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Rising oil prices

How high are they going and what are the options?


May 13, 2005
Copyright © 2005 CARIBBEAN BUSINESS. All Rights Reserved.

Record crude-oil prices impact Puerto Rico’s economy

Every $10 increase per barrel of oil costs local economy an estimated $750 million

Record-high crude-oil prices and forecasts of further increases in the near future have sparked yet another wave of concern regarding the resource’s volatility, which is having a profound impact on Puerto Rico’s economy.

In the past two years, the price per barrel of crude oil has more than doubled, increasing from $28 in 2003 to $57 in the first quarter of 2005. Prices are projected to remain high throughout 2005 with Goldman Sachs predicting in March that oil markets have entered a "super-spike" period that could drive the price to $105 a barrel. Such a rise in crude-oil prices will have a major impact on the global economy, raising the prices of goods and services, affecting consumers’ buying power, and generating economic problems worldwide.

Examining today’s oil prices, it is easy to see little has change over the past 30 years since the world endured a major oil crisis in the early 1970s. The Middle East region is in turmoil, the Organization of Petroleum Exporting Countries (OPEC) has sprung back to life, and Middle Eastern countries still control about two-thirds of the world’s oil supply. Increasing demands for energy, particularly from developing huge-population countries such as China and India, as well as higher oil-extraction costs in the Middle East, have caused the price of oil to hit new highs.

In October 1973, OPEC, which was founded in Iraq in 1960 to promote the interests of oil-producing countries, voted to cut off oil supplies to the U.S. in retribution for its support of Israel in the Arab-Israeli War. The oil embargo created economic havoc during the 1970s and early 1980s, pushing gas prices up, generating high inflation, and contributing to slow growth and even recession in developed economies. OPEC’s oil embargo also became the symbol of economic troubles in the West. The oil cartel was practically dismantled in the late 1980s with lower oil prices remaining for most of the decade.

Today, President George W. Bush’s words seem to echo those of President Jimmy Carter in 1977. "It is becoming very clear to the country that demand is outstripping supply," Bush said recently. In 1977, Carter stated, "The diagnosis of the U.S. energy crisis is quite simple. Demand for energy is increasing while supplies of oil and natural gas are diminishing."

Impact on Puerto Rico

Higher crude-oil prices are having a major impact on Puerto Rico’s economy and contributing to limited growth. A Banco Bilbao Vizcaya Argentaria (BBVA) report stated that each $10 increase per barrel of oil imported to Puerto Rico costs the local economy an estimated $750 million, which leaves the island and can’t be used for goods and services, knocking percentage points off the island’s economic growth. According to the American Enterprise Institute, a $10 per barrel increase also shaves a half percentage point off the global gross domestic product (GDP).

"It is important to point out that in Puerto Rico’s recent history, periods of high oil prices, such as now, always have led to a recession or slow economic growth," the BBVA report states. "There is no doubt that if oil prices stay above $40 per barrel, the recovery of Puerto Rico’s economy will weaken and economic growth in fiscal 2005 will be below the 3% that had been forecast under more favorable conditions." The island is particularly vulnerable to oil shocks because of the Puerto Rico Electric Power Authority’s 70% dependence on oil for electricity.

Prof. José Auger of the Puerto Rico Planning Board’s Program for Economic & Social Planning said that for each 10% increase in petroleum prices, the GDP loses 0.14 percentage points; each 10% increase in oil prices is reflected in a 0.28% decrease in consumption.

Auger believes at current levels the effect hasn’t been so great on the economy over all. "The question is what is going to happen in a year if the price continues to rise," he said. Auger added that political developments in the Middle East, elections in Iraq, and Syria’s exit from Lebanon are developments that could bring stability to the region and help bring lower crude-oil prices.

Record gasoline prices almost certainly will affect local driving habits and change lifestyles by cutting into budgets and spending. Gas prices stateside already have forced more commuters onto public transportation and made some opt to put away gas-guzzling cars in favor of bicycle travel.

