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Oil Eyes $50 - Where Will It End?

By Andrew Mitchell

09 August, 2004

Prices have already risen by more than a third this year, hitting a fresh peak on Tuesday at $44.24 a barrel, the highest price in the 21-year history of New York Mercantile Exchange crude futures. Time and again analysts have called a top to the rally, only for prices to march higher as strong demand leaves the world supply system with no leeway to cope with potential disruption in big producers like Iraq, Russia or Venezuela.

And just as a surprise upsurge in Chinese oil demand has revolutionised the oil market this year, so it will take a sustained economic or political shift to bring down prices now, analysts say.

"Getting down from here will not happen soon and it will not be easy," said energy economist Philip Verlerger in Aspen, Colorado.

"We need to see inventories build up and to see inventories build up we either need a big recession or a really mild winter which will leave us sitting in piles of heating oil."


Fear of attacks on energy infrastructure by Islamic militants has reinforced oil's rise, encouraging heavy buying from big-money funds who stand to make big profits if prices spike yet higher.

Most producers in the OPEC cartel are already pumping at capacity, so there is no chance of a sudden wash of extra supply to deflate the market. And it will take years for exploration projects viable at today's prices to turn into new production.

"Without any significant bearish news on the horizon and crude demand close to its peak for the year, speculators will have the opportunity to continue to push for new highs in the weeks ahead," said a report by PFC Energy.

It may be that the only way to douse the oil rally will be for prices to rise so high that they turn boom into bust.

So far the jump in energy costs appears to have done little to hurt global economic growth, with China's expansion slowing only slightly and the United States posting solid growth.

But economists warn that oil prices are now approaching the sort of level that will stifle global growth and in turn stunt fuel demand.

"There will be the delayed effect of oil prices on demand. It takes time but it does happen and people forget about it at their peril," said Leo Drollas of the Centre for Global Energy Studies in London.

Allowing for inflation, prices are near the level hit during the 1973 oil embargo and just over half those during the oil price shock that followed the 1979 Iranian revolution. Both those oil shocks sent the world economy into recession.

"While so far the world economy has pretty much shrugged off oil at $40 per barrel, a sustained rise over $50 probably would take oil prices into the range where they would have a noticeable impact on activity," said Barclays Capital in a report.


One other wild card that might help lower prices would be a change in U.S. president come November's election.

This is due not so much to Democratic nominee Sen. John Kerry's drive to promote alternative energy as because he is seen by some as less likely than incumbent George W. Bush to become embroiled in military action in the Middle East.

"If the U.S. is less likely to go to war over oil, then a lot of this fear premium should disappear," said a European crude oil trader.

But that possibility is still overshadowed by the potential impact of a major supply disruption, even though such an event would quickly be countered by a release in consuming countries' strategic stocks.

Verleger, for example, posits the prospect that Iranian crude exports may be disrupted as part of the fallout from its wrangle with the U.N. over Tehran's nuclear programme.

"All Iran has to do to push prices to $60, $70 or $80 a barrel is announce an export cut to retaliate against any Security Council resolution," Verleger said.

A hypothesis perhaps, but still typical of concerns for oil buyers who see a market stretched to the limit and are prepared to pay up to ensure supplies.

"Getting prices down will need a change in the psychology of the forward buyer," Verleger said.







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