The benefits of higher oil prices

First Published: 2005-04-13

Oil is about to generate a lot of heat in the Bahamas – in more ways than one.

Just a few months ago crude was pegged at about $30 a barrel – up from prices in the low teens a couple of years ago. It is now over $50 a barrel. Gasoline prices are approaching $4 a gallon locally, and are over $2.50 per gallon in California.

Some analysts are already predicting 1970s-style price hikes to over $100 a barrel, which could have profound impacts. The 1973 Arab oil embargo and the 1979 Iranian revolution caused price rises that triggered global recessions.

According to the New York investment bank, Goldman Sachs, “oil markets may have entered the early stages of a multi-year trading band of prices high enough to meaningfully reduce energy consumption and recreate a spare capacity cushion only after which will lower energy prices return.”

What this means is that energy will cost so much that eventually we will use less of it, bringing the price down again. But it will be painful in the meantime. The main cause is surging demand, in the United States and especially in the huge emerging economies of China, India and Indonesia, which now account for almost half of world oil consumption.

Goldman Sachs said US gasoline prices may need to exceed $4 per gallon before American consumers curb demand and buy more fuel-efficient vehicles instead of gas-guzzling SUV’s. And China’s roaring economy is unlikely to draw back anytime soon. That means pump prices could go much higher in the Bahamas.

But it’s not only our mileage costs we have to worry about. The International Air Transport Association is forecasting losses for the global airline industry of $5.5 billion this year because of high oil prices. This will affect the livelihood of 28 million people in aviation and related activities, including Bahamasair and other airlines serving the Bahamas.

And the International Monetary Fund says the world faces a “permanent oil shock” and must adjust to sustained high prices for the next two decades: “We should expect to live with high oil prices…(which) will continue to present a serious risk to the global economy,” the IMF said recently.

The Bahamas imports about 1.6 million barrels of gasoline a year to fuel the 140,000-plus vehicles on our narrow, congested roads, as well as all the diesel and bunker C fuel to run our power stations and kerosene for our aircraft.

The rising cost of fuel imports has been amplified, experts say, because of the weak US dollar, to which our currency is pegged. Today, motor gasoline imports cost us about $94 million a year in foreign exchange – in 1995 the cost was $38 million.

The government’s response to all this has not been very coherent. Basically, Trade Minister Leslie Miller has been left to make occasional noises about a regional energy alliance called PetroCaribe that has been proposed by Venezuelan strongman Hugo Chavez.

Venezuela is the world’s fifth-largest oil exporter, producing up to 3 million barrels a day. Chavez is a former army officer elected in 1998 (and again in 2000) as the leader of a so-called “Bolivarian Revolution”.

Last August, energy officials from Venezuela and the Caribbean (including the Bahamas) apparently agreed to form a regional company to distribute cheaper oil on a government to government basis. But it is not clear just what the status of this proposal is now.

Caricom officials said world oil prices threatened to provoke “social unrest” and economic ruin for cash-strapped Caribbean countries. A meeting was set for November in Nassau, which never happened. Another was planned for February, but also failed to materialise. So Mr. Miller said recently he would visit Venezuela this month.

There has been no public consultation on this important issue, which has a lot of teeth. The closest thing we have to a report was this recent comment from Mr Miller: “The talks have not gone as we had anticipated, but you always have to expect stumbling blocks. We’re still waiting to get the final word from Venezuela on whether they accepted our proposal on the lowering of fuel costs in this region.”

Venezuela’s state oil company, PDVSA, happens to own the BORCO transhipment terminal on Grand Bahama and has made noises recently about rehabilitating the mothballed refinery, but there has been no official comment on this either. In the 1970s, BORCO was one of the biggest refineries in the world, but it closed in 1985 during a world oil glut. It would take a massive investment to re-open, but with world refining capacity now at a premium, experts say it may be worth the cost.

But all Mr Miller thinks about is the creation of a national energy agency to import and distribute fuel from PetroCaribe – displacing Shell, Esso, Texaco and Focol – the private companies that currently supply our fuel. Presumably, Venezuela will give Caricom oil at concessionary prices to buy support for Mr Chavez’ ongoing confrontation with the United States, which he recently described as “the most negative force in the world.”

Venezuela is a member of the Organisation of Petroleum Exporting Countries, which controls 40 per cent of global oil production and sets production volume quotas to maintain stable prices. But refined product sales are not bound by OPEC rules; and neither are exports of heavy crude from Venezuela’s tar belt, which could be refined in Trinidad to supply fuel to the Caribbean.

It is unclear just what our government’s real position on all this is, as only Mr Miller has been carrying the ball so far. What is clear is that we have no thought-out national energy policy. And if Mr Miller has his way we will embark blindly on a costly initiative with serious consequences – including a significant expansion of the country’s inefficient public sector.

Experts are sceptical about such a project. They point to the capital-intensive nature of the business – apart from the transportation and storage facilities, service stations carry million-dollar price tags and complex operational and safety procedures are required throughout the supply chain. They say it makes sense to keep the financing of such a high-cost industry in the private sector.

“If the government takes over fuel buying, transport, and distribution, it will still have to pay shipping, storage, trucking and station costs,” One industry analyst told Tough Call. “All of this will have to be managed as well. So in the end, I can’t believe that costs will go down. Also, the government would have to assume all liabilities, and national energy companies around the world have serious problems,” he added. “They suffer from neglect because profits go into the treasury, and reinvestment in the energy sector is not a political priority.”

For example, Mexico’s state-run oil monopoly, PEMEX, announced recently that it was on the verge of bankruptcy, with total liabilities of $88.5 billion and an annual investment requirement of $10 billion.