Stateside trucking companies also are reporting growing difficulties meeting fuel costs. Locally, Truckers Transport Cooperative President Rafael Hernández said the rising prices have cost the 130-truck cooperative about $1 million in the past year. "A typical contract is for three years, and no one thought the price of crude would rise to above $50 a barrel," Hernández said.

What is behind the recent spike in crude-oil prices?

Analysts place most of the onus for the sharp increase on booming demand from China and India. China, where car sales are increasing 20% per year, saw demand grow in 2004 by 5.8 million barrels a day to 20 million barrels a day, placing it second in consumption behind the U.S. Furthermore, Asia’s demand in 2004 accounted for 3.3% of the rise in world demand.

The surging demand has prompted increased pressure on oil producers to increase production and has given proponents of drilling in the Arctic National Wildlife Refuge another argument to begin drilling there, a measure recently passed in Congress. On March 16, OPEC also announced it would increase its production quota by 500,000 barrels per day and was prepared to approve an additional 500,000-barrel-per-day quota increase should oil prices remain at current levels.

Another factor is the political volatility in oil-producing regions. Virtually everywhere oil is produced outside the U.S. is roiled by political turmoil. Violent unrest in the oil-rich Middle East demands the world’s attention on a daily basis. Oil traders are wary of the possibility of the renationalization of the Russian oil sector with the dismemberment of Yukos, the country’s second-largest oil firm. The Yukos affair, which saw its chief executive officer, a political rival of Russian President Vladimir Putin, imprisoned, has cast a shadow on the once high hopes for the development of Russia’s untapped reserves. Yukos had been the main source of supply growth in recent years, but that growth is expected to slow meaningfully, according to Goldman Sachs. Rebellion in Nigeria also has stymied the country’s efforts to develop its oil sector, and political battles in Venezuela have cut output there.

Market analysts say swings in prices are a common phenomenon in commodities markets. The market will respond to the increase in prices by spurring more exploration, they say. Other analysts say the dimensions of the demands from countries like China and India soon will make cheap oil a fading memory.

Yet, other analysts make a more dire prediction–that the world may be reaching the point of peak oil production, when the world begins to "run out of oil" as production capacity starts an inexorable decline. Although scientists have made such predictions on the fringes of the mainstream for more than a generation, the prospect of peak oil production is gaining more attention with the skyrocketing demand.

Still, the peak-oil scenario continues to be one not widely held, according to U.S. News & World Report. The publication also reported market observers generally agree the world’s so-called "spare capacity," reserves that could quickly be tapped to meet demand in response to rising prices, has disappeared.

Goldman Sachs reports that upward revisions of U.S. GDP have "reduced the fear that $40 to $50 per barrel of oil is hurting the U.S. economy." However, a sharp slowdown in China or other emerging Asian economies has the potential of placing a drag on the global economy.

Long-term changes required

The current situation brings back memories of oil-price spikes in 1973, 1978, and 1990, all of which threw the U.S. economy into a recession. On each of those occasions, calls for energy conservation and increased use of alternative energy sources emerged, only to fade away with the stabilization of oil prices. This time around, indications are that more long-lasting efforts to conserve oil and turn to alternative sources are being taken seriously.

Hybrid cars that use both gasoline and electricity are becoming increasingly popular and their widespread use could bring oil demand and prices down, analysts say. The Bush administration allocated $1.7 billion to research and development of fuel-cell technology. In California, which has an array of tax incentives and rebates to promote alternative energy, Gov. Arnold Schwarzenegger recently signed an executive order to build 150 to 200 hydrogen-fuel stations on the state’s freeway system at a cost of $90 million that will be paid by energy companies, automakers, and high-tech industries.

