why are oil prices so high? SEPT 2004

http://news.bbc.co.uk/2/hi/business/3708951.stm

This is SEPT 2004 article

Why are oil prices so high?

No sign yet of oil prices dropping back to earth Crude oil prices have risen by about 30% this year to levels not seen since the early 1980s. The latest rises are causing worries in importing countries about the economic cost of higher energy prices. Higher fuel prices can cause unwelcome rises in inflation, restrict economic growth and are unpopular with voters. Major oil exporters are divided between those such as Saudi Arabia and Kuwait that favour lifting output in an attempt to ease prices, and those such as Venezuela that argue against conciliatory moves towards big consumers, principally the US. The price of US-traded light, sweet crude rose in September to more than $50 a barrel while UK-traded Brent crude from the North Sea rose to $46 a barrel. BBC News Online explains why prices are so high. RISING DEMAND Global economic expansion is driving what the International Energy Agency says is the biggest increase in oil demand for 24 years. There is higher than expected demand in industrialised countries and China's rapidly expanding economy has created a huge demand boost. US demand has risen because of strengthening economic recovery and greater need for higher grade crude oil suitable for processing into petrol (gasoline) for the fuel-hungry Sport Utility Vehicles (SUVs) popular with US drivers. Chinese demand is up 20% over the past year. Traders are betting this rapid growth will continue for several years although there is some chance that the economy will "overheat" and oil demand growth will slacken. Among suppliers only Saudi Arabia has significant spare capacity that it can make available to the market. LOW STOCKS Oil companies have tried to become more efficient in recent years and operate with lower stocks of crude oil. This means there is less of a cushion in the market against supply interruptions. Events such as violence in the Middle East, ethnic tension in Nigeria and strikes in Venezuela have had a greater effect on prices in the past year than might have been the case if stock levels were higher. OPEC STRATEGY The producers' cartel Opec accounts for about half of the world's crude oil exports and attempts to keep prices roughly where it wants them by trimming or lifting supplies to the market. In the past, Opec ministers tended to wait for prices to dip before agreeing to cut output. China's booming economy is sucking in a huge amount of oil But Opec is now acting more aggressively, announcing production cuts to pre-empt any weakening in prices. International oil companies traditionally used times of seasonally weaker demand, when prices were lower, to rebuild stocks. These windows now appear to have been closed. Data error is an additional factor, some analysts say. Consumption forecasts by market experts turned out to be too low. The result was that producers kept supplies even tighter than was needed to prevent rebuilding of stocks. ACTION OF SPECULATORS The combination of low stocks and Opec action to keep them low leaves the market exposed to the prospect of sudden price rises if supplies are threatened. This has not gone unnoticed by professional market speculators. Hedge funds and other speculators betting on the possibility of higher prices have themselves exacerbated price pressure in the market. Opec officials tend to blame speculators for 2004's run-up in prices, ignoring the organisation's earlier role in preventing stock rebuilding. Opec argues that its members are now pumping flat-out - which is largely true - and that it is powerless in a situation where factors other than mere supply and demand are at work. VIOLENCE IN THE MIDDLE EAST The world's major oil consumers remain dependent on the Middle East for their oil. Recent violence in Iraq and Saudi Arabia has again raised fears about an interruption to supplies. Iraqi exports have been cut by sabotage attacks on oil facilities. The reduction in supplies has been relatively modest but it has caused some doubts about Iraq's longer term prospects of becoming a large and stable oil exporter. Attacks on foreign workers in Saudi Arabia by Al-Qaeda-inspired militants have also increased tensions. Any substantial attack on Saudi oil facilities would be a major event for world oil markets. The country is the world's biggest oil producer and, by far, the biggest exporter. OTHER POLITICAL TENSION Analysts also view political tension in non-Middle East states Nigeria and Venezuela as having the potential to disrupt exports and drive up world prices. And there have been worries that a dispute between Russia's government and the country's biggest oil company, Yukos, will lead to the shutdown of a good deal of Russia's production. Yukos pumps a fifth of Russia's approximate 8.5 million barrel a day output but faces bankruptcy and/or dismantling over huge government demands for back-taxes. INSUFFICIENT US REFINERY CAPACITY Low US gasoline stocks and pressure on US refiners to increase production of new gasoline blends have also helped drive world crude oil prices. Environmental regulations demand new grades of gasoline, which can vary from state to state. But building processing facilities to serve so many different markets is expensive and environmental concerns can make planning permission difficult to obtain. This means refiners are struggling to meet demand and are competing with each other, and with China, to secure supplies of the high quality, light, sweet crude needed for new gasoline blends. Saudi Arabia's previously spare capacity, now being pushed into the market, is mostly of a heavier grade than is suitable for processing into gasoline. It will not alter the supply-demand situation for high grade crude oil. At best, it will have a limited psychological impact, sending a message that the world's largest oil exporter will do what it can to cool prices.