Current Trends in the Oil and Energy Markets

2:00 P.M. EDT

MODERATOR: Good afternoon, and welcome to the New York Foreign Press Center. We're pleased today to welcome back Michael Rothman, who is the Senior Energy Market Specialist for the Global Securities Research and Economics Department at Merrill Lynch. I would remind everyone to please silence your cell phone, and, before asking your questions, to wait for your microphone and to identify yourself and your news organization.

Michael.

MR. ROTHMAN: Can I take this home as a souvenir? Because it's -- (laughter) -- that's pretty cool.

Good afternoon, everyone. This is not a prepared lecture. The last time I spoke to the group, and there was about 15 people, we tried to set it up as a giant Q&A -- just question and answer period. Some basic points that we made a couple years ago were about what was happening in the oil markets. Most of the interest, I would assume, in this room, has to do with the fact that oil printed at near $50 last week -- not because the Republican National Convention's going to start in a week.

So let me give you a couple of basic background points -- some of the things that we see happening in the markets, what you're all facing; and when you're looking at this, and most of you are probably not really focusing or specialists in oil, so that -- this is meant to be kind of in layman's terms. Believe me, nothing I'm saying is going to be that interesting, but okay. Anybody else want to throw a metal box up here? Are these -- are we all good? Okay.

The point, I would say, to start with, when you look at why and how could oil prices have possibly gotten up $15 in six weeks and why are they at $50 a barrel, why are we making these historic highs, you have to turn back the clock, I would say, not quite, but about 19 months ago, going into Gulf War II.

One of the things in my business, people who are forecasting what's going to happen in the oil markets and what's going to happen with prices, OPEC or action in consuming country governments was this prevalent view that a war with Iraq seemed like it would be very likely, and that crude prices after this took place would crash, crash in the context of falling back to $20 or below, just like 1991. And that was the context that everybody was looking at the oil markets in about the beginning of 2003. The view we had at that time, and the one I shared at this briefing when I came last, was that the oil markets were not at all like 1991, that after the war, assuming there would be no widespread devastation, prices would probably stay at around $30 a barrel. And this is a very counter-consensus call and, of course, the people who attended the briefing in this room asked, where's that coming from and why is it $30 and not much, much lower?

Part of the reason is that when you look at events back in '90 and what was happening after Iraq invaded Kuwait, there was about seven million barrels a day of spare oil production capacity in the OPEC countries. And you don't have to be oil people or supply/demand specialists to know that that's a very large volume of barrels that are available on an incremental basis.

If you take the picture from this side, I only have one chin. I think I get two chins from from my left, but I'll turn this way more so it's not as obvious. (Laughter.)

The other thing is, if you look at what was going on back in 1990, inventories were glutted. And I don't know that there's a big dossier about me, it's not a very sexy background, but I've been going to OPEC meetings for the last 18 years, and the last four have been very, very different than the previous 14. If you go back to 1990 and you say, what was the environment like then, OPEC used to oversupply the market because there was a very big divide about how best to administer the market. You typically had Iran and Saudi Arabia as the two boxers in the ring, and they had very different views about how the group should operate, how they should try to administer prices.

But the tendency was one of oversupply. And back in 1990, when Iraq invaded Kuwait, inventories were glutted. You were about 125 million barrels above normal in the OECD countries. That number is not going to mean a lot to you, so you just have to take it for granted that that's a very high margin of storage. I would say it's a glut; some people call it a storage overhang. It's a lot of oil.

The other thing to keep in context is with that storage overhang, and seven million barrels a day spare capacity, once the uncertainties about a war passed; you would expect prices to gravitate towards their medium. And around 1990, really from '86 through, I would say, '96, oil was a $20 commodity. That was the midpoint of a price that OPEC tried to administer, so no issue of prices retreating.

When we go back 18 months ago, or 19 months ago, and look at the pending developments in the Middle East, you had inventories running at an enormous deficit. Storage was about 130 million barrels below normal. Revised data later showed that the deficit was almost 200 million barrels below normal, so there was a huge, huge amount of pressure on available supply simply because you didn't have the storage to tap into, at least on the commercial level. And the other thing is that when you looked at spare capacity in OPEC, there was only about two million barrels a day of oil that would be available.

Now, at the time when I spoke here, I believe Venezuela was still in the throes of dealing with the general strike. They had ultimately lost about half of the production from one of their big fields, Maracaibo. About 15 percent of their output effectively has gone away, and you realized that structurally, there was going to be a lot of pressure on oil supply for the foreseeable future. That is the environment that we've been living in, I would say, since the beginning of year 2003.

So now you fast-forward that and you say, okay, structural tightness: Iraq has been somewhat sloppy in terms of the postwar situation. There were a lot of forecasts -- not from us -- but there were a lot of forecasts that you would see a huge amount of production come out of Iraq in a postwar environment. There was a belief and reports published, actually, by a number of Wall Street firms that Iraq would be producing five million barrels a day by now -- more than double what they're currently near producing -- and, of course, a larger production number than they've ever been able to generate.

And the idea was that in a postwar environment the oil fields in the south would be developed, and if you look at the published reserve estimates, somehow, mathematically, we should be able to get this huge increase in production. The oil markets would be glutted and, hence, you know, part of the quote was oil would crash for that reason, too.

