Oil and Gas

CSIS's Verrastro examines global energy markets, new strategies for oil majors

With oil prices declining from recent highs, Frank Verrastro, director of the energy program at the Center for Strategic and International Studies, breaks down the current state of world energy markets. Did high gasoline prices this fall cause a lasting shift in consumer demand? Why are major oil companies beginning to invest more money in alternative fuels? Should Congress pass legislation to expand refining capacity? And how accurate is the idea that world oil production may be nearing its peak? Verrastro tackles these questions and more.


Brian Stempeck: Hello and welcome to OnPoint. I'm Brian Stempeck. Joining us today is Frank Verrastro. He's the director of the energy program at the Center for Strategic and International Studies. Frank thanks a lot for being here today.

Frank Verrastro: Sure Brian, glad to be here.

Brian Stempeck: In the past three months, since Hurricane Katrina, we've basically seen oil prices just start to come down a bit. Gasoline prices are coming down. What's happening on the markets right now that's driving these prices to decline?

Frank Verrastro: Oversupply and some demand destruction, although the big debate right now is how much is actually destroyed versus a temporary blip that's off on demand that may actually come back. I think the early assessments right after the storms were that demand was significantly off for gasoline. And we've had a mild heating season so far, but as you start looking at the data and combing through some of it just means that people weren't able to get fuel. So demand was off, but demand may actually be stronger than we earlier anticipated. So we think prices will come back.

Brian Stempeck: How much are we seeing in terms of consumers basically going to the gas pumps saying this is too expensive and cutting down on usage? Is that starting to happen? I know that's always a tricky question to ask.

Frank Verrastro: That was happening post-Labor Day. And into September you're starting to see people come back now. It's the holiday season. Folks are driving. Gasoline prices are down again, down from what they were. And crude oil prices instead of being $70 are back in the mid-50 range. So I think that's maybe reversing.

Brian Stempeck: So the demand is starting to come back right now?

Frank Verrastro: Yes, yes.

Brian Stempeck: Immediately after the hurricane hit we heard a lot of talk about the U.S. refining sector not being up to par. Basically it was overworked and when a couple went down, the entire thing fell apart. Prices went through the roof. And we've seen talk in Congress about addressing that, different ways to do that. Is the oil industry doing that on its own now?

Frank Verrastro: No, I think two things that happened, for the last 25 years we've been working off these twin surpluses as we call them. And it's a surplus of global crude oil supply and domestic refining capacity and now we've worked to the point where demand has come up so much and quickly, that there is no more surplus capacity in the world. And if you believe the IEA statistics and the projected demand for the fourth quarter of this year it was 86 million barrels a day. Global refining capacity is about 84 and a half, so you were bound to have this gap that had to be filled. Well you fill that gap by building stocks in a counter seasonal basis. So when the storms hit in the fall it's the end of the driving season. Initially we took down about 28 percent of our refining capacity in this country and that's a substantial portion. Some of that is still out, although it's probably about 7 percent. But as a result of that fuel supplies have been less and less going forward. And the ability to build heating oil stocks and other things were affected. Now we got some supplies out of Europe, which really helped when there was a stock draw down and we changed the regulations to allow different fuel specs to be met in different states. That also helped supply and demand destruction because price was so high. But I think one of the keys to the heating season has been the weather has been so mild.

Brian Stempeck: So is the hurricane then an aberration? Is it just that it happened at this time when we're normally storing oil for the winter season?

Frank Verrastro: Yeah.

Brian Stempeck: But at the same time should there be a policy response to what happened?

Frank Verrastro: I think so, especially if you start looking at the hurricane. And today is the last day of the hurricane season for this year, thank God. But we've had 26 named storms this year and we've had 13 hurricanes. And five were Category 5. With all the instability that people talked about last year, we had strikes in Norway and Nigeria. We had the concern in Venezuela. We had YUKOS in Russia. We had sabotage in Iraq. The single largest lost to production in 2004 was Hurricane Ivan in the U.S. Gulf of Mexico. And absent some calamity in December the single largest loss of worldwide production this year will be the U.S. Gulf of Mexico from Katrina and Rita. So it has exposed some vulnerability clearly.

