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Analysts: Rising Oil Prices Reflect Demand Outstripping Supply - 2004-08-06

Oil prices have come close to $45 per barrel this week, and some analysts predict a $50 barrel is within sight. The reasons that oil traders give for the daily fluctuations vary, is legal problems for the Russian oil giant Yukos, the next an attack on a pipeline in Iraq or sluggish oil production in Venezuela. But a growing number of analysts now believe there is a longer-term problem that will keep oil prices high for the rest of this year and well into the next, the demand for oil is growing faster than supply, and the OPEC oil cartel can do little to change that.

The Organization of Petroleum Exporting Countries (OPEC) says it wants the prices of crude oil to remain somewhere between $25-$28 per barrel. But oil for delivery in September is selling for close to $45 per barrel these days. So why aren't the producers pumping more oil to bring the prices down? The answer, more and more analysts believe, is that they cannot.

Oil expert with the London-based Investec Securities Bruce Evers is one of them.

"OPEC, for a number of years now, has not invested in spare capacity, and as a result, with demand rising, they are struggling to keep pace with demand," he notes. "Demand is expected to increase by around 2.5 million barrels a day this year, and quite possibly by two million barrels per day next year."

What is driving the demand for oil is economic growth across the globe. The U.S. economy is expected to grow by three to four percent this year, Japan has emerged from years of economic doldrums and China's economy continues to grow at a sizzling pace. In fact, for the first time, China this year surpassed Japan in energy use and is the world's second largest oil consumer, behind the United States. High oil prices bring windfall revenues for the producing countries, so they have an interest in keeping oil prices high. But they also worry that the high cost of energy could plunge the industrialized countries into a recession, reduce consumption and drive oil prices down.

This is what happened just a few years ago. At its meeting in Jakarta in the fall of 1998, OPEC decided to increase production by two million barrels a day. But then Far Eastern economies began to crumble, and demand for oil slumped. With the market flooded with oil, prices plunged below $10 per barrel, and it wasn't until the following year that the oil producers were able to reduce supplies and drive prices back up again.

Oil analyst with the Center for Global Energy Studies in London Manouchehr Takin says that, while the oil market is tight, there are no shortages, and he does not anticipate there will be any in the near future.

"My belief is, yes, the levels of inventories are low, production and supply are just about balanced, but we have observed that OPEC countries have tried and have increased their production," he notes. "And at present, there is spare capacity in Saudi Arabia. They can increase their production by nominally 1.5 million barrels per day."

Investec's Mr. Evers is not as optimistic. He says OPEC may be able to boost production by about one million barrels per day, but that, he says, will take at least another three months. With energy use in the late fall and winter reaching its peak, even the additional one million barrels a day would not be enough to meet the extra demand.

He also says, as long as supply remains as tight is it is today, the markets will continue to keep prices at current levels.

"We've got three factors at the moment," Mr. Evers adds. "You have growing unrest in southern Iraq, where the majority of exports are coming from, you've got uncertainty surrounding Yukos, and you have a very limited spare capacity against strong demand. So, we could well see the prices around current levels for another six months or so."

Walid Khadduri, editor-in-chief of the Middle East Economic Survey in Nicosia, Cyprus, says there is another factor that could influence the prices of oil in the foreseeable future.

"If it [oil] is going into consumption, then prices could remain high," he says. "If a lot of it is going into storage, then prices could go down, because it doesn't make sense to store at such high prices."

With most oil producing countries pumping as much oil into the market as they can, and with too little spare capacity to make up for even temporary disruptions in supply, the prices of oil will remain at their 20-year high for some time to come.