Well, last May, which is about the time that I was here, one of the things that we talked about was the fact that the insurgency in Iraq was much, much worse than anybody had expected; that their ability to exploit production, move oil out of the country, was going to be hampered; one of the main pipes in the north that had been operational was knocked out of commission, the 42-inch line through Ceyhan; a bridge, the Al Fatah Bridge, was destroyed in the war, all the pipelines in the base of the bridge got taken out with it. So their ability to move oil to Turkey, which had been a mainstay feature of their exports, was no longer available.

In June -- actually, I was in Saudi Arabia, I think, when it happened -- the pipe which they reopened got bombed. I think two weeks later the pumping station at Haditha was destroyed. The north-south line was sabotaged and they were only able to move oil out through the south. So exports were going to be sub-optimal.

And later on, in the last six months, this has become more of a focus in the oil markets. But the big issue, and the reason when you start looking about crude prices being at $50, again, these are the background factors, what's happened? What's generated this big spike in oil prices? Is this a new paradigm? Does OPEC want oil prices at $50 a barrel? Is this what the world's going to live with?

And the answer is, no, we don't see that as being the case. What we're seeing, or at least what we think we're seeing, is an analogue available only if you go back to the '70s -- really, '73, when you had the Arab oil embargo, and '77-'78, when Iran was going through tremendous political turmoil, which ultimately resulted in a shutdown of their production. Their oil output collapsed in November of 1978 -- so from about 5.5, 5.8 million a day to zero.

And during those periods, one of the things that we observe, which was coming from very, very sketchy, and I would even say problematic supply/demand data, was hoarding. People were afraid that we were going to run out of oil. And I don't know how many of you spend time in the northeast during the winter, but this is where I grew up, have a house full of children. When they talk about a big snow storm coming, I know my own wife runs out and buys a lot of milk and staples and other supplies because you're afraid you're going to get snowed into your house, and that milk run creates its own shortage.
People think there is going to be a [short] supply. They go out and they start trying to accumulate this oil, and effectively, what it does is put pressure on available goods -- in this case, available oil.

Two of the countries that continue to come up as being large buyers of oil for precautionary reasons are India and China. And I published a note this morning, in fact, detailing some of the information about China and their demand numbers, or what's considered to be demand, which I'll explain to you, because it's a little bit technical, is running about double the expected growth rate and double the trend that we've seen in the last few years.

That increase in demand is not, to me, really demand. And when we talk about it, you have to make a distinction between oil that you're actually combusting -- if you look at how oil is used, it's either burned in some sort of an engine or it's turned into plastic. That's what happens to oil.

So if you look at the demand side of the equation, it picks up consumption, but it also picks up changes in inventories; and the problem we have is once you get outside of the OECD group of nations, there is no data available on storage levels. There is no reason to supply that data because they're not part of any member organization. The OECD was formed back in 1974. And again, this is long, long dated stuff, but the OECD was essentially created as a counterweight to OPEC after the embargo.

So you have these nations sharing supply and demand information, but countries outside of the OECD don't supply that information and supply/demand data becomes very problematic. So we have a couple of pieces of data to look at that appear pretty significant. One, which we published a couple of weeks ago, actually two Thursdays ago, was about India. It's a very rare data point. To me, it's a one-off data point, but refiners there appear to have bought about 25 million barrels of crude for purely precautionary reasons in June.

India we don't think of as a smokestack economy. It's not as industrious when you look at its base for economic activity as China or Korea. But this volume of oil, not quite, but almost a million barrels a day for precautionary reasons, for lack of any other word, is a type of hoarding.

China appears to be doing the same thing as well, and the volume is fairly significant. And it's created a vicious cycle of sorts where people are producing oil in OPEC almost at full tilt. If we were sitting around six months ago and talked about what would happen to the price of oil if OPEC was producing almost 30 million barrels a day, even if you didn't know that much about the oil markets, you would have said it's going to be way, way lower. And people who know about the oil markets would have thought it would crash. Because any model of supply and demand no way saw that kind of demand for that crude, just way below it, almost three million barrels a day below it.

So where is oil disappearing into? It appears to be a hoarding phenomenon and we think it has to run its course, almost like a flu, and when it does pass, prices should gravitate much lower, somewhere down towards $30 a barrel, but of course, we're nowhere near that. We're $15 north of that.

Most any type of modeling that you do for the price of oil, based on something fundamental, whether it's inventories or demand cover, even capacitization, all kick out numbers somewhere around 30. I know from talking with some people in the OPEC, the range could be as low as $22 a barrel to as high as 31, none of which is near, you know, where we were last week.

So those are kind of background pieces of information I'd like to give you. We have plenty of time, and I'd like to just make this a giant question and answer period until I have to leave, which is at three o'clock.

Yes, sir.

QUESTION: Hi there, Zeb Eckert from NHK.

What's the role of speculators in this very high oil price?

MR. ROTHMAN: The issue of speculators is often thought of as something dirty, you know, and speculators are somehow bad. But in the markets they're quite critical. In commodity markets, in particular, if you just had commercial entities trading to one another, the markets, in effect, wouldn't be doing their job. Oil companies, airlines, fabricators, what I would consider to be bona fide users of commodities, are usually participating in a market to somehow shed risk. Somebody has to be on the other side of that transaction, so speculators are actually very, very key part of markets functioning.

