Bush high oil price policy: Ready for $262/barrel oil?

Ready for $262/barrel oil?

By Nelson Schwartz, FORTUNE senior writer
January 27, 2006: 4:40 PM EST



DAVOS, Switzerland (FORTUNE) - Be afraid. Be very afraid.

That's the message from two of the world's most successful investors on the
topic of high oil prices. One of them, Hermitage Capital's Bill Browder, has
outlined six scenarios that could take oil up to a downright terrifying $262
a barrel.







The other, billionaire investor George Soros, wouldn't make any specific
predictions about prices. But as a legendary commodities player, it's worth
paying heed to the words of the man who once took on the Bank of England --
and won. "I'm very worried about the supply-demand balance, which is very
tight," Soros says.

"U.S. power and influence has declined precipitously because of Iraq and the
war on terror and that creates an incentive for anyone who wants to make
trouble to go ahead and make it." As an example, Soros pointed to the regime
in Iran, which is heading towards a confrontation with the West over its
nuclear power program and doesn't show any signs of compromising. "Iran is
on a collision course and I have a difficulty seeing how such a collision
can be avoided," he says.

Another emboldened troublemaker is Russian president Vladimir Putin, Soros
said, citing Putin's recent decision to briefly shut the supply of natural
gas to Ukraine. The only bit of optimism Soros could offer was that the next
12 months would be most dangerous in terms of any price shocks, because
beginning in 2007 he predicts new oil supplies will come online.

Hermitage's Bill Browder doesn't yet have the stature of George Soros. But
his $4 billion Moscow-based Hermitage fund rose 81.5 percent last year and
is up a whopping 1780 percent since its inception a decade ago. A veteran of
Salomon Bros. and Boston Consulting Group, the 41-year old Browder has been
especially successful because of his contrarian take; for example, he
continued to invest in Russia when others fled following the Kremlin's
assault on Yukos.

Doomsdays 1 through 6
To come up with some likely scenarios in the event of an international
crisis, his team performed what's known as a regression analysis,
extrapolating the numbers from past oil shocks and then using them to
calculate what might happen when the supply from an oil-producing country
was cut off in six different situations. The fall of the House of Saud seems
the most far-fetched of the six possibilities, and it's the one that
generates that $262 a barrel.

More realistic -- and therefore more chilling -- would be the scenario where
Iran declares an oil embargo a la OPEC in 1973, which Browder thinks could
cause oil to double to $131 a barrel. Other outcomes include an embargo by
Venezuelan strongman Hugo Chavez ($111 a barrel), civil war in Nigeria ($98
a barrel), unrest and violence in Algeria ($79 a barrel) and major attacks
on infrastructure by the insurgency in Iraq ($88 a barrel).

Regressions analysis may be mathematical but it's an art, not a science. And
some of these scenarios are quite dubious, like Venezuela shutting the
spigot. (For more on Chavez and Venezuela, click here.)

Energy chiefs at the World Economic Forum in Davos downplayed the likelihood
of a serious oil shortage. In a statement Friday, Shell's CEO Jeroen Van der
Veer declared, "There is no reason for pessimism." OPEC Acting Secretary
General Mohammed Barkindo said "OPEC will step in at any time there is a
shortage in the market." But then no one in the industry, including Van der
Veer, foresaw an extended run of $65 oil -- or even $55 oil -- like we've
been having.

It's clear that there is very, very little wiggle room, and that most
consumers, including those in the United States, have acceded so far to the
new reality of $60 or even $70 oil. And as Soros points out, the White House
has its hands full in Iraq and elsewhere.

Although there are long-term answers like ethanol, what's needed is a crash
conservation effort in the United States. This doesn't have to be
command-and-control style. Moral suasion counts for a lot, and if the
president suggested staying home with family every other Sunday or otherwise
cutting back on unnecessary drives, he could please the family values crowd
while also changing the psychology of the oil market by showing that the
U.S. government is serious about easing any potential bottlenecks.

Similarly, he could finally get the government to tighten fuel-efficiency
standards and encourage both Detroit and drivers to end decades of steadily
increasing gas consumption. These kinds of steps would create a little
headroom until new supplies do become available or threats like Iran's
current leadership or the Iraqi insurgency fade.

It's been done it before. For all the cracks about Jimmy Carter in a
cardigan and his malaise speech, America did reduce its use of oil following
the price shocks of the 1970s, and laid the groundwork for low energy prices
in the 1980s and 1990s. But it would require spending political capital, and
offending traditional White House allies, and that's something this
president doesn't seem to want to do.


.

Relevant Pages