And market flexibility is the key to rational, best-price supply, experts say: “By maintaining access to the global oil market through multiple suppliers you let competition do the job of regulating and guaranteeing a best-price for The Bahamas.

“Only a limited number of refineries can process Venezuela’s heavy crude oil into useable fuels, so having access to crude is not even half the battle. A single refinery accident, closure, or off-cycle maintenance can create a supply crisis,” one analyst said. “Tying yourself to one supplier and a single logistics and management chain is a guarantee that a catastrophic failure will occur sooner or later.”

And without assured supplies of fuel, the entire Bahamian economy will be forced to shut down. That will be a a lot worse than paying a few cents more at the pump.

World oil demand is around 80 million barrels of crude a day. And the consensus is that OPEC can add only another million barrels a day to the total. Since much of the world’s production capacity is in politically unstable countries, it is easy to foresee disruptions that will take more than this out of the market.

So assuming that we are in for years of rising prices, what will the impact be?

First of all, some analysts say the government can keep a lid on pump prices just by varying the stamp tax and duty it charges on imports: “There is a windfall to the treasury when prices go up, so there should be a floating tax rate that will guarantee revenue projections while keeping prices down.”

A barrel holds 42 gallons of crude oil, which is refined at a cost to produce gasoline. Added to this are shipping costs and government taxes, plus the 44-cent and 33-cent markups per gallon for local retailers and wholesalers. Pump prices in Nassau are now over $3.50 per gallon – the highest ever.

According to Revenue Secretary Ehurd Cunninghan, government revenue is up 4 per cent, an achievement that he attributes to improved collection. But it is much more likely to be due to higher oil prices and increased consumption. We have to factor in the rising number of vehicles (including SUV’s) on our roads, and the fact that Bahamians use their cars the way they use phones. According to government figures, some 34,000 cars and trucks are imported annually.

So let’s not overlook the benefits of higher oil prices, some argue. In the European Union stiff gasoline taxes have promoted conservation without damaging the economy. One analyst told Tough Call that taxes should be kept high and a rebate scheme worked out for construction vehicles, buses, taxis, ambulances and the like. A lower fuel tax could also be set for the Family Islands.

Although many industry observers believe increased exploration and production will prevent prices from spiking over $100 a barrel, the International Energy Agency , a watchdog agency set up in 1974 by the industrialised nations to monitor oil supplies, says high prices may be necessary to bring demand in line with supply.

And with higher world incomes and greater oil efficiency today, “prices could need to go higher than their 1970s peaks in real terms before equilibrium returns to the market,” according to a recent commentary in the Financial Times.

A draft IEA report suggests dramatic measures such as reducing highway speed limits by 25 per cent, shortening the work week, imposing driving bans on private vehicles and promoting public transport. Civil servants in the Phillipines have already begun four-day work weeks in a deparate attempt by that government to cut its oil bill.

Whatever the analysis, there is no doubt that we are in for some serious inflation in the cost of power and transportation. So now is the time to put our heads together and come up with a national energy policy that takes account of renewable fuels and promotes fuel efficiency and conservation. Is this too much to ask of our government?

For the long-term, experts say that plentiful supplies of natural gas may be the solution to our energy woes. Gas could become the preeminent fuel of the 21st century, but it requires huge investment in special ships, regasification terminals, and pipelines. And, as we have seen in the Bahamas, there is a lot of hostility to such projects.

Both Trinidad and Venezuela have large natural gas reserves, and Trinidad is already a major supplier of LNG to the United States. Tractebel, one of the companies vying to set up LNG terminals in the Bahamas, is a major investor in Trinidad’s gas fields.

The comical bust-up between Manuel Diaz and Leslie Miller notwithstanding, all indications are that the government will approve two LNG plants in the northern Bahamas to supply power to South Florida – and hopefully to our own power stations.

As Health & Environment Minister Dr Marcus Bethel pointed out recently (and as we have previously noted in this column) handling LNG is safer than handling gasoline or diesel. And it will bring the possibility of reducing our dependence on high-priced oil that is a major environmental pollutant.

But as one energy executive put it, “Supply is not the issue; it is the delivery of gas to the market. Before this transition occurs, a world-wide infrastructure for natural gas, such as that now enjoyed by oil, must emerge.”

The views expressed are those of the author, and not necessarily those of the Nassau Institute (which has no corporate view), or its Advisers or Directors.

This article was first published in The Tribune on Wednesday, April 13, 2005.

The column ‘Tough Call’ by Larry Smith is published in The Tribune every Wednesday and is reprinted here as a courtesy. Mr. Smith founded and successfully grew an advertising agency over 20 years. Under his direction Media Enterprises diversified into short-run commercial printing and publishing, and is now the largest non-fiction book wholesaler in the Bahamas. He has 30 years experience as a journalist and publicist and has contributed numerous articles and columns to the Bahamian press. A former reporter at the Nassau Guardian, local correspondent for Reuters and editor at the Bahamas News Bureau, he conceived and edited the Bahama Almanac (published 2000 by Media Enterprises), wrote the commentary for Mike Toogood’s Portrait of an Archipelago (published 2004 by Macmillan Caribbean), and edited the Bahamas Environmental Handbook (published 2002 by the government). In 2003 he took a year’s leave of absence from Media Enterprises to lead a transition management team at the Nassau Guardian after the paper was acquired by local investors. After leaving the Guardian he was contracted by the Tribune as online manager/editor and columnist. He has a degree in political science and journalism from the University of Miami. Mr. Smith can be contacted at:

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