Brian Stempeck: In your opinion what needs to happen next? Is it just the industry basically taking it upon itself to build or expand their current refineries? Or does it take the House and Senate to finish up this refining bill that we saw move through the House this fall?

Frank Verrastro: My sense is that the Congress is probably not going to act this session. As you well know they're getting ready to go home. There really wasn't any consensus on what to do next. People are going to kind of wait and see what best practices are. In terms of next year my concern is that as you go forward, if we actually are entering a period over the next 20 years, we're going to have more severe storms and a greater frequency of storms in the Gulf of Mexico where a lot of our refining and gas production is located and processing facilities. We're going to be dealing with this on an ongoing basis. I think the refiners internationally are going to invest, especially in Asia and in the Middle East, for export refineries. New construction in the United States probably will be done through expansion, not through gas rig construction.

Brian Stempeck: Is there any alternative? I mean I've heard this problem raised before, that all of the refineries and so much of the oil and gas production is concentrated on the Gulf Coast. Is there any alternative to that though? I mean these are huge facilities. What else can you do besides -- it's not like you can pick these up and move them.

Frank Verrastro: Yeah, you can't. I don't think you can relocate it. It's like why do you rob the banks? Because that's where the money is. It's a situation if you look at the amount of production that's come out of the Gulf of Mexico and also for importation of crude oil and where the SPR is and the pipelines are located, we'll still have a concentration of facilities in the gulf. So that's not going to change. It would probably behoove us to start looking when we're placing new LNG facilities that maybe we place them closer to consumption centers along the East Coast and West Coast. And maybe only one in the gulf, but not several in the gulf.

Brian Stempeck: What do you see as the dominant trends on the world oil market right now? In the past year all the talk was about China and India ramping up their oil demand. That seems to be decreasing right now. What are the trends that you see?

Frank Verrastro: I think there's three. On the demand side we've seen over the last 25 years an acceleration in demand. It took 18 years for the world to go from 60 to 70 million barrels a day. It took eight to go from 70 to 80. And if the projections are correct, by 2010 we'll be at 90. So that's five years from now. On the supply side, last year we had the lowest available surplus capacity that we've had in the last 30 years. And that's a combination of demand increasing and lagging investment. If 75 percent of the oil resources are held by the national oil companies or ministries, if international companies can't get access to that, then investment decisions by those countries are really going to drive extra supply. It looks like non-OPEC production, the contribution that we can expect from those countries, is going to be less and less. And we're looking at further concentration in the Gulf states and the OPEC members.

Brian Stempeck: Is that why we're seeing the oil companies undertake new initiatives? This week we saw BP basically announce their plan on alternatives. Is that them saying that we don't have access to these state run oil facilities? We're going to have to do something else.

Frank Verrastro: Yeah, I think there's a couple of things. In BP's case, BP now is more of a gas company than oil company, even as an international major. But it's one of those situations where if you can't get access to low cost reserves you look at other sources. So you look at Russia. You look at the Caspian. When you get by that you start looking at new investment in the United States with new technology. And we've seen some of that. And then you also look at alternative fuels. I mean that's got to be the component that has to increase over the next 50 years, nonconventional. Because the price is higher, the technology is better and we really need the contribution and new supply.

Brian Stempeck: Do you think we're at a tipping point right now in terms of seeing the oil majors start to get more into these alternative fuels?

Frank Verrastro: Yeah, definitely. I think both from an investment point of view and just in terms of supplementing conventional supply sources. When you start looking ahead -- and in BP's case its power generation. And they're such a large natural gas producer that if you're concerned about global emissions, greenhouse gas emissions, and you're also looking at the increase in power generation and energy sources for power generation, you have to look at alternative measures as well as gas and coal and nuclear. It just has to be that way.

Brian Stempeck: I was going to ask about that as well. Is climate change starting to drive these energy companies to behave differently? We're seeing right now the Kyoto Protocol conference going on in Montreal. Europe is already moving ahead with its emissions trading scheme. Is the message starting to get through to U.S. energy companies that they might need to address this in the future?