If you look at what's happened in oil, specifically in the last six months, one of the things that's received a lot of attention, certainly one of the things I have written about in my own research, was that large -- what's called large non-commercials, in this case, hedge funds in the oil market, built up a record high net long position in crude.

Typically, when we look at the data, which is available publicly -- it comes from the CFTC -- it comes out every Friday night, and it breaks out, essentially, the open interest positions or the net exposures in the different markets by large commercials, which again, think of those as oil companies, airlines -- large non-commercials, which we think of as hedge funds, and then a small trader category.

The critical number there is 300 contracts. If you're below that, you're considered a small trader, regardless of what your business is or your tie-in is.

But what we see is that the large non-commercials -- hedge funds -- built up a massive position. Normally large is 60 to 65 million barrels, net long or net short. In March, that number got to 136 million. It's currently about, I believe, we're 82 million right now, as of last Friday night's data.

Now, the interesting thing is that when you look at the most recent run-up in the price of crude, the rally that started, again, at 35 -- just in the last few weeks -- 35 to 46, really, 50, as the print goes last week -- you did not see a huge increase in the net long position of non-commercials.

So the thing about blaming speculators for the run-up is not something the data really supports. In fact, it looks like hedge funds are becoming much more nervous about pressing alongside of the market. Because, typically, oil price movements and their position in the market are highly correlated -- positively and highly correlated. So as oil prices are moving higher, you're usually seeing them build up a bigger and bigger net long position.

In this case, we saw oil prices move higher, and their long position didn't rise at a commensurate level. I can only attribute that to trepidation on their part. Certainly, prices are well above anything that's politically palatable to both the large importing countries and even the OPEC countries. So in one regard, you're fighting gravity. But if you have a more specific question, ask it. But that's --

QUESTION: No, that's -- I was a little curious, you know, to what extent they're playing into --

MR. ROTHMAN: The speculation right now seems to be more on the part of people buying physical oil and scrambling to buy that oil to stick it in storage. That's a different type of speculation. Unfortunately, there is no data that you can look at, weekly or monthly, to truly assess it. But it is a type of speculation. If you want to go back in history and find when has that occurred, it also happened in the '70s, twice. It happened with the Arab oil embargo, when there was a forced dislocation of crude to the U.S. and selected other countries, and then, again, '77-'78, when the turmoil in Iran ultimately manifested in their production being shut down.

Go with the first hand up.

QUESTION: Hi, my name is Sandro Pozzi. I work for the Spanish daily, El Pais.

Because of this thing of China and India, we can say that it's a bubble that can explode in any minute, and if they decide not to accumulate more oil, the bubble explodes.

MR. ROTHMAN: Okay. I work down at the World Financial Center. I was there on September 11th. I never like to hear the word "explode" used in a sentence being directed at me, so in terms of the idea of the bubble bursting, if you think of it as a speculative bubble, at some point, it does run its course. There is not an infinite volume of storage space for oil to be built up on any sort of precautionary basis.

It won't sit in tankers. The merge every day of large VLCC or ULCC is prohibitive. And the tanks, whether they truly exist or they've been exhausted, has a physical limit.

The issue for me is, right now, trying to make an assessment about when will that precautionary buying end, and what might help precipitate an easing of those pressures to build that oil up. One issue that's received a lot of debate is the use of strategic petroleum reserves. In the OECD countries as a whole, you have 1.43 billion barrels of crude and refined products sitting in 13 countries; half of it sits in the United States, the next two largest chunks sit in Japan and Germany, and then 10 other countries hold the rest of it, about 12-13 percent of the total.

The amount of crude oil, not even the refined products, but the amount of crude oil that can be released on a coordinated basis is around 9.6 million barrels a day, which is probably a little bit over Saudi Arabia's production right now.

It hasn't been discussed. The OECD has not talked about this security blanket in the event of something developing that creates a genuine shortage of oil, but the fact that it exists is probably the big difference between what we saw in the '70s, particularly '73 and '78-'79, if you look at those windows, because the OECD had just formed and precautionary stocks really did not exist through the shocks of both of those periods. So it's an under-discussed option. But in terms of your question about when the bubble bursts, you know, when it bursts, I would expect the buying pressure to dissipate, physical oil becomes more available, it frees up spare capacity in OPEC, you know, creates the same cycle, but downward.

The fellow with the red shirt.

QUESTION: I'm Lennart Pehrson. I'm with the Swedish newspaper Sydsvenska Dagbladet.

First, could you explain how or if the squeeze in the natural gas market, how that affects the situation? And secondly, could you give specific a forecast in prices for, say, Election Day a year from now?

MR. ROTHMAN: (Laughter.) The latter, I think, is a bit of a problem.

In terms of natural gas, what I'll tell you is the markets break down very, very differently when we talk about U.S. versus the foreign markets. And then, even if you talk about gas, where it just stays as methane or it gets liquefied and is being shipped dominantly to some markets like the Far East -- Japan specifically, or the U.S. In the U.S., natural gas has its own supply/demand balance. Outside the U.S., the price of natural gas tends to be a formula off a crude. It's a price on a BTU equivalency, so the only real market that seems to be seeing a bone fide squeeze on supply is in the U.S. And one of the things that's happened -- and I've only been following natural gas since '91, which is a fair, long -- fair amount of time anyway, but if you look at what's happened in the U.S. from '78, when the Gas Policy Act was created and all of the surplus deliverability that ensued, we had what was called "the bubble." I call it "the kielbasa." It was a bubble that was stretched out over 16 years. But there was a huge amount of surplus capacity available in the U.S. system. And the price of natural gas traded down, generally, somewhere about $1 to $1.30 per million BTUs, or what's called a decatherm.

