What's Up With Oil? Prices, Supplies And Technology In Our Energy Future

By David J. O'Reilly, Chairman of the Board and Chief Executive Officer
Chevron Corporation

San Francisco, California

When the Commonwealth Club first asked me to speak, I wasn't sure anyone would want to hear about an "Old Economy" issue like energy -- especially not from an "Old-Economy company" founded in the 19th Century.

The last time oil prices made really big headlines was way back in 1981, when they hit an all-time high. Nobody noticed when in early 1999 – adjusted for inflation -- they hit an all-time low!

All the latest business stories had been about internet stocks, venture capital, IPOs, and "dot-com" millionaires. Then suddenly energy was back on the front page. Oil prices reached a peak of $30 a barrel just a few weeks ago, almost three times the price in early 1999. Gasoline and diesel prices rose 50 to 60 percent. Airlines tried to raise ticket prices. OPEC's every move has made the news. Truckers, farmers and politicians protested. And, in fact, in Washington today, the Senate is considering a repeal of the 18-cent-a-gallon federal excise tax on gasoline.

Investment and innovation have been keeping energy prices affordable, and supplies reliable. And they are -- in fact -- the keys to global energy security in the future.

Has the "energy crisis" of the 1970s returned, with its odd-and-even gasoline lines, 55 mile-per-hour speed limits, and lowered thermostats? Is this a case of déjà vu all over again? Today I hope to convince you it is not.

The world today is in much better shape from an energy standpoint than it was 20 years ago. Throughout the '90s, more countries have opened to outside investment in their energy sectors. Meanwhile, we've enjoyed enormous benefits from technology. We've seen major innovation within the energy industry, which has fully embraced the tools of the Information Economy. Investment and innovation have been keeping energy prices affordable, and supplies reliable. And they are -- in fact -- the keys to global energy security in the future.

The world consumes about 77 million barrels of oil a day. About one third of this is provided by the OPEC countries. In 1997, OPEC and some other oil producers decided to boost their output. They thought that demand was rising fast. But this was a major miscalculation. OPEC pushed oil production up, just as the Asian economies -- and their energy demand -- started going down. The result was a global oil surplus.

Oil prices fell throughout 1998 and early last year, they hit a 70-year low of $11 a barrel. Gasoline in most states dipped below a dollar a gallon. OPEC countries were hit hard, losing about $50 billion in oil revenue compared to their normal annual levels. So, in March of '99, OPEC and two non-members, Mexico and Norway, agreed to reduce production -- and within a couple of months, oil prices started rising again.

Ironically, OPEC took production down just as the Asian economies -- and their oil demand -- started going back up. The surplus disappeared. World oil inventories fell to historic lows. And the oil market reacted with $30-a-barrel oil. So in just a year's time, we went from one extreme to the other.

This week, OPEC officially decided to raise production about 1.7 million barrels a day. Norway and Mexico also said they would increase output. The market saw that decision coming, and prices have now retreated to the $27-a-barrel range. We won't know the true impact of OPEC's decision for a while, partly because much of that new oil probably started entering the market earlier this year. But we do know that it that took us a while to get into this situation, and history tells us it will probably take us a while to get out.

We also know that OPEC will remain important. They control four-fifths of the world's known oil reserves, as well as most of the world's excess production capacity. You might think OPEC is back in the driver's seat, just like 25 years ago. But let's look a little closer.

OPEC is a group of 11 very different countries -- and they've had mixed success trying to control the oil market. In fact, it took the lowest oil prices since the Great Depression for them to agree on the production cuts of 1999. Consider all the factors that OPEC can't control. These include changes in oil demand from improved energy efficiency and economic growth. They can't control the weather, and a cold winter makes a big difference. Nor can OPEC control the production rates in non-OPEC countries, which produce two-thirds of the world's daily oil supply.

Consider also the lessons of the past. OPEC drove prices way up during the 1970s. Those prices stimulated conservation, new investment in energy efficiency and new production from other countries. Prices peaked in 1981, and between the late '70s and the early '80s, U.S. oil demand fell by 4 million barrels a day. And then, in 1986, prices collapsed. And since that time -- except for the Gulf War in 1991 and this latest spike -- oil prices have been generally flat in real terms.

OPEC hasn't forgotten that chain of events. And today, all the oil-exporting countries have something new to think about as well. Mexico is a good example. They sell a million barrels a day to the United States. So they definitely benefit from high oil prices. But Mexico today relies more on manufacturing than oil.

The OPEC nations depend on their oil earnings. But they also know they need to diversify their economies and for that, they need affordable energy just like the rest of us. Add it all up, and we begin to see that OPEC has incentives for supporting moderate prices, as well as disincentives for giving us the opposite.

OPEC's biggest producer -- Saudi Arabia -- has been advocating price stability in the $20 to $25 per barrel range. Other producing nations have said the same kind of thing. So the experts still believe that oil prices over the next decade are going to behave a lot like they did in the last one.

