Running on empty oil markets

20 August 2004
Olympians competing in Athens are not the only ones breaking records at the moment. Oil prices have been hitting new highs of performance virtually every week since June - the Greek authorities would demand drug tests. Prices for US crude topped $46 a barrel in mid-August and OPEC's monthly average price for its basket of crudes hit $41.33 on 13 August - its highest level since September 1990, immediately after the Iraqi invasion of Kuwait, and up by more than 40 per cent on the figure 12 months ago.

While consuming countries, nursing their nascent economic recoveries, squeal with pain, the good news for Gulf economies enjoying the windfall is that analysts have stopped dismissing the strong performance as a flash in the pan. When prices stayed above $30 a barrel immediately after the fall of Saddam Hussein last year, traders and OPEC members alike saw a slump around the corner. No longer. In the wake of the record highs in the US in early August, alarmist forecasts saw prices exceeding $50 a barrel before dropping. Most analysts are less bullish but nevertheless the consensus is for prices to remain above $35 a barrel throughout the remainder of the year. And even better, from a producer's point of view, few see a fall much below the $30-a-barrel mark throughout 2005.

The explanation is two-fold. Fresh supply threats, real and imagined, have been producing brief spikes on an almost weekly basis. Iraq is one of the prime culprits, although the market is becoming increasingly immune to its myriad problems. Unrest in Nigeria is another serial source of stimulus, as are terrorist threats in Saudi Arabia. The precarious rule of President Chavez in Venezuela was a slow-burning threat - and the original catalyst for the current strong price period through a strike that decimated production in late 2002. Output has yet to recover.

But the apparent insignificance of some of the events that have moved the market is telling. Even a single refinery fire has been known to have an impact. Rumours in July suggesting Moscow was to bar troubled Russian giant Yukos from selling oil never appeared credible and were subsequently denied. And Saudi Arabia has yet to lose a barrel of output through terrorism. The problem is that the underlying fundamentals of soaring demand and shrinking spare capacity are creating a market so tight that the merest hint of the gap closing further is enough to send prices skywards. 'When spare capacity becomes thin, oil prices tend to rise quickly in any event,' says Paul Horsnell, head of energy research at Barclays Capital. 'When you get a supply shock on top of stretched capacity, then prices can rise even more sharply.'

Until recently, excessive speculation was widely blamed for adding a hefty premium, as was the so-called 'missing barrels' thesis - that significant quantities of crude were languishing unrecorded in inventories. The August market report from the Paris-basedInternational Energy Agency (IEA) was titled 'Irrational Exuberance'. But the contents of the study gave the lie to both arguments. For the ninth consecutive month, global demand forecasts were revised upwards. In the latest instance, the 2004 prediction was raised by 750,000 barrels a day (b/d) in light of unreported demand in OECD countries. The missing barrels had been found. And far from suggesting that all is in fact rosy in fundamental terms, the IEA claims that OPEC's remaining spare capacity is only 650,000 b/d.

The figure is much disputed, chiefly by swing producer Saudi Arabia. Since late July, when OPEC President and Indonesian Energy Minister Purnomo Yusgiantoro questioned members' short-term ability to raise output, Riyadh has been engaging in a pantomime exchange of 'oh yes we can, oh no you can't' with the sceptics. In response to the IEA report, Saudi Petroleum & Mineral Resources Minister Ali Naimi stated publicly the following day that the kingdom c

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