When you look at what happened to that market through the '80s and the '90s, the supply and demand lines eventually converged and crossed. The U.S. became much more dependent on imports to meet growing demand, and you saw the surplus deliverability -- this excess capacity -- get eaten away.

However, if you look at prices from sort of 50,000 feet up, you'll see that look almost like a step-function through the '90s and even into the early part of the current decade. And what was happening is that, as pressure developed for supply, prices would rise; the responsive producers became more and more muted. And the reason is you started having problems actually producing gas to the point where natural gas production in the United States has actually declined. It's actually declined, even with an extremely high commodity price.

So the price of natural gas, at least in this country, doesn't have a whole lot to do with U.S. production economics anymore. The price of natural gas that we see has to do with two parameters. The supply response is not going to be domestically produced gas. It's going to be building a pipe out of Alaska, actually permitted during the Carter Administration -- that pipe can move about 5 billion cubic feet a day -- or to build facilities, terminals, ships, the infrastructure to move liquefied natural gas to the United States.

That number that you need as sort of a minimum price to get that supply response is somewhere around $4 per million BTUs. The consortium that wants to build a pipe from Alaska wants a guarantee. I think that number is $3.80 per decatherm. I have heard discussions that it was somewhat higher, but I know it was somewhere around $4. And the economics to build terminals and facilities and ships for LNG into this country is somewhere between $4 and $4.35 a decatherm, so 4 seems to be like a natural bottom.

The top end of the price range, if you think of gas as, you know, how it's going to trade, is somewhere $6.5 to $7 a decatherm. Why? Because at that price level you kill off about as much marginal or incremental demand as possible. Fertilizer output is the first thing that gets hit. You know, you will get fuel switching on the margin, where it exists by utilities; smeltering will be affected, but the idea is to choke off demand where you can so you effectively free up gas during the spring and summer to build and, you know, build up your storage.

In this country, when we have our winter, natural gas is drawn down fairly dramatically and you have to have storage gas to be able to meet that consumption. So the pressure on supply actually develops post-winter because now you're scrambling to make sure you're building up your storage by enough.

So that's a general answer to your question.

Yes, sir. You've got to wait for the microphone. Protocol.

QUESTION: Hi. My name is Torsten Riecke. I'm with Germany's business daily, Handelsblatt. I've got two questions.

First of all, given your analysis for the recent price increases on the oil market and putting so much emphasis on hoarding, what is your forecast for the next, let's say, half year? Do you expect those things are going to be temporary and we will see a downturn?

And the second question is, when you look at the 5-years futures, which has gone up very recently, and much higher over the average of the last 10 to 15 years, what do you make of this fact?

MR. ROTHMAN: Okay, two things. One is hording is something I would say is a transitory phenomenon. You don't have unlimited storage so it literally has to run its course. When it stops, it's probably something that everybody will become aware of because physical oil will back up or demand for loadings from OPEC countries will back up. But it has to run its course, and to predict it is like trying to predict the behavior of a panicked crowd. You just -- just get out of it. You know, let the crowd do what it's going to do.

But, assuming that it will moderate and that what we're seeing is going to be transitory, prices should fall back, and I think down to 30 or the low 30s is what we've talked about in our own research. The reason I say 30 or even above it is probably a little more difficult to explain because I've got to kind of take a step back and talk about OPEC and the price band and what they're trying to administer and, you know, what's been the supply response.

So, at the end of '99, as a firm, we initiated a view about a change in the paradigm. You know, what's the center of gravity for oil prices? For the mid '80s through, I would say, 2000, oil was viewed as a $20 commodity. It was the center point of a range that OPEC tried to administer. It was a price that was viewed as acceptable to producers and consumers.

And that notion of what the right price is started to change in '96 when Abdallah started to run Saudi Arabia, openly talked about the fact that prices were too low and related to budgetary pressures.

As things evolved, leaving out some of the specifics, the range that OPEC talked about equated to $24 to $30 for WTI, the crude that we price on American -- that's Nymex in this country. $30 as the top of range being viewed as too high means that, for whatever reason, when prices get to it, OPEC has to do something forceful to push the price down. So you expect a response, in this case, a supply response.

The issue in the last two years is that that price range has not generated any type of big increase in supply from the non-OPEC countries. Back in '99, when this whole idea of administering a higher oil price change, most investors looked at that whole situation as portending a collapse, and the idea was with a higher average commodity price, the oil companies, the non-OPEC producers would effectively blow their brains out and just produce all of this crude because different projects would somehow become economical.

Five years into it, that hasn't been the case. Most companies, as they've reported their operating statistics have missed their production targets. The growth in non-OPEC supply has averaged much, much lower than anybody had expected. And so for the OPEC countries, particularly going back to the start of the second Gulf War, realized that there was a capacity problem as well.

I remember sitting with the minister in Saudi Arabia talking about this, but things are very different now than they were 15 or 20 years ago, when I started doing this because the system just didn't have that much fat to deal with these locations. And I'm talking about production capacity and not emergency stocks in the OECD.

