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Will Higher Gas Prices Bring More Production? Don't Count On It

Monday, 9 Jun 2008 | 3:45 PM ET

Rising oil prices should encourage more exploration and production, right? Not if you are Venezuela, Russia, or Iran. Just the opposite, says Goldman’s oil seer, Arjun Murti, who gave an infrequent interview to Barron’s that appeared in this most recent issue.

High prices mean these, and other key producing countries, don’t need the incremental revenue. They are getting plenty of revenue through price, they don’t need to get it through volume. It also means they have sufficient capital to develop their industry on their own. That leaves Western oil firms increasingly on the sidelines, unneeded, thank you very much. Witness the expropriation in Venezuela. Could more countries be tempted to follow suit?

Since the government calls the shots in many key oil-producing countries, there is even less chance they will respond to higher commodity prices, as market forces would suggest. “Logically,” notes Murti, “there is less incentive for Russia to massively grow their supply and bring down oil prices; frankly, that’s true for a lot of the countries.”

In effect, OPEC’s logic rules just about everywhere. And can we really blame them?

Iraq, too, is part of this, but by default. Only recently has Iraq been able to restore pre-war production to 2.5 million barrels a day; it’ll be another five years before this can be boosted to 4 million barrels a day.

Assuming there is enough stability to rebuild Baghdad will desperately need all the revenue it can generate, which lead to best efforts boosting production. But it is hardly inconceivable that Iraq will sometime calculate their national interest is to keep prices high. It will be another bitter reminder of the U.S.’s continued superpower erosion.

Meanwhile, our more market-driven economy is already responding to higher oil prices – with negative demand-growth for gasoline, which will soon squeeze refiners’ margins.

But even our huge consumption is not what it used to be. High oil prices are now being propped up more by non-OECD (vs. OCED) demand, and a major question is whether this demand will drop off. “The biggest risk is that emerging-market growth abruptly changes for some reason,” says Murti, who notes it will probably be sudden. “That’s what we worry about.”

Remember, Goldman does not subscribe to peak oil--but peak price. The prediction is for prices somewhere between $150-200 over the next 6-24 months, which translate into pump prices as high as $5.75 per gallon.

But peak price also suggests there will be a downside. It is worth noting that Goldman’s long-term forecast is for oil to fall back to an indulgent $75 per barrel. But that’s 20 years out.

Questions? Comments? energysource@cnbc.com