FACTBOX: Why oil prices hit a record high above $139

Mon Jun 9, 2008 7:37am EDT

Reuters) – U.S. crude oil last week hit an all-time high of $139.12 a barrel.

Prices have rallied from a dip below $50 at the start of 2007 and this year have risen by around 40 percent from $95.98 a barrel at the end of last year.

Adjusted for inflation, oil is well above the $101.70 peak hit in April 1980, according to the International Energy Agency, a year after the Iranian revolution.

The balance of demand and supply is tight with daily demand of roughly 86 million barrels per day, almost the same level as daily supply.

The following are other major factors that have driven the oil market higher.

DOLLAR WEAKNESS AND FUNDS

A combination of weaker performance in other asset classes and expectations of continued strength across the commodities complex has drawn in investors and speculative funds, providing further support for the market.

An added incentive for them has been the weakness of the dollar against other major currencies, which makes dollar-denominated commodities relatively cheap.

They are also seeking an inflation hedge, as commodities tend to rise when other asset classes fall.

OPEC

The Organization of the Petroleum Exporting Countries (OPEC) has been at the forefront of those citing speculation and a weak dollar as the reason for higher prices, saying it is pumping enough oil to keep the market balanced.

Saudi Arabia, the biggest OPEC producer, is expected to raise output close to 9.5 million barrels per day (bpd) in June up from around 9.1 million bpd in May.

OPEC has not officially increased output since a meeting last September and has no plans to meet formally until September 9.

PEAK OIL?

Some analysts have questioned whether OPEC is capable of raising its output significantly.

The so-called pessimists have argued the world’s oil supplies are at or near a peak.

Optimists say there is still plenty more oil and improved technology will ensure it can be extracted from the ground, but a host of political issues has hindered production from many of the biggest reserve holders.

Iraq’s output has been disrupted by years of sanctions and then war. Sanctions have also limited exploration in Iran and violence has interrupted flows in Nigeria.

Adding to the difficulties of getting oil out of the ground, high prices have fuelled a trend for resource nationalism, or resource-holders seeking to keep the bulk of their natural wealth for themselves.

The biggest OPEC producers already prohibit foreign operators from accessing their oil reserves.

Non-OPEC Russia, the world’s second biggest oil exporter, has also been limiting foreign involvement in its upstream while its output has stagnated.

DEMAND

There is mounting evidence high prices have begun to erode demand, but continued growth in China and other emerging economies is expected to offset the impact of any fall in developed countries.

While high taxes reduce demand in some developed economies, subsidies spur consumption in emerging economies.

In the developed world, some governments are considering reducing taxes, while emerging economies, struggling with the growing burden of subsidies, have started to lift them.

REFINERY BOTTLENECKS

Even if there is plenty of crude to meet demand that does not mean there is an adequate supply of refined products, such as diesel and gasoline, as there is a lack of refining capacity.

Faced with planning battles and reluctance to invest in the downstream sector, which is not always profitable, the world’s biggest energy consumer the United States has not built a new refinery for decades.

(Reporting by Barbara Lewis)