rumsfeld, presiding over a huge U.S. military build-up of warplanes, ships and tens of thousands of troops in the oil-rich Gulf region, said a final conclusion on Iraqi cooperation could be made "in a matter of weeks, not in months or years."

"Of course Rumsfeld is a hawk, but if the test of compliance is cooperation then clearly Saddam is not cooperating," said oil broker Nauman Barakat of Fimat International Banque.

Chief U.N. weapons inspector Hans Blix and Mohammad ElBaradei, head of the U.N. nuclear watchdog, say there are big gaps in Baghdad's arms declarations, and are demanding quick answers before they report to the Security Council on Jan. 27 on Iraqi compliance.

"I think (the Iraqis) have said that there are still certain areas they are ready to provide more information. I think that in other areas they said they are ready to reconsider their position," ElBaradei said in an interview with Reuters.

"What we tried to do today at this meeting is to impress on the Iraqi authorities that the time is running out."

U.S. national security adviser Condoleezza Rice, on U.S. weekend television, said: "Clearly the 27th is an important date ... (It) probably marks the start of a last phase of determining whether the Iraqis have fully complied." Exile talk dismissed

From Beirut, a special envoy of Saddam's dismissed talk of the Iraqi president going into exile.

"As we have said before, we reiterate now that this is merely nonsense and one of the tactics of psychological warfare," said Ali Hassan al-Majeed, a member of the Revolutionary Command Council and a cousin of Saddam.

Rumsfeld said he hoped Saddam would choose exile, but he was unsure of the prospect. "There is at least a possibility," he said. "His neighboring states are in a process now of trying to avoid a conflict there by having him leave the country."

Saddam remained defiant.

"After putting our faith in God, victory is absolutely assured. We don't see it on the horizon, rather it is in our grasp and inside our chests," he told a group of army officers.

Oil traders said Venezuela's general strike, now in its seventh week, also was keeping the heat under crude prices.

Venezuelan President Hugo Chavez said Sunday he was "winning the oil war," restoring crude flows and restarting ports and refineries. He said oil output which fell to 500,000 barrels per day this month was now at 1.2 million bpd, versus three million bpd normally.

Striking oil workers said that production was only half the volume given by Chavez.

Leading OPEC producer Saudi Arabia is moving to fill the gap by raising output by between 500,000 and one million barrels a day, industry sources said.

Riyadh is opening up the taps and by February could be pumping nine million bpd, up from eight million recently, the industry sources said Sunday.

"The Saudis are cranking it up. The message is that there is a big increase on the way," said one senior Western oil executive.  

www.globeandmail.com By DEBORAH YEDLIN Monday, January 20, 2003 – Page B2

To hedge or not to hedge. That is the question in the oil patch these days because commodity prices are miles ahead of what was used to determine capital budgets for 2003.

In most instances, oil prices of $21 (U.S.) or $22 a barrel or natural gas prices around $3 per thousand cubic feet were plugged into capital spending programs for the coming year. But since that budgeting period -- which usually happens during the fourth quarter -- prices have jumped. No one expected oil would average $26.15 in 2002, much less hit $34 last week.

The high prices -- a result of political strife in Venezuela, higher than expected inventory drawdowns and continued sabre rattling in the Middle East -- are presenting energy companies with the unheard-of opportunity to hedge oil production for the rest of the year at prices close to $29 a barrel.

The high prices mean billions of dollars in extra cash flow for the oil patch, not to mention the Alberta government's coffers. Yet even with those heady prices, companies aren't exactly rushing to crystallize those gains.

Although locking in a guaranteed rate is something mortgage holders are encouraged to do so they know exactly what their fixed costs are, the same logic doesn't necessarily apply in the world of the oil and gas producer.

Some companies even have stated policies that they do not hedge. Period.

Some of this might be because of a perception that hedging is done by the faint of heart who can't bear the commodity price risk. Then there is a fear of hedging at too low a price, which means leaving dollars on the table. Finally, no one wants to stand up at the annual general meeting with a red face and address the issue of hedging losses.

On this one, the oil patch appears stuck between a rock and a hard place.

It's an industry where the risk/reward ratio is always front and centre, with a tendency to play the risk variable a little harder than in other businesses.

And when it comes to hedging, the view is often that you just can't win either way.

On the one hand, the market has shown itself unwilling to pay up for sudden spikes in commodity prices, especially over the past couple of years. Shares in oil and gas companies have continued to trade at levels reflecting oil prices in the low $20-a-barrel range, and not the average $26.05 of the past two years.

On the other hand, the market also doesn't reward companies that put hedges in place that have worked in their favour; risk management is all part of sound business practices, and when investors buy shares in an oil and gas company, it could be argued that they are buying management first and the assets second.

Still, from a purely logical perspective, why not take advantage of the market's willingness to lock in at a price that is very rich compared with historical standards, even if some of the upside is shaved off the price peak? The reality is, companies have never before been able to lock in oil production for an entire year at a price approaching $30 a barrel.

By not taking advantage of it because the price might move even higher looks a bit like greed has overtaken fear.