So, what does all of this mean to consumers? Let me say first that despite some of the news reports earlier this month, the government isn't forecasting a supply shortage. And to that I would add that except for safety, nothing is more important to Chevron than keeping customers supplied.

...when you subtract the pump taxes, U.S. gasoline - on average - today costs just five or six cents a mile. That's half of what it cost 30 years ago or even 50 years ago.

So now you might ask: supplied at what price? We've seen a lot of volatility in the last year or so, from the very low to the very high and lately, the very rapid as well. So it's understandable that consumers are concerned. But if you've taken a closer look and kept up with the news reports, you know that gasoline is still a good value. Especially when you look at other items we all buy.

Gasoline in the last 15 years or so is up just 7 percent. Take the taxes off gasoline and the average price in recent years is actually about a dollar a gallon. Compare that to milk at about $3 a gallon. Or carbonated water at $2.50, or more. If you take the current national average price for regular gasoline, about $1.60 a gallon and adjust it for inflation, it's actually cheaper than gasoline was in the early '60s.

Meanwhile, average fuel economy has doubled. So again, when you subtract the pump taxes, U.S. gasoline -- on average -- today costs just five or six cents a mile. That's half what it cost 30 years ago or even 50 years ago.

California gasoline without taxes right now costs about 7 cents a mile. That's still a good value in personal transportation. But of course the issue in this state isn't just price. It's the fact that we pay more than people in most other states. Our customers often point this out to us. Here's a line from an e-mail we received just this week: "I'm looking for a horse . . . a lot cheaper to operate than my car." And she signs it, "best regards . . . Theresa."

Here's what we said in our reply to her, starting with taxes: Californians currently pay about 50 cents a gallon -- the nation's fourth highest rate. In New Mexico, pump taxes are 15 cents lower per gallon. In Georgia, 20 cents less.

We also have a unique California gasoline formula, which is mandated by the state to help reduce smog. Compared to other states, our gasoline costs an extra 5 to 8 cents per gallon to make. Having our own formula also keeps our market separate from the rest of the U.S. market. So when supplies of our unique gasoline run short, prices can go up quickly. And it usually takes a while to bring in more supplies that meet the strict California standard, and re-balance the market.

Earlier, I said the world is in much better shape on energy today than 20 years ago. So let's return now to the longer term, and the investment and innovation that I believe are the keys to energy security.

The last decade saw a wave of countries opening their energy sectors to outside investment. Latin America is one dramatic example. Argentina and Venezuela led the way, and now Brazil is moving in the same direction.

Even more dramatic were the events set in motion by the fall of the former Soviet Union. Almost overnight, the newly-free countries in the Caspian region started to build new energy partnerships, and they've attracted billions in private-sector dollars. One big success story has been the joint venture between Kazakhstan and Chevron to manage the giant Tengiz Field, on the eastern shore of the Caspian Sea. Another has been Chevron's leadership and investment in the Caspian Pipeline Project, now under construction. Next year it will start moving new supplies of oil from Tengiz and other fields to the world market.

The trend has also touched the major producers of the Middle East -- such as Saudi Arabia and Kuwait. The countries in this critically important region are either starting to work with foreign investors, or they are talking seriously with potential partners.

Engagement, not isolation, is the new course. Countries once closed, and global companies like Chevron, are forming new partnerships. We're providing new capital, technology and know-how to find new oil and gas fields and get more production out of the older ones. The beneficiaries are not just the oil exporters. They are the people and economies of the world, especially in the developing nations, who need reliable and affordable energy.

Another reason the world energy sector is in better shape today is technology. This is the innovation side of future energy security. Economist Lester Thurow has said that the oil industry "has been infused by so many new technologies that it should be thought of as one of the new, man-made brain-power industries."

...the oil industry "has been infused by so many new technologies that it should be thought of as one of the new, man-made brain-power industries."

The oil business today relies heavily on computers and technology. Finding and developing new fields is a case in point. The conventional view is that the world has enough oil to last us at least until the middle of the 21st Century. And much of it is locked in older, giant fields. Over the years, a lot of people have said we're going to run out sooner than that. But technology always proved otherwise.

The oil and computer industries actually began their long romance back in the '50s and '60s. And in 1985, Chevron was the first oil company to purchase a Cray supercomputer. That machine, once the pinnacle of computing, now could probably be outperformed by a Sony Playstation! So, one of our newer tools is the visualization center we created in San Ramon with Silicon Graphics. In this center, our scientists put on 3-D glasses and analyze room-sized seismic images of oil and gas reservoirs from all over the world. This gives us a better idea where the resources are hidden -- and it shows us how to recover more oil for less cost.

