This earlier post reported on an interview of Matt Simmons, the Houston-based investment banker who is an expert on forecasting oil supplies. Following that interview, this Barron’s interview of Mr. Simmons warns that the Saudi oil supplies are not what they appear to be and that, because the Saudi oil industry is state-run, there is no independent auditor of national reserves who can verify just how large — or small — the Saudis’ reserves are. As Mr. Simmons notes, that makes a big difference for the following reasons:

With global demand for oil on the rise, and prices hovering near $50 a barrel, the Saudis’ production profile is more than academic. The No. 1 oil producer, Saudi Arabia pumps 13% of the world’s oil and boasts 23% of its oil reserves. Moreover, the Saudis alone claim to have excess production capacity and the ability to increase output if demand continues to rise.

If the Saudis’ numbers are correct, the kingdom could continue to produce at current levels of about 10 billion barrels a day for the next 50 years, or more. That would give the industrial world time to develop alternative energy sources and prepare for a graceful transition.

If Simmons is right, however, the world could face a dangerous imbalance between rising oil demand and diminishing supply, perhaps within the next 10 years. Oil prices could soar, economies could suffer, and oil-dependent nations, such as the U.S., China and Japan, would be forced to scramble for additional energy sources.

Matt Simmons’ opinions are not to be taken lightly. Read the entire article.

Houston-based ConocoPhillips announced earlier this week a $2.36 billion “strategic alliance” with Moscow-based OAO Lukoil under which Conoco will buy a 7.6% stake in the Russian oil company and get a share in joint projects. The deal provides Conoco access to Russia’s enormous but largely undeveloped oil and natural-gas reserves and opens a possible avenue for it to become the first Western petroleum producer to return to Iraq.
For energy producers looking to increase reserves, Russia represents one of the few places in the world where large reserves are available to private investors.The agreement will contribute to Conoco’s proved reserves and production, which are closely watched market measures of an oil and gas company’s prospects.
The move catapults Conoco ahead of most of the other major oil companies, which have have been largely unsuccessful in seeking a Russian partner. The deal also reflects the strong interest in Russia from foreign investors despite increasing concern over a recent Kremlin clampdown on political life and control over the energy industry. To ensure Conoco’s minority stake is protected, Lukoil agreed to give the company one seat on the 11-member board and change its corporate charter to require unanimous board approval of top corporate decisions.
Conoco plans to raise its stake to 10% by year end and to 20% within two to three years, which would cost about $3 billion at current prices. As Conoco’s stake rises, it would gain another board seat. This corporate governance arrangement addresses a problem that has tubed earlier Western investments in Russian oil and gas companies. For example, BP PLC sold its 7% ownership in Lukoil in 2001 because the stake was too small to have an effective voice in company decisions.
Although Lukoil was overshadowed in recent years by faster-growing Russian competitors such as Yukos, Lukoil is run by Russian oil and gas veterans, and its management maintains extraordinarily close ties with the Kremlin. That political stroke has come in handy lately since Yukos and its founder Mikhail Khodorkovsky ran into trouble with the Kremlin and Russian President Vladimir Putin last year, as related in these earlier posts. Those troubles scuttled Yukos’ negotiations with Exxon Mobil Corp. over a large investment in the Russian company.
The deal also gives Conoco an interest in Iraq’s vast oil fields. A part of the deal gives Conoco a 17.5% interest in a 1997 contract granted to a Lukoil-led group to develop Iraq’s West Qurna oil field, which is a major prospect with estimated reserves of 15 billion barrels. Although the contract was canceled just before the U.S.-led invasion in March 2003, all such Saddam Hussein-era contracts are currently being reviewed by Iraqi oil and gas officials.
Meanwhile, the stampede to gain a foothold in the Russian oil and gas market continued on other fronts this week as Royal Dutch/Shell Group executives met with Russian oil and gas officials in The Hague. Shell has recently expressed interest in a joint venture with OAO Gazprom, the big Russian natural-gas company. Those discussions have become more serious since Gazprom’s announced merger with Russian oil company OAO Rosneft, which will transform the company into a huge state-controlled oil and gas company.
Stephen Kotkin, a Princeton history professor who specializes in the business politics of Russia, analogizes doing business in Russia right now to a rugby scrum with market reformers, hard-line security advisers and members of Mr. Putin’s inner circle all wrestling for the upper hand in policy making. If market reforms are allowed to gain traction, then the rule of law will become established and likely supersede Russia’s notorious security apparatus. However, I remain skeptical that such reforms will take place so long as Mr. Putin remains in power.