But on this issue, there are as many opinions as there are analysts.

Some, such as Tom Ebbern of Tristone Capital, argue that companies should take advantage of an opportunity to offer enhanced consistency of results; others call it a mug's game because companies are penalized if they make what turns out to be the wrong call on commodity prices.

Although commodity prices and capital budgets remain the primary drivers for making hedging decisions, another factor in the equation is the ability to put the hedge in place. The short story is that it isn't as easy, or as cheap, as it was only 12 months ago because of the disappearance of companies such as Enron, Dynegy and Williams Cos., which acted as counterparties to the hedges by taking on the commodity price risk.

Although the gap in Canada has been filled to some extent by the banks, the liquidity in the market has dried up significantly with the result that the credit requirements are more significant.

Still, as all the forecasters at the annual dinner held by the Calgary Society of Financial Analysts last week pointed out, troughs follow peaks -- and that should be enough to answer the question of whether or not companies would be well advised to take advantage of the price curve and hedge their bets. dyedlin@globeandmail.ca

www.guardian.co.uk

Heather Stewart Thursday January 16, 2003 The Guardian

Crude oil stocks in America have run dangerously low, raising fears that the government will be forced to tap its strategic reserves even before any full-blown conflict with Iraq.

Inventories are down to their second-lowest level since records began in 1976 as the oil workers' strike in Venezuela holds back supply, the US department of energy revealed yesterday.

Official estimates put the minimum stocks needed to run US refineries at 270m barrels a day but the DoE said there were only 272.3m barrels left in the system, down 6.4m barrels from a week earlier.

The shortfall helped send oil prices soaring again yesterday, with Brent crude for February delivery up 64 cents a barrel to $31.25 by the afternoon.

Paul Horsnell, oil analyst at JP Morgan, said that with US refineries guzzling 15m barrels of crude every day there was just four hours worth of slack in the system.

"Things are getting a bit tight if it gets below 300m barrels," Mr Horsnell said. "Once you start running below that level, prices become more and more sensitive even to minor changes in supply."

With the build-up to a conflict in Iraq accelerating, Mr Horsnell said, there was considerable potential for interruptions in supply in coming months. "What's alarming about this is that it's got nothing to do with Iraq - it's got nothing to do with the Middle East," he said.

The US government holds a massive strategic petrol reserve in salt caverns below Texas and Louisiana. Despite the spike in the oil price, industry spokesmen insisted yesterday that it was not yet time to turn on the taps.

"I don't see a reason, really, to release the SPR," said John Felmy, chief economist for trade body the American Petroleum Institute, arguing that there was not yet a crisis. "We can't declare an emergency at this point."

Mr Horsnell said that, although the oil price would be high enough normally to justify dipping into the SPR, the White House might be hoping to keep back supplies until the outbreak of a war with Iraq, when prices might rise further.

There is little sign of an early resumption of normal oil supplies from Venezuela, the world's fifth-largest exporter, where striking workers are trying to force president Hugo Chavez to call early elections by starving the oil-dependent economy of cash. Cumulative loss of production is approaching 100m barrels.

The oil markets were temporarily calmed last week by the prospect of a compensatory increase in supplies from Opec, the oil producers' cartel. But yesterday's jump in prices suggested traders are losing faith in Opec's ability to help. Oil ministers from the Opec countries agreed to raise production by 1.5m barrels a day at a meeting in Vienna last weekend.

Lawrence Eagles, at commodity analyst GNI, said the 270m-barrel floor was probably an overestimate of the minimum amount needed to keep refineries running, and just-in-time production methods meant a smaller margin for error was sufficient.

"Regardless of whether that particular cut-off point is right, though, we have clearly gone down to very low stocks," he added. Mr Eagles calculates that reserves, plus the SPR and stocks of finished oil products, could keep the US economy going for 77 days.

www.stuff.co.nz 16 January 2003

NEW YORK: Oil prices jumped toward two-year highs on Wednesday as US crude stocks sank to nearly their lowest level in more than two decades.

A 45-day oil workers' strike in oil exporter Venezuela has drained world oil stocks.

Fresh signs of a looming US-led war on Iraq further fired supply concerns that have pushed prices up more than 30 per cent in two months and reinforced fears that rising energy costs could stunt economic recovery in the US.

New York light crude closed 83 cents higher at US$33.25 a barrel, within 40 cents of two-year highs struck in late December.

Brent crude futures in London rose 61 cents to US$31.22 a barrel, just three cents below a new two-year-high of US$31.25.

US government data showed crude oil stockpiles fell more than 2 per cent to 272.3 million barrels last week, just 2 million barrels above the lowest level since the government started keeping records in 1979.

The report strengthened fears of an oil supply crunch as the US, the world's biggest consumer of oil, enters peak winter heating demand. Frigid temperatures are forecast in the US's northeast - a heavy consumer of heating oil - in the next 10 days.

The Energy Information Administration warned that "localised disruptions" would occur at US refineries if US crude oil inventories fell below 270 million barrels.