The $100 prize

Daniel Yergin, one of the world's leading energy experts, weighs in on crude oil's march into uncharted territory

Geoffrey Scotton
Calgary Herald
Sunday, January 06, 2008

As one of the world's foremost experts on energy, particularly oil and gas, along with geopolitics, Daniel Yergin is sought out for his insight on the dynamics of world crude and natural gas markets and their impact on the economic and political sphere.

Yergin is the chairman and co-founder of Cambridge Energy Research Associates, arguably the world's leading energy consultancy. During his career, Yergin has been the recipient of the Pulitzer Prize for his 1990 No. 1 bestselling book, The Prize: The Epic Quest for Oil, Money and Power. The work was subsequently made into an eight-hour PBS/BBC series viewed by more than 20 million people and translated into 12 languages. His 1998 followup Commanding Heights: The Battle for the World Economy, co-written with Cambridge Energy colleague Joseph Stanislaw, received a similar treatment.

Cambridge, Mass-based Yergin has chaired the U.S. Department of Energy's Task Force on Strategic Energy Research and Development, and is a board member of the United States Energy Association and a member of the U.S. National Petroleum Council. He is also the only foreign member of the Russian Academy of Oil and Gas and a "Wise Man" of the International Gas Union. Yergin is a distinguished visiting fellow at Yale University's centre for globalization, a trustee of the Brookings Institution, a board member of the New America Foundation, a director of the U.S.-Russia Business Council and an adviser to the International Institute for Economics.

Herald economics reporter Geoffrey Scotton spoke recently with Yergin about the recent breaching of the $100 US per barrel level for crude oil, which Yergin describes as "a very strong psychological measure." All figures are in U.S. dollars.

Question: What does $100 oil mean?

Answer: At one level, it's a record and it's a score. But really, if you dissected that price, it tells a lot of what's going on in the world. It's telling us about the strength of the global economy, in particular Asia and particularly in China. It's telling us about mounting geopolitical fear of risk of disruption, in terms of, particularly, Iran and Iraq. It's certainly telling a story about the weakening of the (U.S.) dollar and the continuing weakening of the dollar. It's telling us that there is a series of small disruptions, interruptions.

The other thing that it's telling us, that I think is important that gets overlooked, is how rapidly costs have gone up in oil and gas development. That's maybe the great overlooked factor here, because the public and politicians focus, of course, on the price, but what the industry deals with is the reality of these costs that have gone up so dramatically.

In a way, $100 oil tells a pretty dramatic story of how much things have changed in just three or four years.

Q: Does it stand out less when one considers it in the context of sharply increased, and rising, costs?

A: I suppose. The $100 is really part of a trend and embedded in it is how rapidly costs have risen.

Upstream costs -- we created this thing that's called the IHS/CERA Upstream Capital Cost Index and the newest one shows that costs continue to go up dramatically. Basically, since 2000, costs have doubled and most of that doubling has been in the past three years.

Among other things, what that has done is lead to delays and postponements, and scaling back and re-prioritizing projects. So all of that means that there is a noticeable lag in responding to this, what is really a global commodity boom.

Q: Do high oil prices mean the world economy is going to grind to a halt?

A: It's striking to me that there was more anxiety when oil was hitting $50, $60 or $70 and more concern when it's hitting $100, although it's completely obvious that $100 is higher than $70. When we were at $50 or $60, we were nowhere near the $99.04 record April 1980 -- we're now above it, so we're now in uncharted territory -- and price tells a story. It also provides a lot of information. There will be an inevitable response, but there's always a lag. If we stay in this kind of a range, we'll see more of an impact. We've created this scenario we call breakpoint, where oil averages $120 and spikes as high as $150. Six or eight months ago, it seemed like the twilight zone and now it kind of has a reality to it. The idea is that when you get up to the breakpoint, at some point oil starts to lose its traction in the transportation sector.

Q: Is $100 oil based on reasonable fundamentals?

A: In our view, the current price is somewhat de-coupled from the fundamentals of supply and demand. The market is tight, but we think without these other factors at work, particularly the dollar, the fear of disruption and the rapid acceleration of costs, we wouldn't see prices where they are now. There's one other factor that's brought us there -- it's just the momentum. There's this kind of excitement about it in international markets. People expected it to happen. So, to some degree, there's been a self-fulfilling prophecy in this.

Q: So, there's psychological momentum at work?

A: There's no question that all these factors come together and ramp into psychology and people piling in. When the Fed cuts interest rates, it not only affects interest rates, it affects the price of oil and I think that a lot of people have been betting on the Fed, and that means going long on oil as a hedge against the dollar.

Q: What does $100 oil mean for Canada and for Alberta, and for our place in the world's economic echelon?

A: We did a scenario that touched on this last week. I find that most Americans do not realize that by far the most important source is Canada; they don't realize the role Canada plays in terms of natural gas and how tied together our economies are. Obviously, Canada, and Alberta in particular, has been a big beneficiary of this. When we do our analysis of where the major growth is going to be over the next 10 years in terms of oil production, Canada is right up there near the top of the list. I think that in general that $100 oil is a symbol of the age, but so is the relationship of the Canadian loonie to the U.S. dollar. These prices are all telling us about change in the global economy.

Q: How about Alberta and the oilsands? There's been an awful lot of interest in the oilsands in recent years. Presumably, $100 oil is going to make the attention paid to the oilsands even stronger.

A: It certainly heightens the interest, it heightens the interest in energy security and that's beneficial to the oilsands. But the oilsands is having to cope with the same rising costs. This is a capital-intensive industry, so it certainly should give a boost to the oilsands, but this high-cost environment is also a challenge for the oilsands.

Q: Is it fair to characterize $100 oil as a concrete sign that energy has taken on a new importance in the world?

A: One hundred dollar oil is a very clear sign that energy is at the top of the global agenda once again and that there's worldwide recognition of its importance. It's also why people are talking so much, wherever I go in the world -- whether it's Russia, China, western Europe, the Mideast as well as North America, people are talking about energy security in one form or another. It's a sign of the times.

Q: In terms of high crude prices, along with high finding and production costs, analysts also cite a security premium or a fear premium. What other factors are being felt?

A: Costs are a very big piece of this, (the U.S.) currency's a big piece of this and also the best global economic performance in a generation, or maybe ever, has been part of it. Like so many things that happen, it's a lot of things coming together.

Q: What do you foresee as the impact on the U.S. economy?

A: If prices stay in this range, when it starts to pass through to consumers, coming at the same time as the deepening credit crunch, it certainly will add to the worries about the U.S. economy and it will raise the temperature politically because it arrives as the presidential campaign is starting to move into overdrive.

Q: What about the impact on developing economies, particularly those of China and India?

A: The Chinese would like to slow down their economy. The Indian economy is less sensitive. Oil looms much larger in the Chinese economy. I think the Chinese government . . . would like to cool off their economy some and slow down the demand growth in energy, but there are political concerns about what the political impact will be of deregulating price. It's still a big political challenge for them.

gscotton@theherald.canwest.com

© The Calgary Herald 2008