04-10-04

Oil producers' cartel OPEC agreed production stood at 23.5 mm bpd in April but successive rises applicable from 1 July and 1 August have boosted this figure to 26 mm bpd, or 28 mm bpd including Iraq. There seems to have been little resistance to the move from those traditionally keen to rein in output, such as Venezuela.

Moreover, according to OPEC president Purnomo Yusgiantoro, the all-out drive for increased production has resulted in actual output of 30 mm bpd. Yusgiantoro indicated that a further 1-1.5 mm bpd could be brought on stream but on paper it seems unlikely that any more production will be needed in the long term.

In practice, however, oil market mathematics has meant little since the outbreak of war in Iraq and it would surprise no-one if additional OPEC capacity was brought into production. OPEC has not commented on where the additional 1-1.5 mm bpd capacity is located but it seems likely that it comprises solely of spare Saudi production capacity. However, once the decision to utilise this capacity is taken it will be 30 to 90 days before it can actually be brought on stream.

Prices have fluctuated wildly over the past few months, but all benchmark crudes have exceeded $ 40 a barrel and some have pushed $ 48 a barrel. These mark the highest prices seen since the early 1980s in absolute terms, but when inflation is taken into account prices are still substantially lower now than during the second major oil shock of the 1970s.

While the high prices have a negative impact on the global economy as a whole, they have obviously had a more positive impact on the domestic economies of the Middle East's oil producing states. Oil prices over the past year have averaged around $ 35 a barrel, yet national budgets have generally been based on an $ 18-$ 24 barrel. The Iranian, Saudi, United Arab Emirates and Kuwaiti governments will all benefit to the tune of billions of dollars.

Apart from fears over Iraqi oil supplies, there have been various contributing factors to the high prices, including higher demand in the US and the Far East; the potential for a prolonged halt to production at Russian oil company Yukos, which has had its assets frozen; and general fears regarding international terrorism. Any upset to oil production or processing around the world seems to have an exaggerated impact on the markets.

The big question is whether the current high level of prices is here to stay or merely a temporary if stubborn spike. If even a $ 30-$ 40 barrel average is likely over the next decade then it will become financially viable to develop a large number of finds around the world that have hitherto been considered marginal fields because of high production costs.

These certainly include the type of ultra deepwater fields located in the gulfs of Guinea and Mexico, but should also include some Middle Eastern discoveries.

However, it remains to be seen whether such a price level will become the norm. While OPEC has spent the past year insisting that high prices were merely the result of the work of speculators and would quickly come down, the cartel's position now seems to have changed.

In early August, Yusgiantoro commented "in response to expected future demand growth in the coming years, member countries have plans in place to further increase production capacity by around 1 mm bpd towards the end of this year and in 2005." Such medium term investment would not be required if quota cuts were expected within the next 18-24 months.

While security risks have played a major role in the price increases, there now seems little doubt that global demand is higher than almost all analysts predicted. The International Energy Agency (IEA) claims that world economic growth is driving higher demand and the association's figures indicate that global demand for oil has risen this year at it fastest rate since 1980.

The areas of highest growth are concentrated in regions that are experiencing most growth in car ownership and industrial growth, such as China and other parts of East Asia. Efforts to rein in car use and the use of oil as a power sector feedstock in western Europe have had relatively little impact on demand on a global scale. In addition, many US consumers continue to opt for vehicles with lower fuel efficiency, such as sport utility vehicles (SUVs).

Given the amount of effort that goes into predicting commodity prices it is difficult to understand why this demand increase was not picked up sooner. The only obvious explanation is that analysts know too little about the internal workings of the Chinese economy and so rapid increases in oil use in the world's most populous country can go undetected for some time. In addition, oil companies generally operate with much lower stocks today than 10 or even 5 years ago. They are therefore less able to respond to short term localised reductions in production.

OPEC's use of the $ 22-$ 28 price mechanism -- latterly somewhat redundant -- means that there are no longer periods of prolonged low prices when oil companies and governments can replenish economic or strategic stocks.

The Iraqi situation does not look like being resolved for years to come, so political and security uncertainty will continue to plague already sensitive markets. This knowledge, combined with the likelihood of generally higher prices, means that global production capacity needs to rise.

In the past, the looming presence of quota restrictions has dissuaded the development of some finds but increased investment is likely in the short term by both Middle Eastern state-owned oil companies and foreign investors in opening up new fields in the region.

Some Middle East oil powers could benefit from sustained high prices more than others. Iran has the potential to produce far more crude than it currently yields and increased investment in major undeveloped fields could make a big difference to the economy as a whole. However, the Iranian government needs to decide whether it welcomes the kind of foreign involvement in its oil sector that such levels ofinvestment will require.

Production rises in Libya look to be far more likely: The country's re-admittance into the family of nations has come at just the right time and production costs of $ 1 a barrel will see a flood of investment over the next few years with or without high oil prices: A $ 30-$ 40 barrel will merely intensify the competition for acreage. No matter what their potential for increased production, however, none of the region's oil producers will object to the current high price of oil.

Source: The Middle East