Goldman Sachs indicates the current crude-oil environment "looks more like the 1970s than it does the 1980s or 1990s." During the 1970s, the world experienced an extended period of very high oil prices, stagflation, the fall of the Shah of Iran, the Iranian hostage crisis, the fear the world was running out of oil, two major oil embargoes, and a deep global recession, states the Goldman Sachs report. However, the report also indicated Goldman Sachs doesn’t believe the world is "running out of oil." The report states that in contrast to the 1970s, industrial oil consumption is a much smaller piece of the oil demand in the U.S. In Goldman Sachs’ view, rising oil demand from China and India perhaps is equivalent to the industrial consumption that used to occur in the U.S. in the 1970s.

Island looks for energy alternatives

Puerto Rico’s dependence on oil for its electrical power requires the Commonwealth to seek energy alternatives. Puerto Rico Electric Power Authority (Prepa) Executive Director Héctor M. Alejandro said he foresees approval by Prepa of alternative energy projects to contribute electrical energy to Puerto Rico’s power grid. "In the near future, there will be an alternative energy project," he said.

Prepa’s charter, says Alejandro, limits the power company to providing energy at the lowest possible price. Alternative forms of energy are currently too costly to compete with Prepa’s oil-fired plants, but the power company is moving to diversify fuel sources. In recent years, Prepa has reduced its reliance on oil from 98% to just below 70% with the addition of the 540-megawatt EcoEléctrica natural gas plant and the 454-megawatt coal-fired AES plant.

The authority is also planning a 464-megawatt, dual-fired, gas-oil generator at Prepa’s San Juan plant to go online in 2007 at a cost of $377 million and a $415 million, 507-megawatt dual-fired, gas-oil plant in Mayagüez in 2009. A $125 million gas pipeline will serve the two plants, either coming from the EcoEléctrica gas port in Guayanilla or from a gas port to be built in Mayagüez. By 2012, Prepa hopes to have a balance of one-third oil, one-third gas, and one-third coal to produce electricity.

Alejandro said it currently isn’t possible to predict what level petroleum prices have to reach before alternative sources of energy become economically viable. He said planning at the agency is a long-term proposition that has to take into account a number of technical and economic factors. Oil prices, he said, have their ups and downs.

"Even two years [with oil prices remaining high] is too short a time for planning purposes," he said. However, advances in technology in solar and wind power are rapidly bringing alternative technology into range to be competitive with oil and gas, Alejandro added.

Prepa currently is examining a proposal for a wind farm in Guayanilla. Under the Public Utility Regulatory Policies Act of 1978, Prepa must purchase energy from any private company that can provide the power at the so-called "avoided cost," which the utility currently estimates to be six cents per kilowatt-hour.

Edison Avilés, spokesperson for the Puerto Rico College of Engineers, agrees so-called "green" sources of energy are currently too expensive to compete with other sources on the island. Nonetheless, he said that will change by 2010 when advances in technology bring down the prices of solar and wind power.

One of the factors in lowering the price of solar and wind are laws in several states, which allow environmentally conscious consumers to choose to buy electricity from solar and wind providers although the price of the power may be higher than provided by local power companies. The practice is bringing badly needed capital to solar- and wind-generating companies, which is being invested in research and development that in a few years will lead to better technology and lower prices, Avilés explained.

"Such a practice in Puerto Rico would be illegal under Prepa’s charter, which acts as a straitjacket since it requires the authority to provide electricity to the public at the lowest possible price," said Avilés. One alternative would be for the government, through legislation, to subsidize a pilot project to put Puerto Rico on the road to alternative energy supply by the time the "green power" becomes competitive.

Another promising technology that seems ideal for Puerto Rico is ocean thermal technology (OTEC). The technology operates by using ocean water, which has a temperature of 80 degrees Fahrenheit, to boil propylene, which boils at 68 degrees Fahrenheit. One of the byproducts of the process is potable water.

Baltimore-based Solar Sea Power International has expressed an interest in building a 100-megawatt ocean-going OTEC plant in waters off the coast of Puerto Rico, according to Solar Sea Power International President Robert Nicholson. Nicholson said the technology is sound enough to attract investors willing to pay for the $250 million plant. "There is absolutely no risk to Prepa," he said. "All it takes is for Prepa to buy power at avoided cost." Nicholson said he has attempted without success to interest the power company in the project.