So the idea of what is the right price was something, to me, the market was going to put at 30. It was going to price itself at the top end of the range to encourage a supply response, perhaps, a demand response, but it would somehow discount this signal that we need more supply or anymore supply capacity.

That's where I expect prices to eventually gravitate back to -- that's our view. That's why we're not looking at these prices as a new paradigm, or we're going to be afforded a $50 market for the foreseeable future. This, to us, looks like a spite high, and the hoarding issue is fairly key to that because you have so much oil being produced by OPEC disappearing to the markets that you have to make a decision that it's actually being burned or consumed, actually consumed, or it's being built up in stockpiles, and we simply don't have that data. And that is a limitation of global supply/demand work.

You don't have data for the developing world. It doesn't exist. The best-case scenarios are three years after the fact. That's the best-case scenario for the non-OECD world. So, no, I don't see prices persisting at this level. The demand is not really demand. It seems to be hoarding, plus actual consumption, and when it does run its course, we're looking for prices to retrace fairly dramatically.

QUESTION: How about the future (inaudible)?

MR. ROTHMAN: Good question, the back-end of the curve. Part of what people will never quite get into and you're, you know, I assume, mostly generalists looking at a lot of different issues, but the back-end of the price curve in the future trades at a spread, normally to the very front of the curve.

Normally, if you follow futures over time, you'll see the front-end move a lot, and the back-end tends to move in a much more muted fashion. But if the front-end gets pulled up to a dramatically high level, the back-end gets pulled up as well. It just doesn't stay at a price, and, you know, have this occur. So 35, let's say, as the December '99 price, can be viewed by some as the market's implicit forecast for where our crude oil price will be at the end of 1999.

In our opinion, that's a misleading indicator because that back-end price is not an embedded forecast, it's a very thinly traded market that's being affected by spread trading, which is not something I think the foreign press corps wants to have a discussions about.

Ma'am.

QUESTION: Outi Toivanen-Visti from Business Weekly Finland.

Let's assume that is not a spite that this goes, like, longer time, and what is the critical timeline when the consumers and industry are going to relax at? For example, the automobile industry is going to create more oil efficiency engines and consumers are not using oil that much?

MR. ROTHMAN: Okay, basic healthy question. Oil prices go up, when do consumers respond, or when does it have some sort of deleterious impact on the economy?

Our own economist, Dave Rosenberg, and I actually published a joint report a couple of months ago. And it was, what if we're wrong and oil goes to 50? Because we were not looking for oil prices to go to 50, unless there was some sort of disastrous supply shock; and it did.

So, you know, that report had to come off the shelves because we were wrong and oil was up at 50. What does it mean? And they published an addendum to that, a day ago, basically reiterating the view that oil at 50, even if it stays for some period of time, doesn't look like it's going to have the damaging effects on the economy, like what we saw in the '70s, '73, '74 period, or sort of '79, '81 period, where rising oil prices seem to precede this recession or coincide with a global recession.

Economic output per barrel of oil consumed has more than doubled since the '70s, is a point of fact I discussed when I did the briefing, I think it was 15 months ago, and the world has learned to live with less oil. You have natural gas; nuclear, hydro, coal exploited more for power generation. It doesn't mean there is no effect. In a very basic sense, the price of oil goes up; it affects input prices. It does have a cost push concern associated with it, but the vulnerability of the economy to those changes in prices seems to be much, much less than what we saw going back 30 or 35 years.

Now, I do know that in his report, he specifically mentioned 60 as a price that could precipitate, I guess, a severe or a potentially significant negative economic effect. But all I'm doing is parroting what I remember reading. So that's the best I can answer the question.

Yes, ma'am.

QUESTION: Maria Teresa Cometto with Corriere Della Sera (Italy).

What do you think of the two candidates' programs about oil? And are there any signs of that?

MR. ROTHMAN: Your mike just broke.

QUESTION: (Laughter.) And if Kerry is elected, do you think it will affect in any way the oil market?

MR. ROTHMAN: There's two issues. Publicly, I'm not going to be able to address that, mainly because I have not written about it, and there are many, many rules about what we can say publicly if we haven't published a commensurate report. So what I will comment around is what they have said about dependence on the Middle East oil supply, and things like that. That I can talk about because I have written about it.

There is a geologic fact, which is inescapable, about where the bulk of incremental supply lies. Saudi Arabia, at the end of the day, is probably the key player when it comes to being able to increase supply oil, much less grow production. The Saudis only produce from 20 of the currently named 83 fields. They are the only producer in the world that can probably add about a million barrels a day of production capacity a year, and their minimum sustainable capacity is probably at least 22 to 24 million day versus, you know, 10-5/10-7 today.

Comments about somehow removing dependence on supplies from the Middle East, I think, are reflecting more hope than anything else. Aside from the concentration of oil in these countries, there is a related phenomenon about political risk, and the two, essentially, cannot be separated. So I'm not exactly sure what anybody's plan is going to be that somehow it doesn't include supply remaining available and flowing as freely as possible out of the Persian Gulf. I simply don't see it. Russia became a target of hope for supply post-September 11th. However, Russia's quantity, quality of structures is really not the equivalent of a Saudi Arabia. It's not even close.

So without breaking any rules, I think that's about as much I'm going to be able to say. Okay?

Yes, sir.

QUESTION: Hi, Frode Froyland, the Norwegian Business Daily.

