04-06-05

As an institution, the US Federal Reserve exerts its greatest influence in the very short term by adjusting overnight interest rates. But the Federal Reserve chairman is expected to think big -- that is long-term -- thoughts, and Alan Greenspan complied by delivering his second major speech on oil in the last six months. His message: Despite the recent turbulence, the energy markets will sort themselves out.

"Markets for oil and natural gas have been subject to a degree of strain over the past year not experienced for a generation," Greenspan told the National Petrochemical and Refiners Association Conference in San Antonio. "Increased demand and lagging additions to productive capacity have combined to absorb a significant amount of the slack in energy markets that was essential in containing energy prices between 1985 and 2000."

Since then, oil prices have risen markedly, especially in the last year. In reaction to the doubling of oil prices, consumption in the US has not decreased, Greenspan said. But the rate of increase has stalled.
In the natural gas market, Greenspan said, there has been "significant gains in gas efficiency among a number of gas users such as petroleum refineries, steel mills and paper and board mills," leading to an actual decline in natural gas usage since 1998.

In general, the US did markedly reduce its energy intensity -- the amount of fuel used per $ of economic output--following the oil crisis of the late 1970s. But with the low oil and energy prices of the 1990s, improvements in conservation have declined. In recent years, America's energy bill relative to gross domestic product has dipped. Lately though, America's oil bill has risen rapidly.

Unlike in the 1970s and early 1980s, most of the money spent for oil is sent overseas. Thus, higher oil prices act as a tax on US consumers, Greenspan has said.

"The longer-term outlook for oil and gas is, if anything, more conjectural," Greenspan said. But he noted several possibilities for conservation.

"The more than 200 mm light vehicles on US highways, which consume 11% of total world oil production, [may] become more fuel efficient as vehicle buyers choose the lower fuel costs of lighter or hybrid vehicles," the chairman allowed.

In recent years, world oil reserves have increased, even beyond the amount consumed, Greenspan said. That's the good news.

The bad news is that "investment to convert reserves to productive capacity has fallen short of the levels required to match unexpected recent gains in demand, especially gains in China." Also, "The status of world refining capacity has become worrisome as well."

The recent energy price increases have been reflected in the stock market, but only partially. Oil and gas stocks like ExxonMobil, ConocoPhillips and recent takeover target Unocal are up between 40% and 60% in the past year.

But energy exploration companies, like Transocean, Diamond Offshore Drilling and Noble have seen their shares rise by 66% on average, though those averages have been supercharged by small companies whose shares have tripled or quadrupled in some cases.

Over the very long term, Greenspan was more less certain what would happen, but more certain that whatever happened would work well. The economy of the US and the world could change its fuel mix, using more of what will be discovered later.

"The experience of the past fifty years -- and indeed much longer than that -- affirms that market forces play the key role in conserving scarce energy resources, directing those resources to their most highly valued uses," Greenspan concluded.

For Greenspan, the big difference between now and six months ago seems to be that the price for oil futures has solidified at higher levels as the world has gotten used to higher current prices. This is a problem now, but one that will lead to its own solution.

Sustained higher price will "stimulate the research and development that will unlock new approaches to energy production and use that we can now only scarcely envision," Greenspan said.

Source: Forbes