Puerto Rico must learn to conserve energy

Another important element in the mix of attacking high oil prices is conservation. As a major U.S. mainland business publication reported recently, "Even the White House, which once dismissed conservation as little more than ‘a sign of personal virtue,’ is getting in on the act. In a mid-March speech, President George W. Bush said America needed a strategy that ‘must promote conservation’ as well as diversifying and updating the country’s energy sources." Prepa spokeswoman Virginia Gómez said the authority’s conservation efforts so far have been restricted to pamphlets available to clients at Prepa’s sales offices.

Puerto Ricans actually are becoming less energy-efficient, according to a study conducted by Dr. Albith Colón of Energtech Inc. consulting service and director of the Association of Energy Engineers.

Energy use per person began to increase as energy prices declined in the late-1980s and 1990s. Per capita energy use is projected to increase in the future, and the projected demand for energy services in 2025 is markedly higher than in 2002, states the Energtech study. The average home in 2025 is expected to be 6% larger (1,788 square feet in 2025 vs. 1,689 square feet in 2002) and to use electricity more intensively.

Residential energy use is projected to increase by 25% between 2002 and 2025 (10% by 2010), according to Energtech. On the other hand, commercial energy use, including electricity-related losses, is projected to grow by an average of 1.7% per year between 2002 and 2025. Energy consumption per square foot in commercial use is projected to show little increase, with efficiency standards, voluntary government programs aimed at improving efficiency, and other technology improvements expected to balance the effects of a projected increase in demand for electricity-based services and generally stable or declining fuel prices," Energtech reported.

Energtech suggests a series of measures to advance energy savings and efficient energy use, including educating residents about the Commonwealth’s energy savings policy; implementing energy saving programs; promoting and diversifying the use of renewable and nonrenewable power plants; providing incentives to the private sector; and offering economic alternatives with electrical generation at the micro and macro levels. The Commonwealth also must promote a philosophy to implement high-visibility public energy projects and energy saving through massive advertising and renewable and nonrenewable energy sources.

Colón said the Association of Energy Engineers presented its study to the island’s two main political parties before the November 2004 elections, but saw nothing materialize from its pitch for creating renewable energy sources. "We expected to see something, but there wasn’t anything," Colón said.

Edgar Bigas, executive director of the Puerto Rico Chamber of Commerce, said the price increases haven’t yet prompted complaints from the chamber’s membership. "Most private-sector budgets allow for these kinds of increases," he said. Bigas said the factors keeping prices up could be temporary. Warmer weather combined with an increase in oil production by OPEC could bring the prices down. However, Prepa’s price adjustments are irritating, he said. "We are really bothered every time the oil-adjustment factor brings prices up," he said.

Meanwhile, Puerto Rico residents are dealing with the high cost of gasoline, which has increased 35 cents a gallon in recent weeks. Gasoline Retailers Association President Efraín Reyes accused gasoline wholesalers of predatory practices, raising the price of gasoline in accordance with the rise of a Gulf Coast reference price, the price established by markets on the U.S. Gulf Coast, when in fact they bought the gasoline at a lower price.

"Wholesalers buy a tanker of gasoline at one price, but, when the reference price goes up, they raise the price to retailers although they purchased it at a lower price," said Reyes. "However, if the situation is reversed and the reference price goes down, they don’t lower their price."

Alejandro García Padilla, secretary of the Consumer Affairs Department, said a lag of eight to 15 days in response to changes in the Gulf Coast reference price is to be expected because gasoline wholesalers maintain gasoline reserves that should be distributed at the reference price used to buy the product. García Padilla said his department has found no evidence to back Reyes’ allegation. "We haven’t been able to sustain these allegations," García Padilla said. "We are studying the situation, but since I have been secretary, the price of gasoline has only gone up."

