HOUSTON (Dow Jones)--When Goldman Sachs analysts made their controversial call in 2005 that oil prices would hit $105 a barrel, they predicted such a spike would cut energy consumption globally and lead to the development of a greater oil supply cushion.
While the price forecast doesn't seem half as far-fetched now with oil futures trading near $90, the consumption and supply aspects of their argument haven't materialized. If anything, the surge in the price of oil this decade has exposed the tortoise-like effect of efforts to grow energy production, whether from the Organization of Petroleum Exporting Countries or the major oil companies, or their would-be successors in venture capital and renewable energy.
These interests are spending billions more, but adding capacity is proving to be a long, hard slog, whether in conventional hydrocarbons or carbon-free innovations like cellulosic ethanol. Against a backdrop of oil prices that have barreled higher this decade, the world has adapted in a way that's surprised many economists and industry experts and essentially enabled the oil boom to persist.
Among bulls in the oil market, there may be no greater source of confidence in long-term fundamentals than the mammoth growth in China's oil consumption and the belief that the Asian tiger's arrival as a major petroleum importer represents a permanent shift in global markets. China's ability to absorb higher prices has been a critical factor in the energy boom.
In its report predicting "super spikes" in oil prices, Goldman Sachs fingered a "sharp slowdown in economic growth in China" as the prime risk that could challenge the bank's thesis of structurally higher oil prices. But the Chinese economy has been immune to such a slowdown. Nor has China taken significant steps to remove fuel subsidies that insulate Chinese consumers from the effects of higher energy costs. China is expected to address these subsidies in the years ahead, but the pace of reform is expected to be slow.
Americans Keep Filling Tanks
If the China boom is one pillar underlying oil demand, it's getting help from the other key heavy lifter: the American motorist. Average annual gasoline prices have risen in each of the last four years, according to the American Automobile Association. Through September, the average price for 2007 is $2.71 for a gallon of regular, 14 cents higher than the average for 2006, and double the $1.35 averaged in 2002, according to AAA.
Throughout this period, U.S. gasoline consumption has also continued to rise - albeit at a slow rate compared with recent history, underscoring the consumer's ability to absorb steadily higher prices at the pump without radically altering driving habits. Smaller cars and hybrid vehicles have grabbed some market share from sports-utility vehicles, but the American car fleet hasn't changed dramatically since oil prices took off earlier in the decade.
For the heavyweight oil producers in OPEC, the pattern of slow, plodding change has been in place, even as oil prices moved off lows below $10 in 1998 towards $90 today. While the group has voted as a unit - in cutting global oil output last year and raising it modestly this year - some countries such as Iran and Venezuela have struggled to reach their former production heights.
Others are aggressively trying to build additional capacity, including Saudi Arabia, which is in the midst of a multi-billion dollar capital investment campaign, and Libya, which is courting western companies after renouncing weapons of mass destruction and shedding the burdens of international sanctions.
Still, the conventional wisdom that OPEC opposes stratospherically-high oil prices because of concerns about the potential impact on economic growth no longer holds true. The cartel's increasing hawkishness at protecting ever-higher prices suggests this fear has diminished amid a recognition that consumers can - and will - pay higher prices.
Constraints On Big Oil
The large private energy companies meanwhile, haven't been able to fill the gap in bringing new oil supply to the markets. In recent years, Big Oil has become accustomed to the realities of an opportunity-constrained environment and its steroid-like effect on oilfield economics.
"Most of the big projects will go ahead, but with delays or postponements," said Daniel Yergin, a longtime energy analyst and historian in a recent interview. But in cases where there is a "real gap" between the private companies and host governments, "things can be postponed, possibly for a very long time."
The upshot is that even though the oil majors such as ExxonMobil Corp (XOM) are scoring earnings records due to high commodity prices, they're struggling to replace, let alone increase, production, a difficulty that in itself has emerged as a bullish factor for oil prices.
With many of their traditional operating basins in the U.S. and Europe now in decline, the western oil giants are forced to compete for access to major reserves in places that are politically unstable, environmentally challenging or both. In other cases, as with the Canadian oil-sands projects, the companies must employ costly techniques to make good use of an exceptionally low-quality tar-like fuel. Adding to the access challenge, oil companies face tough competition among themselves for supplies and staff that inflates costs on everything from drilling rigs to experienced petroleum engineers.
Analysts who are more skeptical of $100-oil - and there are many - typically argue that some sort of hit to demand is the most likely source of a fall in prices. Some say a correction could be exacerbated by an exodus of financial investors who have crowded into commodities in the wake of the housing downturn. Adherents of the "peak oil" theory say high oil prices themselves will ultimately deliver that hit to demand, though there's debate over what that level is.
Renewable energy may be a potential wildcard in the equation, if innovators are able to progress critical technologies at a faster pace than is now expected. Some analysts expect energy to play a central role in the 2008 U.S. presidential campaign, potentially leading to new policies that speed the development of viable renewable technologies.
The political saliency of energy in the U.S. depends largely on gasoline prices, which so far haven't increased appreciably with the latest jump in crude prices. That could change if prices rise suddenly, either in the coming weeks, or as the 2008 presidential campaign gains momentum next year.
Source: John Biers; john.biers@dowjones.com; 713-547-9214