You said that eventually the oil price will fall back to 30-something. For how long is that forecast? I mean --

MR. ROTHMAN: That's our long-dated price. In other words, that's what we see as the center of gravity. Just like if we were doing this 15 years ago and you talked about an average oil price, you know, how do we look at prices as the normal value, we would have said 20. We would tell you for the foreseeable future, it's somewhere around 30.

QUESTION: Are we heading there now? I mean are we in trouble --

MR. ROTHMAN: Well, we're $5 off the high, but we're $15 away from 30, so it's a little hard to, you know, to say, yeah, we're going to be there in a week. If I was that smart, I would coach and just play golf all the time, and obviously I'm not doing either of those. So we will simply have to continue to monitor it.

That's it? We shut down the room? I don't believe it.

Yes, sir.

QUESTION: (Inaudible), Jiji Press. Japanese Press Wire Services.

The gasoline prices in the United States stay greatly stable while crude prices oil seems kind of higher.

Could you explain that?

MR. ROTHMAN: Absolutely. If you look at the price of gasoline in the United States, there's four basic components. The largest component, which rarely changes, is tax. It's somewhere between 41 and 43 cents per gallon. You then have something called the marketing margin, which is literally between the refiners and the retail station. That's a pretty small component. It can be 3 to 4 percent of the price, but it doesn't move around a lot.

The next two biggest parts are the focus of the attention. One is crude oil. The price of crude oil represents about half of the price of gasoline. And most of the changes in crude oil prices account for most of the changes in gasoline prices as a general rule.

However, this other component -- and this is going to sound like, you know, a weird expression -- but it's called a crack spread and it refers to the price difference between gasoline and a crude oil. You look at it as the per barrel premium that gassing will command to crude.

So, if crude oil is $42 a barrel, just to make this easy, and gasoline is $44 per barrel, that spread is 2. That spread, the gas crack, in the last six weeks, has fallen by $10 per barrel. So while the average price of crude went up, it was more than offset by a decline in this crack spread.

So the question is: Why did the crack spread collapse, or why did the crack spread fall by about 50 percent? In a very general sense, you can look at that differential that premium gasoline commands to crude as reflecting gasoline supply/demand factors. While the price of oil may reflect global supply/demand factors, for gasoline it's, you know, literally motor fuel considerations.

And in the last six weeks, really the last seven weeks, inventories of gas in the United States actually built up contra-seasonally and went from being very, very low relative to normal to above normal. That rebuilding of inventories occurred for a couple of reasons. One is, imports flew in. The price spread between U.S. gasoline and the foreign markets became very, very wide in the spring. It takes time for refiners to try to make U.S.-spec gasoline, but eventually it's like an arbitrage. It's a huge price differential between the markets and ultimately it acts to attract gasoline supplies, which it finally did.

The other, which is a little more difficult for people to understand, but it's still quite important, is that gasoline demand levels themselves moderated. If you compare consumption year over year, it had been running very, very high in the spring and, in fact, the level of disappearance for gasoline here did not seem to make sense given the coincident economic data. We assumed it was people in the secondary market, what we call wholesalers and jobbers, buying as much gasoline as possible because of fears about a shortage. It sounds like what we were talking about with crude oil, right?

The reason that that was the case was because we had new rules affecting gasoline supply this year. A very high-octane blending component called MTBE was forced to come out of gasoline in Connecticut, New York and California. MTBE -- again, I know this is like chemistry, but it's a type of a compound called an ether, and the thing about it is it doesn't evaporate very quickly and it's very, very high in octane, and when refiners make gasoline they really tend to think of it as making octane. That's kind of the way it's going to be framed out.

And taking MTBE out means you have to put something else in that meets the same sort of environmental regulations. And the only choice you really have is a material called ethanol. Ethanol is an alcohol. Anybody ever open up a bottle of alcohol? You can smell it in about one second -- very volatile. It goes to vapor very quickly.

The reason that that matters is, in the summertime, U.S. gasoline has to be made so that it doesn't evaporate too quickly. So if you're pulling MTBE out and you're putting ethanol in, all of a sudden you really can't make as much gasoline because you have to start pulling other volatile compounds out of your blending components in order to meet the federal requirements.

That was something people knew about, really, going into the gasoline season and I think that's why you had the apparent demand numbers or the consumption numbers being high. I don't think it was people driving so much, I think it was people who owned tank farms buying gasoline because they didn't want to have a run-out situation.

And when we say demand normalized, what happened is, if you think of this as your trend and you have demand running way over your trend, eventually, it's got to correct. So, between demand normalizing and imports showing up, gasoline inventories in the U.S. rebuilt. In fact, they built contra-seasonally. And that caused this crack spread to collapse. So that's why gasoline prices at the pump have actually declined, even though the price of crude oil has gone up.

The other thing coming up -- and I'll get to your question -- the other thing coming up is that in September refiners can start making what's called winter-grade fuel. U.S. regulations for gasoline are fairly complex, and I'm just scratching the surface with you but you can already see how this gets into a bit of a matrix. But come September, refiners are allowed to make gasoline that can evaporate, you know, more easily. It's called the winter-grade rule. And the one component that can get put back into it is butane. Butane is a very high-octane component but, of course, it goes to vapor very quickly. It can boost gasoline supply anywhere between three and seven percent, depending on which market you're in, so that's already being discounted by the market as well. It's part of the reason the crack spread has also been under pressure.

So a very long answer for a very simple question. I'm sorry.

