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The Guardian: Q&A: Oil

The Guardian: Q&A: Oil

 

Mark Tran looks at the reasons behind the surge in oil prices and their possible impact on the world economy

 

Wednesday June 2, 2004

Posted 3 June 04

 

How much does a barrel of oil cost?

 

US light crude touched a fresh 21-year high of over $42 (£22.7) in New York today before dropping back a few cents. That means oil prices have gone up by about a quarter since the start of the year and are now well over the $22-$28 target range set by the Opec oil cartel.

 

Why have prices gone up?

 

The main factor has been strong economic growth in the US and China. With a red-hot economy, China’s oil demand looks set to rise about 20% in the first half of this year on top of 11% growth last year, according to the International Energy Agency (IEA). At the same time, higher growth in the US economy, which devours 25% of all world oil, is driving competition between Asia and the US for supplies. The rate of demand growth has caught forecasters by surprise, with the lack of refining capacity in the US also putting pressure on prices.

 

What about political factors?

 

Recent attacks in Saudi Arabia, including the Saturday raid in the eastern oil city of Khobar that left 22 dead, have sparked fears of a disruption to oil supplies at a time when Opec is producing at virtually maximum capacity. Iraq’s oil production is also being hampered by sabotage, adding to market unease. Throw into the mix speculation by hedge funds, which are betting on higher oil prices, and the result is expensive oil.

 

How do high oil prices affect the world economy?

 

The rule of thumb is that a $5 increase in the price of oil sustained over a one-year period lops 0.3% off global growth, according to the International Monetary Fund. But the IMF takes an optimistic view on the current situation. It expects prices to decline and says the global economy is generally able to adjust to oil prices more easily than it did in previous decades. Similarly, the Bank of England is not unduly worried.

 

What do the pessimists say?

 

They point out that the three global recessions in the past 30 years were all preceded by a sharp rise in oil prices and there are also longer term worries about oil supplies, with the recent decision by Shell, the Anglo-Dutch giant, to sharply pare back its reserves, not helping matters.

 

Is the world running out of oil?

 

Major oil reserves are becoming harder to find and more expensive to develop. Many of the fields outside Opec countries are mature, which means that finds are now smaller. They need more costly technology to develop and they fall faster from peak production. Some experts though, such as Professor Peter Odell of Erasmus University in Rotterdam, think there are plenty of reserves left and that the world is running into oil rather than out of it.

 

Will Opec increase production?

 

Opec is meeting in Beirut tomorrow and the cartel is coming under intense pressure from the US and Britain to crank up production. Some Opec members are willing to oblige. Saudi Arabia, the world’s biggest oil exporter, has proposed an increase in production of 2.5m barrels a day, or 11%. Algeria has gone so far as to suspend quotas altogether, saying that will be the only way to significantly lower prices. Others are more wary of boosting production as they fear a replay of the crash in oil prices that followed a 1997 decision to raise production just before the Asian financial crisis sharply reduced demand.

 

Can Opec really make a difference?

 

That is a big question. Opec is already pumping more than 2m barrels a day in excess of its official limits to meet demand and traders say Saudi Arabia’s proposed increase in quotas will only add 500,000 barrels to existing production. Only Saudi Arabia, the United Arab Emirates and Kuwait have spare capacity and they would really have to pump a lot of oil to make a difference.

 

Why do the Saudis want lower prices?

 

Traditionally, the Saudis have been willing to accommodate US wishes for cheap oil as the Saudi royal family enjoys particularly close relations with the Bush administration. Despite the post-September 11 2001 chill in relations between the kingdom and the US, the Saudis appear willing to help out the US once again.

 

If Opec increases production, when will prices drop?

 

It takes about six weeks for changes in output to affect prices, so a production increase may have come too late for the peak demand in the US, as Americans take to their cars for the summer break. That could hurt George Bush ahead of the November presidential vote.

 

http://www.guardian.co.uk/theissues/article/0,6512,1217181,00.html

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