Oil and Gas:

API's Felmy, EIA's Caruso look ahead to summer pump prices, future trends

Have gasoline prices leveled off at record highs? Where will pump prices go as the peak summer driving season approaches? John Felmy, chief economist of the American Petroleum Institute, and Guy Caruso, head of the U.S. Energy Information Administration, join OnPoint to discuss rising oil prices and future trends.


Mary O'Driscoll: Welcome to OnPoint. I'm Mary O'Driscoll. Today's topic is rising oil prices and what they mean for drivers at the gas pump this summer. Our guests are John Felmy, chief economist of the American Petroleum Institute, and Guy Caruso, head of the U.S. Energy Information Administration. Also joining us today is my colleague Ben Geman with E&E Daily and Greenwire. Welcome to the show today.

Guy Caruso: Thank you.

Mary O'Driscoll: I wanted to ask you, what's going on here? Oil prices are in the high $50 range. They were kind of flirting with $60 earlier this week, yet according to EIA the crude oil stocks and petroleum stocks are actually higher than they were at this time a year ago. So what's going on? If we have adequate supplies why are prices hitting such high records?

Guy Caruso: Well that's a good point Mary. Inventories are the one bright picture that is part of this story. They are up over a year ago for what crude oil and gasoline, but the real driving force is demand on a global basis. World oil demand grew more than 2 1/2 million barrels a day last year, which is about 3 percent over the previous year. We see another very strong year this year and it's not only the United States, but countries like China, India and elsewhere. And crude oil production and capacity is not keeping up with that demand. So essentially what we've got here is a tight crude oil market globally and tight products markets in the United States as well as in other main consuming centers.

Mary O'Driscoll: Well, you've got some new information that's coming out today that shows that the supplies for the summer, the crude oil and petroleum supplies for the summer are going to be higher than they were or they'll be adequate or what is the information, the latest information?

Guy Caruso: Well, we think the supplies will be higher, however demand will also be higher and therefore these relatively high inventory numbers that we're seeing for both crude oil and gasoline are going to come down over the summer as typically happens in your peak driving season. We draw down our inventories of both crude oil and gasoline and indeed we also import a lot of gasoline to meet those peak demands. So we're going to need all of those sources in order to meet the kind of demand we're looking at, which is about another 2 percent growth year on year. Despite all that, we think prices will still increase from the $2.21 national average that we had on Monday, to probably average closer to $2.30 for the driving season.

Mary O'Driscoll: OK. Mr. Felmy, I mean, is it all kind of a tight market situation that's going on right now, from the industry's point of view?

John Felmy: That's right. What we've seen is, from the industry situation, the performance has been pretty remarkable this year. We've had record production of gasoline. Record production of diesel fuel and indeed record imports of those products or near record imports, but the cost has been high. Crude oil is that $57, is $1.36 a gallon, you add-on to that $0.44 in taxes and you can see kind of the base cost, if you will, of gasoline. So the driving force is crude oil. The key to going forward is what will happen with demand, particularly in the second quarter when you tend to see a decline, but it's not clear that will happen this year worldwide. Then how will the supply system continue to function? Fortunately, even though there's instability, we're seeing fairly high levels of output.

Ben Geman: Do you concur with EIA's projections on where gasoline prices are going to go?

John Felmy: Well, because of antitrust laws we don't forecast prices explicitly, but the key is going to be how do these tight markets continue forward? In other words, what got us here is strong demand, tight supplies and so what will happen with those two factors going forward will determine the price.

Ben Geman: Is it possible that this is starting to become a permanent fixture of the energy landscape? There was a presentation recently by a member of the House of Representatives, Roscoe Bartlett, on the idea of peak oil. Do you guys agree that we're sorted at the peak of the Hubbert curve or we're going to soon reach the peak of the Hubbert curve in worldwide oil production?

John Felmy: Absolutely not. People have been saying we're running out of oil for a long time. Only a short period after the discovery of oil in Pennsylvania, the chief geologist of Pennsylvania said we were going to run out of oil in four years and that was just using it for kerosene. The key is going forward is that we continue to develop technology. Markets continue to move the appropriate resources around and we find more oil than what we use. So as long as reserves continue to build you don't even reach a peak. So I would say that's a bit premature to make those statements. That being said, unless we do make the investments required to bring oil resources online you could see the continued tight markets that we experience.

Ben Geman: Mr. Caruso, what about you do you believe that we might be approaching peak oil?

Guy Caruso: I think the real issue is not so much peak, reaching the peak because we don't believe we're there and we don't believe we'll be there. The real issue is what's the cost going to be to bring on these resources to make them into productive capacity? We've taken the USGS outlook for world oil resources and put that in our model and looked out what demand would be and we're looking at worldwide oil peeking somewhere beyond 2025 in our model. Now that having been said, is nice, but as John pointed out is what's really important is what's the pace of investment, technological development, to turn those resources into productive capacity? That's exactly why we're in the position we're in now. During the nineties the world oil market was growing at about a million barrels a day per year. So investments were being made on that expectation. What happened in '03 and '04 is we got much more robust growth, world economic growth, particularly in China, led to a 2.7 million barrel a day increase last year, 2 million barrel a day increase this year and we didn't have enough productive capacity readily available to meet that demand which of course means strong upward pressures on prices, which is where we are today.