Yes, sir.

QUESTION: Domenic Rushe from the London Times.

I wanted to ask you what you thought of the possibility of oil prices rising from this point are, how likely that would be, and what would be the factors you think are most likely to cause that?

MR. ROTHMAN: To get prices to rise above these levels, you know, there's a debate about Newton versus Einstein. You know, Einstein is, once things are in motion they stay in motion; and Newton, gravity's got to take over at some point.

So, you know, what's going to keep the, you know, the Einsteinium trend intact? I would have to say a disastrous supply hiccup. Saudi Arabia having its ability to produce and export oil is probably the top of that list. Iraq has recently been able to get exports resumed fully from the south, but also move it up through the Ceyhan pipe at the highest rate since before the war. But if you look at Iraqi flows, it's very spikey and I think the market implicitly expects those supplies to remain volatile in nature.

So to get a spike up from these levels, particularly at these levels, I think you'd have to have something literally in the category of disastrous occur on the supply side of the equation.

I'm not sure what the second part of your question was. I think I was more focused on, you know, from here up, but was that --

QUESTION: Just the -- well, the likelihood of a rise from here. I mean, are you saying that you think it's very unlikely?

MR. ROTHMAN: Yeah. I think, again, you're fighting gravity. And politically, this is not a palatable level. It's very obvious. If you look at oil prices and OPEC production, you'll actually see a highly correlated manner: Prices get too high, they push barrels into the market; prices start to retreat, they take oil out. They have been pushing everything in. In fact, the Saudis brought on two fields, Katif and Abu Sayyaf, collectively, 800,000 a day of capacity of highly marketable crude. Katif is half a million a day of Saudi light; Abu Sayyaf is 300,000 a day of Arab medium. But that's, you know, very easy to sell. It's not, you know, a gunky, heavy, sour oil. So they're trying to push barrels in to help cool down the price and I expect that will prevail.

Yes, sir. Actually, this woman here first, because she hasn't asked a question yet. Yes, ma'am.

QUESTION: Thank you. Silvia Jelenz, Handelszeitung.

I was wondering, there was also talk that part of the price increase was -- could be attributed to the decreasing value of the dollar. Is that the case?

And two, do you see that maybe some point in the future crude oil prices aren't noted in dollars, but maybe in some other currency or a basket of currencies?

MR. ROTHMAN: I'm smiling because I was waiting for this question by somebody. It's been a big issue in the last, I guess, 14 months.

I've gone through five major bouts of dollar weakness in following OPEC: '87 was one -- I think much more severe than what we have today; '89 was another. I think '92 was the third; '97 was the fourth, and, of course, the last year plus. In all those instances, the issue of going away from dollar-based pricing in OPEC was discussed, never as, I think, a formal part of the agenda, but it never really gained any ground, largely because the OPEC countries are dollar-immunized. They buy a lot of dollar-denominated goods, so you're producing crude, selling it for dollars and you're also spending dollars for a lot of your purchases.

But the other part of it, which I don't think many people are aware of, is that most of the OPEC countries have currency clauses, I guess the word is embedded, in their trade agreements to protect from these fluctuations. And those ranges or those dollar equivalencies can be negotiated over time. Even the Iranians, who you would think, politically, would have the most to gain, at least the hard-line clericy, would have the most to gain by a move away from dollar-based pricing, have said they don't ever envision that taking place.

The fact that the Euro has strengthened against the dollar, or the dollar has weakened generally provides a benefit to non-U.S. refiners and, to a certain extent, to governments that tax oil heavily because the price of crude in local currency terms, of course, becomes less. The crude is bought and sold in dollars. Refined products are bought and sold, usually, in local currency and markets. So that spread naturally widens from a weak dollar.

And for countries that heavily tax oil, like the EU, whether it's the governments that are benefiting or refiners are benefiting is somewhat difficult to say. I don't have the manpower to crunch through those numbers. You could make an argument that maybe a weak dollar should somehow help stimulate demand for this exact reason that somehow local currency prices drop, but we almost never see that occur. Usually, that rent is captured by the taxman or the refiner. But I don't see any movement in OPEC to go to a non-dollar-based pricing. That seems to be the modus operandi for the foreseeable future.

Yes, sir.

QUESTION: Just one. A lot of people think that the rise of China to an economic powerhouse over the next years will change the equation on the oil market very profoundly and I just wonder what your thoughts on this one is.

And actually, do you consider the Strategic Petroleum Reserve of the U.S. as some kind of hoarding? And if so, what makes you so sure that other countries like India and China would go another way and stop hoarding, as you described before?

MR. ROTHMAN: The issue of China and developing Asia and the oil markets and their effect on the global balances is hardly a new phenomenon. If you look at the growth in oil demand during the '90s, the bulk of the increment came out of developing Asia. For people who follow the oil markets, it's kind of an old story.

China became a very big focal point last year primarily because of the metals markets. They were buying more aluminum at one point than the United States, which was a first in history. And I'm not a metals market specialist, but it was something I was very aware of. Copper, aluminum, zinc all saw what appeared to be almost perfectly coordinated upward price pressures as oil last year and the key link in there was buying from China.

On the rough data that's available, China's net change in demand accounted for about a third of the total increase in world oil demand. So whether they become an economic powerhouse is sort of a term that I'm not smart enough to define. The fact is, on the margin, they have been and remain a fairly significant contributor to the growth and demand generally. India has been, but India is much more of a service economy than a smokestack economy so their oil intensity is not expected to be as significant.