Matthew Simmons is the chief executive officer of Simmons & Co. International, which is a Houston-based investment bank that specializes in investment in oilfield service and related companies. Mr. Simmons is one of Houston’s most knowledgeable experts on the oil and gas industry, and in this Chronicle interview, challenges the conventional wisdom that the recent spike in oil and gas prices is temporary:

Q: What do the fundamentals [of oil production and consumption] look like? Are supply and demand out of whack?
A: The fundamentals, to me, look scarier than hell. Demand … is having the smell of a runaway train, downhill on a one-way track. The consensus forecast for 2004 fourth-quarter demand is 83.6 million barrels a day, an increase of over 2 million from where we are this summer. And if you look at the consensus for the fourth quarter of 2005, demand is 85.6 million barrels a day, another 2 million increase from the fourth quarter.
Q: What about supplies?
A: There are very few companies that are showing any ability to grow their global oil supplies by more than 1 or 2 percent a year. If you take all the announced projects of any significance, and if they all come on and peak in the first year, they account for ? at best ? 6 to 8 million a day of fresh supply by 2009. And we just talked about needing 4 of that over the next 14 months.
The missing piece of data in this tight equation is the rate of decline of the existing base. Over 70 percent of the current output is coming from fields that were discovered, at their most recent, 30 years ago. If the global decline rate is only 3 percent per annum, then we lose 11 million barrels by 2009 and add 6 to 8. I don’t see how we balance this market, unless we have a stunning depression.

And Mr. Simmons has always been skeptical about Saudi Arabia’s claims that it owns a quarter of the world’s reserves and can simply increase production to meet rising world demand:

Q: Most analysts accept Saudi Arabia’s claims that it holds about a quarter of the world’s oil reserves. You have challenged the Saudis over their reserve estimates?
A: The grim fact about Saudi Arabia today is that, at the Saudis’ own admission, the Ghawar Field, the king of all kings, is still producing about 5 million of their 8 to 9 million barrels a day of oil. That’s all you need to know to be scared.

Here is a more extensive interview with Mr. Simmons. These are well-supported views of a formidable expert in the oil and gas industry. Take note.
Meanwhile, this Wall Street Journal ($) article reports that the prominent energy-stock analysts John S. Herold Inc. has issued a report contending that Exxon Mobil is overvalued when compared with a group of smaller energy companies that collectively mirrors the capitalization of the energy giant. The Herold report lumped the group of smaller energy companies into a single theoretical stock called “Synthetic Exxon Mobil,” or “SXOM.” Designed to resemble Exxon Mobil both in market capitalization and operational scope, SXOM includes six companies that, during the past three years, would have have generated a 31% return on investment. In comparison, an investment in Exxon Mobil would have yielded just 12%. The report tends to support the notion that the recent spike in energy prices is making the less-expensive stocks of more-aggressive energy companies look better than the more established giants.

This Wall Street Journal ($) article provides a timely overview of the economic and political forces that have caused the increased energy prices over the past two years and how this price hike differs from previous ones:

As oil prices near $50 a barrel, a fundamental difference between this oil crunch and prior ones is becoming clear: This one is less acute, but it may prove to be more chronic.
So far, the current oil-price surge still trails the big blows of the past. In inflation-adjusted dollars, oil peaked in 1981 at $73 a barrel, 55% above where it’s trading now. Back then, moreover, the oil crisis sparked a full-blown recession. Today, despite some signs of a slowing, the economy continues to grow — and, with it, oil demand.

However, it’s that knotty problem of growth that continues to push prices upward:

It’s precisely the steadily rising demand, however, that is worrying the market. Unlike in the 1970s, the problem this time isn’t primarily a supply shock in which the world’s biggest oil spigots have been shut off. It’s that, even though they’re wide open, the world is consuming pretty much everything that comes out of the ground. The resulting fear is that isolated supply disruptions — a change in government in Venezuela, say, or a terrorist attack in the Middle East — could push prices even higher.

And although U.S. energy prices remain relatively high, there are contrarians as to the current prices:

Still, [U.S.] commercial inventories of crude oil are 5% above last year’s level, and gasoline stocks are up 4.5%.
Some observers see the U.S. inventory levels as evidence that there’s plenty of oil to meet growing demand and that today’s oil price is largely the result of excessive speculation. Trading volume has soared in recent months as hedge funds and other fast-moving traders have headed into the oil markets. “I don’t think the fundamentals support prices anywhere close to this level,” says Kyle Cooper, an oil analyst at Citigroup in Houston. He believes prices should be closer to $30.