Mary O'Driscoll: OK. I wanted ask Mr. Felmy, in a message to Congress last month, before Congress when on its district work schedule or recess, which ever you want to call it, API tried, you sent a letter saying, let's try to put this into perspective, put this whole oil situation into perspective, talking about tight markets and increased demand. I wanted to get into this little bit more. Did you see a need to kind of communicate that to Congress? That they had not understood that? Why was that necessary to have to give members of Congress that kind of information?

John Felmy: Well we regularly communicate information on oil markets with members of Congress. We probably send them four or five letters a year, just giving them an update on this is what's happening with markets. These are prices. These are the factors that are going in. So as the congressmen go back to their districts they have a good source of information for actually what's happening, because one of the things we learned many, many years ago is that if you don't spend a lot of time communicating what the facts are a lot of people, and particularly sometimes your opponents, will try to misrepresent things. So what we do is regularly communicate with all of government, the Congress, the legislative and the president's office. So what's going on with markets, what our perception of what's happening and what needs to be done about it.

Mary O'Driscoll: Right and part of, I guess the elements of this tight market situation, is of course the rising prices, but then to put it in perspective, that the $50 a barrel oil, I mean when you compare it to what prices were in 1981 and adjusted for inflation, is what, actually $80 a barrel back in 1981. So we're really nowhere near what we were 20, 25 years ago.

John Felmy: That's right. 1981 was the all-time peak. Where you had $80 a barrel crude oil and you had gasoline over $3.00 a gallon. So we have come down a lot. That being said, it still is a case that it is a burden on consumers because every penny change in the cost of a gallon of gasoline on an annual basis means $1.3 billion more it costs consumers. So it's something we're very concerned about. We feel we need energy policy to be passed this year and hopefully it'll happen.

Mary O'Driscoll: Well how long do prices have to stay at these levels, 50, almost close to 60, before they start eating into the economy? I mean, you're not really seeing people conserving gas right now. People are driving as much as they ever were. So how long do they have to stay at this price? Does it have to rise to a certain price? I mean are you finding any information on that?

John Felmy: Well I think it already has affected the economy. If you look at, you know, we had $40 oil in 2003 or 2004, we have $30 oil and so on. About every $10 increase in a cost of a barrel of crude oil usually means a GDP loss of somewhere of a half to a full percentage point. So there's no question that it has had a negative impact, but we've had said strong economic growth in the 3 to 5 percent range that it hasn't pushed us into recession.

Mary O'Driscoll: I see.

Ben Geman: Is there any concern right now that, you know looking at what type of increment and the increase it causes to create major disruptions in the economy? There was an analyst report recently that predicted there could be something to the effect of a super spike of over above $100 if there was a major supply disruption. I mean how realistic is that concern given how tight spare capacity is right now? Mr. Caruso.

Guy Caruso: Well, one always is looking at contingency plans, but clearly the central case or the reference case, even in that report, was $50 WTI oil, but the real key is that we're operating so close to full capacity on crude production in many of our refining centers, that it doesn't take much, it can take, small changes can make big, large price impacts essentially, a very low price elasticity. So clearly, the only pressure relief valve in the kind of market we're looking at now has been price. Given time, with investments, changes in consumer behavior and the macro economic impacts that John was talking about, take time to feed their way to the system. In our models usually you need about a full year of these higher prices for some of it to work its way through the system. It's a long lead time industry, therefore it didn't happen quickly and it's not going to, I think, adjust quickly.

Mary O'Driscoll: I wanted to know, some analysts, I've been reading a lot of articles about it and some analysts are saying that they don't quite understand why the prices seem to go up so much in light of all this. I mean is this just kind of price speculation? Is it just kind of worst-case scenario, you know predictions that are kind of getting out of hand or what?

John Felmy: Well clearly, you can have some speculative movements on a day-to-day basis because the market participants are really just assessing what the market is and not what the actual market is doing. But over the long run, I really think that it's fundamentals that are driving this. What we've seen is the China factor alone has been an enormous impact on world markets and the tightness of supplies that have been growing slowly, has come into play almost simultaneously. You add to that a couple of other kind of wild-card factors like we've had a very cold end of winter, much longer than you'd expect. Sunday for example, heating degree days were much higher than you would have expected. So you had that demand, you also had economic growth and so on. So over the long run it's market fundamentals that tend to drive the price, in my opinion.

Mary O'Driscoll: OK.