Frank Verrastro: Yeah, I think so. And I think this for a couple of reasons. One is the fact that if you are U.S. company but you operate overseas, especially in a Kyoto protocol country, you're going to start looking for ways to generate emissions credits and keep track of your emissions reductions. So my sense is that a parallel system will certainly develop in the United States or the Western Hemisphere. We won't call it Kyoto. We'll call it something else, but it's got to happen. The second piece is if you look at demand over the next 25 years 60 percent of new greenhouse gas emissions will come from the developing world. And the bulk of that will come from new power generation sources. So unless you start investing in those things you can't meet the demand that's expected. And it can also be very profitable with the new technologies.

Brian Stempeck: Getting back to the global markets that we were talking about. What do you make of the trends happening in South America right now? In Venezuela a major exporter to United States for gasoline and oil, we've seen them basically do some very controversial things lately. Exporting oil to low income residents in the South Bronx recently. They've done other things. Made very anti-American remarks, basically a regional block in South America for oil and gas.

Frank Verrastro: Yeah, Petro Caribe. That's President Chavez's diplomatic initiative. Clearly the White House and the president of Venezuela haven't gotten along. There's been some nasty things said on both sides. Venezuela has been historically one of our top four suppliers to the United States, both in terms of crude and product. It's hard to believe that since there's such a short haul market that they would look for an alternative purchaser for their supplies when they can actually generate a lot of cash this way. Having said that I think higher prices have really helped them out. If it wasn't for the fact that we had $55 oil President Chavez probably wouldn't have had the additional money to run the initiatives that helped them get through their referendum last year.

Brian Stempeck: How much of concern should that be for the White House? We're kind of seeing the same thing happening in Asia. There's talk about regional blocks forming there as well. Is that a danger as the U.S. looks out for its oil demand in the next 20 years?

Frank Verrastro: Yeah, I think that one of the other trends that we're seeing is this geopolitical balance. If you go out 5, 10, 15 years the world starts dividing up into producers and consumers, givers and takers on the market. And depending on what fuel you choose, if its oil that you're looking at, the big production blocks are the Middle East, Africa, Russia and the Caspian. And then the nonconventional fuels from Canada and Venezuela. Well the big consuming blocks are North America, Europe and Asia, especially China and India. They're not co-located and that's going to put a lot more strain on the transportation system, infrastructure, new investment, heightened security concerns and certainly environmental concerns. So the world is changing. The market is changing. And it seems to be moving more east. And then the question is geopolitically is what happens if you get a Russia/China alliance or a Middle East/China alliance? I think if it's handled correctly we don't have to be strategic competitors with China. We can be cooperating. We're the number one and number two energy consumers now. There's a lot of we have in common. And if we share technology we can improve the environment as well.

Brian Stempeck: One last question for you, Frank, because we're running out of time.

Frank Verrastro: Sure.

Brian Stempeck: One idea that we discuss on this show quite a bit is the idea of peak oil. We've had different authors and congressmen come on the show and say we're already there. It's going to be here in the year. It's going to be here in five years. What's your take on that subject in terms of how close we are to seeing a peak in global oil supply?

Frank Verrastro: I mean theoretically, we're certainly using oil faster than we're finding it. There's no question. So to the extent that it's a finite resource, that we're not replacing as quickly, at some point we're going to be running out. I think the peak oil theorists at this point, certainly with respect to Saudi Arabia, are totally off base. I mean I was in Saudi Arabia last year and I've got to tell you, the technology that Aramco uses is just phenomenal. They use diagnostics and know their reservoirs better than any -- or comparable to any multinational company that I've ever seen. And I spent 20 years in the industry. I don't think they're in danger of running out of oil. The other concern is that by hyping the peak oil theory, it doesn't get to a peak and then declines quickly. If you're looking at $55 or $60 fuel you're bringing on alternatives. And if you add the unconventionals, tar sands, oil sands, heavy oil, shale or gas to liquids, you're looking at trillions of barrels out there. Now the price may be more, but it almost makes peak oil irrelevant.

Brian Stempeck: All right, Frank. We're out of time. Thanks a lot for coming on the show today.

Frank Verrastro: It's a pleasure, Brian.

Brian Stempeck: I'm Brian Stempeck. This is OnPoint. Thanks for watching.

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