LONDON – With the price of crude oil hitting fresh highs this week, bringing $50 crude firmly into view, analysts say it will take a sea-change — a recession, an abnormally mild northern winter or perhaps a change in U.S. President — to end the rally in prices.
Early Tuesday, U.S. oil prices hit fresh record highs above $44 a barrel after the head of the Organization of the Petroleum Exporting Countries (OPEC) cartel said there was little the group could do to cool red-hot markets. U.S. light crude struck $44.24 a barrel, the highest since crude futures were launched on the New York Mercantile Exchange in 1983. It settled 33 cents higher at $44.15.
London’s Brent crude followed suit, scoring $40.45 a barrel, a level not seen since the run-up to the first Gulf War when it hit an all-time high of $40.95.
“It’s just up, up and away. There’s no stopping it,” commented Edward Meir, an analyst at Man Energy, adding some brokers believed U.S. oil at $50 a barrel was no longer inconceivable.
Oil prices have surged by more than one-third since the end of 2003 on worries that accelerating global demand has left supplies tightly stretched with little leeway for disruption.
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 revolutionized 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.”
No bearish views in sight
Fear of attacks on energy infrastructure by Islamic militants has reinforced oil’s rise, encouraging heavy buying from big-money funds that 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.
Lowdown on high oil prices
To view a slideshow, click here.
• High demand
• Low inventories
• Supply snags
• Pump problems
• Price pressure
• Economic disruption
• Cartel crunch
• The fear factor
• Vulnerable infrastructure
• The bottom line
World oil demand is growing at its fastest pace in 16 years. U.S., European and Japanese economies are finally growing again and China is sucking in oil — imports are 20 percent higher than a year ago — to power its manufacturing and to make gas for its booming car market. The world consumed 79 million barrels of oil a day in the second quarter. Forecasts call for that to rise to 82.5 million in the fourth quarter.
Stocks of oil are low by historic standards, removing a cushion between demand and supply. The unusually cold winter in the Northern Hemisphere caught oil companies shorthanded, forcing them to run down stocks. But oil companies are keeping less oil on hand than in the past to lower their cost of business. OPEC has kept its stocks low as a matter of policy.
Unrest has disrupted oil production in the Middle East, Nigeria and Venezuela. New production investment has been low in the Persian Gulf and Caspian Sea. Mature U.S. and North Sea oil fields are producing less and new finds have dropped to 6.8 billion barrels annually in 2001-2003 from 11.4 billion barrels per year in the previous five years. U.S refineries are running at near-full capacity, slowing gas deliveries to consumers. Summer driving will only make things worse.
U.S. gas prices rose more than 50 cents per gallon during the first five months of 2004, but higher crude accounted for only about half of that. Severe winter weather delayed U.S. refiners from making their annual switch to summer products. Even if they try to play catch-up, tankers from the Gulf take six weeks to reach the U.S. so new supplies wouldn’t reach consumers until late summer. And because different U.S. regions require different gas formulations, a shortage in one can’t be met with shipments from another.
Oil prices have jumped 30 percent this year thanks to the supply-and-demand problems, the weaker U.S. dollar and speculation. A 10 percent drop in the dollar against currencies of other oil-consuming countries means a 7.5 percent rise in the dollar price of oil. OPEC officials also blame hedge fund bets that prices will go higher for up to 20 percent of $40 oil. But even at $42, a barrel of oil is cheaper than it was in 1980, when it cost $81 in today’s money. (In 1864, oil hit a giddy $8 per barrel — $92 in 2004 dollars.)
High oil prices push up inflation through higher energy and transportation costs; they can push up interest rates and trim economic growth too. A $1 gain in crude oil prices adds $280 million per year to U.S. airlines’ fuel bills. If price rises are steep enough or last long enough, they can trigger recessions, as happened in 1973-1974, when OPEC tripled oil prices overnight, and in the 1980s, when oil prices stayed above today’s prices in real terms for seven years.
OPEC’s 11-member states pump 39 percent of the world’s oil production and half of oil exports. The 44-year old cartel tries to manage prices by regulating output, though quotas rarely reflect true OPEC output. But while OPEC opted to raise output at its June 3 meeting in Beirut, most members are producing at full capacity already. OPEC also has internal policy divisions between pro-U.S. members such as Saudi Arabia and Kuwait and countries less favorably disposed to the Bush administration such as Iran and Venezuela.
Although the U.S. gets only 10 percent of its oil from the Persian Gulf, the Middle East remains the world’s largest oil producing region. Recent violence in Saudi Arabia, including a deadly attack by Islamic militants in Khobar, and a fear that al Qaeda-linked forces are trying to provoke civil war in the kingdom have again raised fears about supply interruptions. Continuing unrest in Iraq will delay the return of its oil to world markets in any significant volume.
The world’s oil infrastructure has many points open to terrorist attack, but it would take simultaneous strikes to cause a significant disruption. Oil wells, pipelines and tankers are the least of the worries. Ports are a bigger potential chokepoint because most oil producing nations have only one or two terminals. But with U.S. refineries already at full capacity — no new ones have been built for years because of environmental concerns and NIMBYism — taking out one would send U.S. fuel prices soaring.
Although oil — and natural-gas — prices have risen sharply, they will likely have only mild effects on overall economic activity, making real U.S.gross domestic product only about 0.9 percent lower than it would otherwise be. Not enough to derail the recovery. Businesses also have more experience with energy price shocks; they understand how the shocks affect them and how other segments of the economy will respond. But many of the factors behind the recent surge in prices are likely to persist.
Election a wild card
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 program.
“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.
OPEC sees no extra supply
Contributing to Tuesday’s rally in crude oil prices were comments from Purnomo Yusgiantoro, president of OPEC, who said the cartel had no spare oil to hand to dampen prices.
“The oil price is very high, it’s crazy. There is no additional supply,” Purnomo told reporters in Jakarta.
“Minister Naimi has said Saudi Arabia can increase production but they cannot do it immediately,” he said, referring to Ali al-Naimi, oil minister for Saudi Arabia, the world’s number one exporter.
Saudi Arabia has said it would produce 9.5 million barrels per day in August, which would be just one million bpd below the country’s full capacity.
Purnomo’s comments echoed those on Monday of Algerian Oil Minister Chakib Khelil, who said OPEC had done all it could to stop this year’s oil price rally.
“OPEC can do nothing,” Khelil told reporters in Algiers.
Yukos woes deepen
The Russian Tax Ministry has begun an investigation into the 2002 accounts of the country’s largest oil firm Yukos, the company said on Monday, the latest twist in its battle against bankruptcy.
Bailiffs have given Yukos one month to pay back taxes. Yukos owes almost $7 billion in back taxes for 2000 and 2001 and analysts have said any bills for later years could bring the total towards $10 billion.
Yukos, which pumps one fifth of Russian oil, has had its bank accounts and assets frozen, raising fears that its sales may dry up at a time when global production is running close to full tilt.
Reuters contributed to this report.