Ben Geman: You know, looking at prices, staying on prices. In the recent Senate floor debate on drilling in the Arctic National Wildlife Refuge many senators noted the high fuel prices right now in pushing for opening up ANWR to drilling. If that were to happen what effect would that have on prices and how long would it be before some of that petroleum came online, if it were to happen this year?

John Felmy: Well, if we were to open up Alaska for drilling in that area, you could probably produce a million barrels a day for 30 years, given a 10 billion barrel reserve, estimate of the resource. If you add that into world supplies there's no question it can be additional supplies. The question is what happens with other producers and a variety of things in terms of what could happen in price. The better question is what does that do for the U.S. in terms of, first of all, our balance of payments and how our overall economic impact works its way through. That could be on the order of $15 billion as an improvement in the trade deficit in that could generate a lot of domestic jobs.

Ben Geman: Mr. Caruso, staying on the price question for a second though, that 1 million barrels per day given the high growing demand worldwide that we've been discussing, would that have any effect on gas or crude prices?

Guy Caruso: It certainly would have some effect, but you have to recognize that, as I mentioned, it's a long lead time. In our work, that we've done for Congress in using the USGS middle case estimate of reserves, which John mentioned 10 billion barrels, means you'd need about seven to 12 years lead time to develop that, permitting and all the other infrastructure. So it would not come on at a million barrels a day on the first day, so it comes on slowly over that time and gets to about a million in mid-case, after about 10 years. So we're talking about that million barrels being available in 2025 in this particular case. So to answer to the price question, it could look like it's minimal over such a long time, but I think it's important because otherwise we're looking at continued declines in domestic production. So I think it's an important development, but when one looks at it as a price maker, I think that would be probably misleading.

Ben Geman: Right, but I mean many people who have pushed for ANWR development have made that explicit point. I mean is a lot of reasons why people say ANWR should be opened, including obviously the need for domestic production. But price was a big piece of the deal for a lot of people. I mean are you saying that even when it's fully online at over at million a day, it would have only an incremental effect on prices?

Guy Caruso: It's difficult to say at that point. As John said, there so many other factors going on, but clearly an extra million barrels a day on the world market 20 years from now would have an impact, but I don't want to overstate it. It's then a market of over 100 million barrels a day per year, even in the higher price cases.

Mary O'Driscoll: Well kind of tagging on to that, there's always so much talk about the energy bill, the comprehensive energy legislation and the need to pass it so that we can help set the country on the right track regarding the production, regarding the whole policy. But people, again, in the context of the energy bill are bringing up the high prices right now. I mean seriously, passing a comprehensive energy bill can't do anything to cure the price problem we're having right now, can it? I mean what can we do immediately to take care of the price problem?

John Felmy: Well immediately you can pass provisions that call for improved energy efficiency and conservation so that people can buy more efficient fuel using devices. That can reduce demand. That can have a price impact. So that's clearly something that can happen and can happen very quickly. But there's also got to be supply aspects of it so that we increase our domestic supply of all energy, both oil, gas, coal, renewables, nuclear, Hydro, basically all supplies of energy. Also we need to have policies that help us build more infrastructure, because we've got a system, whether it be transmission lines or pipelines or terminals or the whole energy supply system that's strained so tight that we need an expansion of the infrastructure to get it to consumers.

Mary O'Driscoll: We haven't even talked about the refining problem, the bottlenecks with refining, that that seems to be, according to a lot of the studies, that that's where the main problem is I guess.

John Felmy: Well, that clearly is an important problem that we need to expand refinery capacity because we face a real challenge, both in terms of total demand, but also we're facing a challenge where the refineries are being forced to refine heavier high sulfur crude oil and at the same time produce lower sulfur products. So there's a real bind there.

Mary O'Driscoll: OK.

Ben Geman: Staying on the production side of things for a moment. Is the United States doing enough to pressure OPEC to up production?

John Felmy: I think by all indications OPEC is producing as much as they can. There's very little excess capacity anywhere in OPEC, some in Saudi Arabia. The question is, if there is some excess capacity, is it the type of oil we can use? I think at $50 oil anybody worldwide who can produce as much oil they possibly can will be.

Guy Caruso: We've got hardly any unused spare capacity in our short-term outlook. It's as low as it's been in a long time. I mean we got very low at the end of '04 with the kind of demand outlook we're seeing for '05 and '06 and not enough incremental production coming on from non-OPEC. We see that being, it's so low that once you get below, say a million or a million-and-a-half barrels a day in an 85, 86 million barrel-a-day industry, you've got issues with respect to quality. As John mentioned, the heavier crude's available when you need light crude or it's in the wrong location. So it's an industry that's straining to meet the kind of demands that we're projecting.

Mary O'Driscoll: Well, that's going to have to be the last word on everything today. I'd like to thank our guest John Felmy of API and Guy Caruso of the U.S. Energy Information Administration. I'd also like to thank Ben Geman, my colleague from E&E Daily and Greenwire. I'm Mary O'Driscoll. We'll see you next time on another edition of OnPoint.

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