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Rising oil prices are on a slippery slope to disaster

Times Online
The Times
June 13, 2008

Rising oil prices are on a slippery slope to disaster

When hauliers blocked the streets of London, Gordon Brown flew to Aberdeen to talk to Britain’s oil bosses. Less than a month later, tanker drivers are threatening further chaos and the Prime Minister wants to fly to Saudi Arabia to talk to Opec.

The pow-wow in Jedda on Sunday between oil-producing and consuming nations will not produce cheap diesel but Mr Brown knows he must be seen to do something – the oil price has almost tripled in two years and expensive fuel is hurting every business, from airlines to chemical manufacturing. The soaring cost of moving goods about the world threatens to unravel a complex web of trade and manufacturing. It is not just about importing refrigerators from China or football boots from Vietnam. It is also about the price of food. Farming is energy intensive – diesel is needed for tractors, fertilisers are made of by-products of oil and gas, and grain is shipped thousands of miles across the ocean.

The Prime Minister ought to find common cause with an oil sheikh. Neither wants to see a global economic slump and food inflation is causing panics in the Middle East. But this meeting will be a dialogue of the deaf, with each side pointing a finger at the other.

The world needs more oil, says the West. According to BP’s annual review of world energy, published this week, global oil production declined slightly in 2007 while consumption rose. Sam Bodman, America’s Energy Secretary, will call for more investment, an end to the protectionist policies of the oil-producing nations and, in the short term, increased output from Saudi Arabia, the only nation with a significant buffer of spare oil capacity.

In Jedda, Opec ministers will listen politely and say that there is no shortage, no refinery is running dry of crude. Opec’s president insisted yesterday that the market was in surplus by as much as 500,000 barrels per day.

Opec fears an imminent oil glut. Look at the American economy, say the Saudis, and look at the American motorist. Petrol demand in the US has been falling since October as the financial storm from the housing sector crimps demand and Americans trade in their SUVs for more modest vehicles. Last month US petrol consumption fell by 130,000 barrels per day.

Meanwhile, consumption surges in China, India, and oil-producing Gulf states, where subsidies shield consumers from high oil prices. It is an upward spiral, Jeff Rubin, of CIBC World Markets, says. “Petrol is 25 cents a gallon in Caracas, 60 cents in Riyadh. In those countries, higher oil prices lead to even greater oil consumption. It leads to higher oil revenues, which in turn are spent on subsidised petrol.”

Opec fears recession, but its logic leads it to keep oil tight to avert a price collapse. It blames the oil price on speculators and hedge funds seeking to ride the upwards escalator in everything from corn to palm oil. Statistics from Nymex, the home of the US light crude futures market, show a close correlation between the rising price of crude and the expanding volume of open interest, the number of contracts traded on the exchange.

The sheer volume of oil futures trading is helping to propel prices higher, says Leo Drollas, chief economist at the Centre for Global Energy Studies. “It used to be just the [oil] industry and a few speculators, now pension funds and investment banks are trading this on their own account,” he said.

You might think that oil company executives would be gleeful about oil at $140 per barrel, but the mood in the corridors at Exxon, Shell and BP is gloomy. They are fearful of the future, and they struggle to find ways of investing their cash hoards. Big oil is not blaming speculators for the price – BP blames barriers to investment and excessive taxation. Some companies, such as Total of France, reckon the world will be unable to raise production to much higher levels, not because oil is running out but because of politics, nationalism and the sheer difficulty and cost of raising the bar.

Like a monster consuming its own tail, the high oil price is damaging the oil industry itself, wrecking the economics of oil refining and raising the cost of drilling wells.

http://www.timesonline.co.uk/tol/news/uk/article4124333.ece

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