Texaco of Puerto Rico Manager Tom Stepp said the pricing of gasoline locally isn’t as simple as Reyes of the Gasoline Retailers Association portrays, declining to comment on how Texaco arrives at its pricing. "That isn’t how we make our decisions," said Stepp "We have to follow the streets based on what the competition is doing."

The Goldman Sachs report said gasoline prices may need to exceed $4 per gallon before U.S. consumers stop buying sport utility vehicles (SUVs). Bayamón Ford fleet manager Raúl Estevez said he couldn’t predict at what point Puerto Ricans will make a similar choice, but said the dealership so far has seen no major decline in consumers’ preference for SUVs. He said development of fuel-injection systems have made cars more fuel-efficient relative to the oil shocks of the 1970s when cars operated with carburetors. Last year, over 61,000 SUVs were sold in Puerto Rico, which includes light trucks, pickups, and minivans.

Car of the future: Hybrid or hydrogen?

Carmakers are betting the trend away from gasoline will continue

Despite the high price of gasoline, residents of Puerto Rico have been somewhat slow to jump on the bandwagon of buying hybrid, gasoline/electricity-driven automobiles.

"People still lack a little knowledge about the new technology," said Saskia Gómez, Toyota public relations official. "We are trying hard to acquaint the public about the advantages of the car."

Last year, Toyota sold only 477 units of its Prius hybrid car, running ahead of only the Avalon midsize sedan, which sold only 97 units, most likely because a completely redesigned Avalon came out this year and buyers were waiting for the newer model, said Gómez. Prius sales are running only slightly brisker this year with 163 units sold between Jan. 1 and April 31, Gómez said.

The story is a bit different in the U.S. According to U.S. News & World Report, citing J.D. Power & Associates, hybrid sales this year will top 200,000 nationwide. With carmakers rushing to convert existing models into hybrid versions–Toyota’s Lexus division began selling the first luxury hybrid, the RX 400h sport utility vehicle–within 20 years, virtually all cars will be hybrids, predicted Jim Press, Toyota’s top U.S. executive.

So far, however, the appeal of the hybrid mostly has been emotional. Driving a hybrid gives the owner a sense of doing something about the environment, and extra dashboard gadgetry appeals to techies, but it doesn’t always translate into saving money. Even with the price of gasoline over $2 a gallon, few automobile owners hold on to their cars long enough to save the $3,000 to $4,000 the hybrid technology adds to the base price of a car. However, other savings do come from a $2,000 federal tax deduction, which President George W. Bush recently proposed raising to $4,000.

Nonetheless, even as the popularity of hybrids grows, some carmakers are looking to an even more advanced technology to power the "car of the future." General Motors, DaimlerChrysler, Toyota, and Honda have built hydrogen fuel-cell-powered prototypes. The fuel cell works like a battery, using the chemical reaction between hydrogen and oxygen to generate energy, with the only byproduct being water.

The Bush administration has allocated $1.7 billion to research and develop hydrogen power, including a fuel-cell vehicle called Freedom Car in conjunction with Ford, General Motors, and DaimlerChrysler. The Department of Energy’s Hydrogen Posture Plan predicts there will be a transition to a hydrogen economy beginning as early as 2010. According to the document, key milestones have been established for achieving a hydrogen economy. Skeptics, though, see too many barriers that have yet to be surmounted and view the milestones as too aggressive.

States are also making other preparations for an economy based on hydrogen. In California, which has an array of tax incentives and rebates to promote the development of alternative energy, Gov. Arnold Schwarzenegger recently signed an executive order to establish a public-private partnership to build 150 to 200 hydrogen-fueling stations along the state’s 21 interstate freeways. Most of the initiative’s $90 million cost would be borne by energy companies, automakers, and high-tech firms. Most automobile manufacturers have developed fuel-cell prototypes, and DaimlerChrysler introduced a fuel-cell car into the German market last month after Europe’s first hydrogen-fuel service station opened for commercial operation in Berlin. Ford also is planning to release its first hydrogen-fuel-cell car by the end of this year.

This Caribbean Business article appears courtesy of Casiano Communications.
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