But futures markets are still betting on continued high prices:

The market isn’t betting on a quick fix. In a big change from past experience, this time it isn’t just the price of today’s oil that’s surging. Futures contracts through May 2006 delivery are above $40. The contracted price of oil to be delivered six years down the road is also rising. After years in which they hovered between $20 and $25, these so-called six-year futures now are trading around $35.

And although the market takes time to adjust to higher energy prices, it does eventually work, as reflected in its reaction to the energy price hike of the 1970’s:

Improving energy efficiency takes a long time. But it can be done, says a longtime advocate, Amory Lovins, chief executive of the Colorado-based Rocky Mountain Institute. He says that between 1977 and 1985, real GDP in the U.S. grew by 27% while oil use fell by 17%.
By his calculation, if the U.S. kept reducing oil use at that pace, every year and a half the U.S. would decrease its daily oil consumption by some 2.5 million barrels, about the amount it currently imports from the Gulf. “It’s a measure of how much we did the last time we paid attention,” Mr. Lovins says.

Read the entire piece. Moreover, here is an NY Times article on speculation regarding similar increases in natural gas prices.
Also, for more analysis on how this energy price hike relative to past ones, review this earlier post on the work of James D. Hamilton, an economics professor from San Diego who specializes in analysis of energy markets.

This NY Times article reports that the recent uptick in oil and gas prices has not translated into an economic boom for the local Houston economy. The article does a reasonably good job of explaining that Houston’s economy is less dependent on the oil and gas industry that in prior eras, and thus less prone to the boom and bust cycles that resulted from past run-ups in energy prices. Accordingly, while Houston’s economy used to be largely countercyclical to the national economy (i.e., Houston would do well during times of high energy prices that would drive the national economy down), Houston’s more diversified economy now tends to be more in step with the national economy.
Curiously, the Times reporter neglected to interview the foremost authority on the Houston economy, Dr. Barton Smith, University of Houston professor of economics and director of the UH Institute for Regional Forecasting. Twice a year or so, Dr. Smith gives an oral presentation over lunch to Houston businesspeople regarding the state of the Houston economy and his predictions for the economy’s future. These meetings provide valuable nuts and bolts information and analysis regarding Houston’s economy, and are extremely popular among Houston businesspeople. Not mentioned in the Times article is that Dr. Smith’s model of the Houston economy currently predicts an annualized rate of job growth of 2.6 % that, if sustained for the next six months, would translate into about 50,000 jobs. That would be the best job growth rate in Houston since 2000.

In what can only be described as bizarre governmental intervention, this Wall Street Journal ($) article describes a politically-motivated Federal Trade Commission investigation that has been launched into the planned closing of an unprofitable Royal Dutch/Shell Group refinery in California and the FTC’s reinstatement of an antitrust complaint against Unocal Corp.
Shell announced plans last year to close its Bakersfield, California refinery Oct. 1 because a nearby oil field will run out of crude in coming decades and because the refinery is too expensive to repair and profitably operate. Given that relatively few refineries in the United States produce the type of environmentally-favored gasoline that California requires, the closure will likely crimp gasoline supply further in the West, where supplies are already tight and prices the highest in the nation. The small refinery handles 70,000 barrels of oil a day, providing 20,000 barrels of gasoline that amounts to 2 percent of California’s needs. It provides a larger percentage of diesel fuel, 15,000 barrels a day, which is the equivalent of 6 percent.
Shell lost more than $50 million over the past three years on the Bakersfield refinery and is facing between $30 million and $50 million in turnaround and environmental costs on the facility, which is old (the original portion of the facility was built in 1932).
So, let’s see here. Rather than encouraging companies to invest and build new refineries that would address the economic problem of tight supplies in the Western part of the United States, our federal government is taking expensive legal actions against one of the relatively few companies in the refining business to minimize its losses in the business. My sense is that forcing companies to operate refineries at a loss is not a sound policy for addressing the problem of tight gasoline supplies in the West.
Separately, the FTC overruled an administrative-law judge and reinstated an antitrust complaint against Unocal for pursuing patents for a special low-emissions gasoline at the same time that the company was helping California regulators mandate that gasoline as a state standard. The complaint originally was filed in March 2003, but was overruled by the judge in November.

Blogging time is restricted for a couple of days, but Arnold Kling’s TCS piece on the Strategic Petroleum Reserve is quite good, as is his blog’s follow up piece. Arnold sums up his theory regarding the SPR as follows:

It should be the responsibility of the private sector, not the government, to obtain insurance against oil market disruptions. The SPR has introduced government into the oil market as a destabilizing speculator.

Arnold also provides an excellent explanation of the concept of backwardation in regard to the price of oil.