When Finance Minister Chidambaram attended the annual IMF-World Bank meeting at the end of September, he had a minor scrap with the IMF Chief Economist, Raghuram Rajan, over record oil and gas prices. Rajan said that rising global demand, especially in China, had created a new situation where OPEC was producing oil flat out but still could not tame prices. Chidambaram refused to accept that rising demand was the only problem, and felt OPEC, along with speculators, was definitely contributing to the problem.
Now, Chidambaram is wrong about OPEC: it has freed members to produce all they can. But he is right in thinking that rising demand is not the only problem. An additional problem is that environmental groups, mainly in the USA but also in Europe, have created a situation where production cannot easily rise to meet demand. Thus western greens have helped raise oil prices for the whole world, including India. This is not obvious, so let me elaborate.
A major problem today is the mismatch between the quality of crude oil being produced and the quality that the world’s refineries have been designed for. The best oil is light with little sulphur, and the worst is high-sulphur, heavy oil, that is a solid at room temperature and needs heating to flow. Historically, the world has first tapped light oil: this is the easiest to produce and many refineries are designed to process it. Heavy oil is difficult and costly to produce, and the technology to produce and refine it has been developed later.However, old fields producing light crude are depleting the
world over, from the North Sea and Alaska to Indonesia and Bombay High. Saudi Arabia today wants to produce additional oil, but this is heavy, high-sulphur crude that cannot be refined in many existing refineries. The change in quality of crude being produced today has meant a gradual world shortage of refineries for the crude actually available. In consequence, refined products have risen in price faster than crude oil. Petrol and heating oil are up more than 60% over the last year, while crude has gone up only 35%. Commodity experts say that the rising price of refined products is dragging up crude prices as well.
This situation has been aggravated by Hurricanes Katrina and Rita in the Gulf of Mexico, which shut down 15% of US refining capacity. These will restart in a few weeks, but meanwhile stocks of refined products are falling.
More serious, environmental pressures have for a decade discouraged global refinery capacity from keeping up with new demand. In the US especially, ever-tightening environmental regulations have obliged refiners to invest in pollution control without compensating returns. This reduced the profitability of refining in the 1990s, inhibiting fresh investment and leading to the closure of older refineries unwilling to invest in pollution reduction. The laws have also made it difficult to set up new refineries.
Hence the US has not built a single new refinery since 1976! The Wall Street Journal reports that in 1981, the US had 325 refineries processing 18.6 barrels/day. Today this is down to 148 refineries processing 17 million barrels/day, although US demand has risen steadily. Greens typically oppose the construction any new refinery anywhere, pointing to possible oil spills and air pollution. One company wanting to build a major new refinery, Arizona Clean Fuels, Yuma, has been trying in vain to obtain the necessary environmental permits for nearly seven years.
Greens have succeeded in preventing any offshore drilling off the east and west coasts of the US for 24 years. The Outer Continental Shelf is estimated to contain maybe 76 billion barrels of oil and 400 trillion cubic feet of gas, but green opposition has meant a moratorium on drilling. No exploration has been permitted in the Arctic Wildlife Refuge in Alaska, which is known to have large deposits. The Bush Administration now wants to drill in all these areas, but greens are gearing up for a major battle.
The Bush Administration has a good case, but so do the greens. I appreciate the force of their argument that a rich country like the US can afford to sacrifice oil production for reduced pollution and flourishing wildlife. The problem is that the consequent high prices of oil and gas hit the rest of the world, including poor countries like India that are not consulted at all.
The silver lining is that markets respond to high prices. The shortage of refineries has sent refinery profits sky-high in the last two years, encouraging new investment even in the face of costly new environmental standards. Global oil exploration has accelerated too. Still, new investment in refining and drilling is being inhibited by green campaigns and regulations on refinery and drilling locations. To this extent, Western greens are doing more to keep oil prices high than OPEC
