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The Times: Question of the week: Oil prices are going through the roof. What will that mean for the world’s big economies?

November 10, 2007
Robin Pagnamenta

Average UK petrol prices rose above £1 a litre this week for the first time. They increased to just under 101p on Tuesday, up more than 17 per cent from about 86p a year ago, according to the AA.

In the past two months prices paid at UK petrol stations have climbed sharply, driven by the increasing global price of crude oil, which exceeded $98 (£47) a barrel this week.

Why do oil prices keep on rising?

Low stocks of oil in the US, the world’s biggest consumer, and a decision last year to cut production by the countries of the Organisation of Petroleum Exporting Countries (Opec), which is responsible for about a third of total world oil production of 85 million barrels a day, have upset the balance between global supply and demand.

Chinese demand for oil is expected to more than double from 7.1 million barrels a day in 2006 to 16.5 million barrels by 2030. Soon after 2010, China is set to overtake the US to become the world’s biggest energy consumer, while sales of new cars in China will exceed those in the US by 2015, generating a huge demand for transport fuel. The figures for India tell a similar story.

In addition, US tensions with Iran and the conflict in Iraq has created nervousness about the security of oil supplies from the Middle East.

Are there any other reasons?

Yes. Big investment banks and hedge funds have also been placing bets in recent months that oil prices will keep on rising, which has driven prices higher. Some economists believe that as much as $20 in the current price of nearly $100 a barrel can be blamed on such “speculative” buying.

Are we running out of oil?

We are running out of oil that is easy to find and cheap to produce. Some of the world’s biggest oilfields first tapped in the 1950s and 1960s – such as Ghawar in Saudi Arabia, which accounts for almost 6 per cent of total global production – are now running dry, or “wet” because of the increased quantities of water that need to be pumped underground to force out the remaining oil. The North Sea is in a similar predicament.

How much is left?

According to BP, there are still 1,208 billion barrels of oil in proven reserves left in the world – another 38 years’ worth at current levels of consumption.

Nobody really knows how accurate such figures are, or how much more oil is left that hasn’t been discovered, but the big deposits are in inaccessible spots – deep beneath the Arctic Ocean, under the earthquake-prone deserts of Central Asia, in the Russian far north and in politically volatile countries such as Iraq. Many parts of Africa also remain unexplored.

There are also vast reserves of unconventional oil in the form of tar sands and oil shale rocks. But these deposits are very costly to extract – both financially and in terms of their impact on the environment.

There are thought to be more than 163 billion barrels of oil in the Canadian tar sands of Alberta, for example. These are now being exploited for oil by companies such as Shell but it may be necessary to use nuclear power to extract it on a commercial scale.

Ultimately, oil is a finite resource. We have been running out of it since we started using it for fuel thousands of years ago.

How much higher can oil prices rise?

Oil prices have already more than quadrupled since 2004 and, in the short term, few people in the industry believe that they can remain at current levels indefinitely without at least a temporary fall. However, many also think that speculators are likely to force prices above the $100-a-barrel level before there is a significant drop.

Can anything end the price increases?

An end to speculative buying or a decision by Opec to boost production could help to force prices lower. This second possibility could come as early as next week during a meeting of Opec in Riyadh, Saudi Arabia.

A decision by Western governments such as those of the US or France to release some of their own strategic petroleum reserves would also help to lower prices. High oil prices are also stimulating a frenzy of investment in new fields that were previously considered too small, expensive or geologically challenging to extract commercially. It is possible that, when more of these enter commercial production, this could have a dampening impact on oil prices.

Have we got enough oil to satisfy demand?

Probably not. World oil production simply cannot continue to grow indefinitely to keep pace with rising demand. By 2035, the world will use more than twice as much energy as it does today and demand for oil could rise from 85 million barrels a day to more than 120 million barrels.

This week, the chief executive of Chevron, one of the biggest oil companies, questioned whether global production could ever rise above 100 million barrels a day. So, against a background of rising long-term demand and increasingly questionable supply, high prices are probably here to stay.

The International Energy Agency predicts barrels will average $110 in 2030, but adds they could rise to $159.

The big oil companies must be raking it in . . .

Yes and no. While big oil companies are hardly in the gutter, surprisingly they are making smaller profits than they were a few years ago because the cost of producing oil has shot up, as well as the price of oil itself.

Companies such as Exxon, BP and Shell are having to develop oil fields in increasingly remote and hostile environments such as Sakhalin in the Russian far east, while national governments are demanding a bigger share of the industry’s profits. A recent study by the analysts John S. Herold showed that the biggest 230 oil companies increased their spending on exploration and development by 45 per cent last year to more than $400 billion – but that their oil and gas reserves edged up by only 2 per cent.

What do high oil prices mean for the economy?

The modern economy is less dependent on oil than it was in the 1970s, so the impact has been less acute than it was during the 1970s oil shock.

The fact that oil prices are quoted in dollars and the US currency is so weak has also helped to cushion the blow for many countries.

Nevertheless, as prices continue to rise they present an inflationary threat and also act as a brake on growth by absorbing the spending that consumers make on other goods.

The possibility of an oil-linked economic shock is certainly growing, especially when combined with the other problems in the global credit markets.

What about the UK?

UK consumers are less exposed than in other countries because fuel taxes here are so high. Certain industries that are heavily dependent on transport – hauliers, farmers and supermarkets, for example – have been particularly hard hit.

And the environment?

The International Energy Agency believes that on current oil consumption trends, global emissions of CO2 will grow from 27 billion tonnes in 2005 to 42 billion tonnes in 2030.

This would be in line with an increase in global temperatures of 6C, according to projections by the Inter-governmental Panel on Climate Change – a scenario that would probably herald an ecological disaster.

Hopefully, high oil prices will help to encourage greater energy efficiency, both by individuals and companies, and also stimulate investment in renewable and alternative fuels that do not contribute to global warming and are less damaging to the environment, such as hydrogen fuel cells. If they don’t, we are in serious trouble.

— The global daily demand for oil in barrels last year, rose to 85m up from 65m in 1980

— The expected increase in daily demand for oil in barrels in India by 2030 is 3.9m

— Daily consumption of petrol in litres in Britain is 69m

— The Chinese demand for transport fuel is expected to be 4 times greater in 2030

Source: International Energy Agency; Automobile Association

http://www.timesonline.co.uk/tol/news/politics/article2843851.ece

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