But when you talk about strategic reserves, you should also probably understand that about 18, 20 months ago, there were formal indications out of China that they wanted to build strategic stocks. They had started running into significant power outages last year. In fact, China stopped exporting coal for that reason. And the idea of putting oil on hand for emergency reasons became part of their thinking.

They were supposed to build storage tanks, which we believe were equivalent to 10 days of estimated consumption, so about 60 million barrels. The tanks were supposed to be built, finished by some time between 2006 and 2008. But, several months ago there were suggestions -- and this is, again, something I published -- that they may have been using segregated military storage facilities to hold incremental supply.

There's about six countries in the world that appear to have separately designated storage for military purposes: the U.S., the former Soviet Union, Japan, Korea, China and Saudi Arabia. There's no data on what those volumes are. I have never seen them -- not in 20 years, but there are a lot of indications that they exist. And again, in the case of China, you have to segregate out buying for consumption and buying for storage.

The U.S., as an OECD member, has weekly data. You can go to the DOE website, the fossil fuel website, and actually get the scheduled deliveries of crude going into the U.S. SPR. There's no mystery to it. The rate's about 110,000 barrels a day. It's a given.

In the case of China or India, you don't have the equivalent counterpart to examine that same data. You don't really know how much they're planning to purchase, why it's going to be one month maybe more than another. It's kind of in a black hole from a data perspective.

And that they're building strategic storage may make sense economically given the dependency on oil and probably the related concern about structural tightness in the oil market. A big volume of storage was collected by the OECD countries almost at exactly the wrong time, '79, you know, when prices were making their highs. That's when panic, you know, it sort of fed on itself.

I'm not in a position to say that they should do it or shouldn't do it, but it makes sense that they want to build some oil for precautionary reasons, particularly given their dependency. And I can understand the concern about disruptions, even though I don't -- you know, I'm not forecasting an outage, I can understand it. The headlines are fairly, you know, regular about activities in Iraq or the Middle East, generally, and that's where the oil is flowing out of.

But you do have to make a distinction between something that you think is transitory and something that's more permanent. Demand growth tends to be highly correlated to changes in economic activity. If you look at the numbers for the second quarter of the year and the amount of oil that appears to be swallowed into the bounce, it would suggest that GDP globally ran 10 percent, which I don't think anybody has ever seen in their lives, and it makes, of course, no sense if you look at it from that perspective.

I don't know if I answered everything you wanted to ask me, but --

Yes, sir.

QUESTION: Could you be a little bit more specifically on the future role of Iraq and how likely is it that it will become the major producer, as was indicated in the more optimistic forecasts, and how much of a risk factor is the country?

MR. ROTHMAN: The question about Iraq and its role, its ability to increase production and exports has been a topic for, you know, two and a half years. To me, it's not settled even today.

Part of what you have to understand is that most people who write about Iraq always reference the 1988 figure that Iraq provided on their reserves. In one month, it was 67 billion barrels. When the Iran-Iraq War ended, it became 110. It seemed amazing that with a pencil they found, you know, 40-something billion barrels of crude. And the reserve data is questionable. If you understand the context in which the numbers were revised, people have simply taken it for granted that they're the second largest reserve- holders in the world. That remains to be seen. That's number one.

Number two, in terms of what is available publicly, what's been indicated from people in the state oil company, and even from OPEC, in my own experience, is that there are fields in the south that look commercial and can be developed.

Collectively, each field is thought to be able to produce about 600,000 barrels a day when fully developed, which would equate to, not quite, but 1.8 million a day of additional capacity. The estimate is it would take about five or six years if, let's say, the political turmoil ceased and you can actually sign contracts and do developmental work before that volume could be realized.

But that increment under, let's say, the best case scenario, is quite pale in comparison to what you could do in Saudi Arabia if they simply diverted funds towards developing that infrastructure. So Iraq can be a major player but they're not going to replace, you know, -- again, they're not going to be a replacement for Saudi oil, especially on a longer-term basis.

I can probably take two more questions. Done, the auction's over. Oh, the hands went up. Okay, sir.

QUESTION: The Norwegian business daily. Has Merrill Lynch downgraded the growth forecast for 2005?

MR. ROTHMAN: Don't know. I don't know that they've changed their global number. That's an easy question to answer. You can actually send me an email or --

QUESTION: You were talking about Iran and hoarding after Iran. What changed there for people to stop hoarding?

MR. ROTHMAN: Well, eventually -- and the data is quite poor, so there's no pretense about the quality of the information you're trying to analyze, but essentially, it ran out of room. Storage capability is the same as, you know, how much food you eat at a meal. I don't care what your favorite dish is, if they bring out 40 plates of it, you're not eating 40 plates of it, especially if they're big. If you take on oil for precautionary reasons, at some point you run into physical limitations.

Even in the U.S., where you have very timely and available data, you'll find that there is a definitive range for crude oil stocks. I'm excluding the Strategic Petroleum Reserve, but for commercial crude oil stocks there's a very definitive range. You have a bottom that occurs naturally at around 265 million. If you get below that level, you can't operate the refining system normally. The high end appears to be about 330-335 million barrels. I don't know that we've ever been able to print a number above that. So it's a physical limitation.

Thank you very much.