The Guardian (UK): The gauges do not lie: oil pressure is building

Nils Pratley
Wednesday July 11, 2007

The last time oil was at $76 a barrel, which was only 11 months ago, a chorus line emerged to tell us it would not last. Speculative money was at play, political tensions would ease, and American drivers would notice a rise in pump prices. All were good points, and a reasonable explanation of why the oil price fell rapidly over the next few months; by January, Brent was close to $50 a barrel.

So why is it at $76 again? Certainly, speculative money is back. Oil, despite being a vast market with huge daily volumes, is also territory for financial players, who these days even include pension funds, who have been persuaded that modern investment portfolios need a smattering of commodities.

But these games are not played in a vacuum. The key driver of the oil price remains the iron law of supply and demand. On this front, last year’s chorus line, amply filled with oil company executives, is striking a different note.

Now the industry is full of explanations of why it can’t pump more oil more quickly. Rigs are in short supply; technical staff can’t be trained fast enough; and costs in general have risen so rapidly that they must feed into spot prices. These factors also affect the state-owned producers within the Opec cartel, so it’s not just the majors, such as BP and Shell, whose production volumes are disappointing.

On the demand side, the US economy’s weakness at the start of the year did not last. Now the International Energy Agency tells us demand for oil will grow at 2.2% a year, not 2% as previously estimated, as China and India consume more. The result, says the agency, is a supply “crunch” in five years’ time and, in the end, insufficient supply can only be balanced by a drop in demand.

That may be the eventual result – in other words, a proper recession – but in the very short-term, it is hard to see how the pressure can be relieved.

The “political premium” in the oil price is not going to disappear while Iraq continues to be a mess. Big new oil discoveries, like Chevron’s find deep under the Gulf of Mexico, are costlier to access and won’t produce soon. And subsidies for alternative energy supplies are not about to tilt the market.

It’s why the data from the trading exchanges says the speculative money is not retreating at current levels: the view is that $70-plus will be harder to shake this time. While the global economic outlook is fair to rosy, it’s hard to disagree.

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http://business.guardian.co.uk/story/0,,2123295,00.html

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