In another example, a lot of tomorrow's oil and gas will come from new fields beneath the deep waters of the world's oceans. Chevron's new Genesis project in the Gulf of Mexico floats like a giant cork in waters more than half-a-mile deep. And it produces oil and gas from deposits 10,000 feet beneath the sea floor. Projects like this will serve the energy needs of millions of people in the U.S., Brazil, Africa and Europe in the years ahead. But they wouldn't be possible without computers and advanced technology to help us design and operate them.

Elsewhere in our business, we're putting the web to work. Three years ago, we began to see that by taking advantage of the Internet we could change our business for the better. We also felt that being close to Silicon Valley might give us an edge. So last year, we created Chevron eBusiness Development Company. Its job is to find new efficiencies for us in the business-to-business sector, the so-called "B to B" trend we've all been hearing about. And they're also trying to win Chevron a piece of the "dot.com" economy.

Indeed, B2B could help oil companies cut costs by 5 to 15 percent ­­ and industry-wide, we're talking billions of dollars in potential savings.

Also last year, we used web architecture to re-invent our business relationships with our service-station dealers. We streamlined our operations and reduced our costs. This month, we announced plans to use that same, internet-based model to create a company with Oracle and McLane called "RetailersMarketXchange.com". It's going to be the first full-service marketplace on-line, linking suppliers with convenience stores and small retailers and branded marketers.

In January, with our partner Ariba, we created an independent B-2-B company called Petrocosm. We believe it can become the world's biggest shared marketplace for on-line procurement of oil and gas hardware and services. Indeed, B2B could help oil companies cut costs by 5 to 15 percent -- and industry-wide, we're talking billions of dollars in potential savings.

So technology has long been a driving force for controlling costs in the energy industry, and I think the energy prices that consumers enjoyed throughout the '90s bear this out. In fact, a recent study by Goldman-Sachs says that oil companies over the last 10 years passed 70 percent of their cost-savings through to consumers. That trend will continue with E-commerce, and I quote from the report: "The internet will help oil companies meet the world's energy needs by ushering in the next wave of cost cutting and productivity improvement."

Earlier, I said I wasn't sure anyone would turn out today for a speech about energy. But we've got a good turnout here today, and now I have to admit I have mixed feelings about all this attention we're getting. On the one hand, I like it when Chevron customers just depend on us without giving it a thought. I like it when motorists pull in, fill up, and get on with their lives. Show me a customer in motion, and I know we're doing our job.

We're the "van" in WebVan; the "express" in Federal Express.

Also, sometimes I think maybe people don't really need to know all the steps to the vast markets and infrastructure, the politics, behind every tank of fuel, and every turn of the ignition key. But on the other hand, I can't help but notice how we take reliable and affordable energy for granted. We get excited about it mostly when the lights go out or when the price goes up. This I find hard to accept, because the central role of energy is so striking to me.

The world relies on oil for 40 percent of total energy and 97 percent of transportation fuels -- gasoline, jet fuel and diesel. Fuels made from oil give us our mobility, taking the kids to school, commuting, distribution. We're the "van" in WebVan; the "express" in Federal Express.

On another point, I think we all appreciate the gifts from the Silicon Valley -- all those wonderful products we can't do without -- the miracle of "info-tech" and the cyclone of e-commerce. But I'd like more people to understand that California's computers and printers and servers don't really run on electricity. They run mostly on natural gas and coal -- the fossil fuels that fire the power plants that make our electricity.

If you take a moment to look closely at energy, you see that the New Economy relies completely on the old, just as the old relies on the new. People criticize fossil fuels and the engines that burn them. But when we look at benefits, as well as problems, we see that the marriage of oil and transportation has given us the modern equivalent of the magic carpet.

Throughout the '90s, oil and energy, plentiful and affordable, helped to drive our phenomenal 10-year global economic expansion. Worldwide oil use in the last decade grew by over 10 million barrels a day to a record 77 million barrels. And most experts see demand for all kinds of energy growing steadily over the next 10 to 20 years. The outlook is clear: To sustain our societies and improve people's lives in the developing nations, we're going to need more oil, natural gas, and power in the new century.

I know it's tempting to look at energy right now as the same old story -- just the price at the pump this morning, OPEC on one side and the American consumer on the other. But that view -- like the Cold War -- belongs in the last century, not the new one.

In the past, when prices have gone up, they've eventually come down. Nobody knows for sure where prices will go next. But we do know, that the forces at work today -- the expanding marketplace, geopolitics, globalization -- will only grow stronger. Together they suggest that the polarized energy world of the 1970s is giving way to something new.

I believe we can look forward to a world where oil-producing nations seek a balance between cheap and expensive. A world where more countries will have a stake in both economic growth and the affordable energy required to get it. A world of energy security, where investment and innovation will ensure that we keep supplies flowing. And a world that should work to the benefit of energy consumers long after the price spike of the year 2000 fades into history.

Updated: March 2000