Ready for $262/barrel oil?
January 27, 2006
by Nelson Schwartz, FORTUNE senior writer
DAVOS, Switzerland (FORTUNE)
Two of the world's most successful investors say oil will be in short supply in the coming
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
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.
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