The increased cost of finding and developing non-OPEC oil has fuelled speculator

LONDON (Reuters) – Saudi Arabia’s call for OPEC to cool prices by increasing supply aims to douse a rally that has sent oil prices up around 20 percent this year to the highest level in 13-years. Despite Saudi Oil Minister Ali al-Naimi’s comments, oil prices are still within a dollar or the $40 mark after rising 22 percent this year. Following is a list of the main factors behind oil’s price surge.
Why are oil prices so strong?
Mon 10 May, 2004 17:18

Saudi calls for OPEC action

LONDON (Reuters) – Saudi Arabia’s call for OPEC to cool prices by increasing supply aims to douse a rally that has sent oil prices up around 20 percent this year to the highest level in 13-years. Despite Saudi Oil Minister Ali al-Naimi’s comments, oil prices are still within a dollar or the $40 mark after rising 22 percent this year. Following is a list of the main factors behind oil’s price surge.

– Low inventories.

Oil companies have sought to become more efficient and free up capital by holding lower stocks of oil. This has given the oil industry less of a cushion against sudden supply disruptions.

A wave of oil mergers following 1998-1999’s price crash also reduced the number of companies holding inventory. A series of supply disruptions last year — the war in Iraq, Venezuela’s general strike, and ethnic unrest in Nigeria — further cut into stocks.

– OPEC supply management emboldens speculators

The OPEC oil cartel, which controls around half the world’s exports, has worked hard to stop stocks building — especially in the United States — during periods of seasonally weak demand. Ministers have announced plans to cut production before prices start to weaken, giving refiners no chance to replenish stocks with cheap crude or products.

The resulting lack of stock cover leaves refiners more vulnerable to supply disruptions and increases the likelihood of price spikes. This in turn has attracted heavy buying interest from big-money speculative hedge funds.

“OPEC strategy has shaped oil markets into a bullish machine in a tense international environment,” said consultants PFC Energy. “This has caught the attention of speculators and hedge funds, who have magnified the current pressures in oil markets.”

The post-September 11 chill in relations between Saudi Arabia and the United States means that Riyadh is no longer willing to act as a guarantor of cheap oil as during the 1990s. “While the Kingdom remains the ultimate guarantor of oil supplies in case of emergency, it has given up its role of price moderator inside OPEC”, PFC Energy said.

– Political tensions in oil producing nations

Tensions in the Middle East, especially Iraq, have undermined traders’ confidence in security of supply from the region, which pumps a third of the world’s oil. Iraqi exports have finally recovered to pre-war levels but traders fear they will be disrupted again in the run-up to the June 30 handover of power to the Iraqis.

A possible August referendum over Venezuelan President Hugo Chavez’ rule could again destabilise exports from a big U.S. supplier. Potential unrest in Nigeria is another flashpoint, while traders fear Islamic militants could also target oil infrastructure.

Shootings at a Saudi petrochemical plant earlier this month have fostered fears of a larger attack on the kingdom’s tightly-protected oil facilities.

Concern over possible supply disruptions have spurred many countries, including the United States, to increase their strategic oil inventories, which withdrawn further supply from an already tight market.

– Rising demand

China’s economic expansion has given a dramatic boost to world oil demand, sucking in crude and refined products from all around the world. Unless China’s economy overheats, traders expect its fuel demand to keep growing for the next two or three years, which has encouraged the speculative hedge funds to bet that high oil prices are here to stay.

At the same time, sharper growth in the U.S. economy, which devours a quarter or all world oil, is driving competition between Asia and the U.S. for supplies.

The demand growth has caught analysts such as the International Energy Agency by surprise. Consumption forecasts have been too low, which means that producers have been keeping supplies even tighter than they needed to prevent stocks building.

Higher demand means that a shortage of refining capacity that has plagued the United States for the last four years has now spread to Asia, again leaving the global oil supply system more exposed to disruption.

–Refinery bottlenecks

Environmental regulations are pushing up the price of making fuel, forcing companies to build expensive new facilities and making it harder to ship supplies between regions.

In the United States, individual states demand an array of different gasoline blends. This makes it harder to ship supplies between states and to import supplies from abroad.

The high costs of building the units needed to make the new grades of fuels means that capacity is in short supply.

Environmental concerns has also made it more expensive to build new refineries, and much harder to get the necessary permits.

The United States accounts for about 45 percent of world gasoline consumption, with demand bolstered by the growing numbers of low-mileage-per-gallon sports utility vehicles on America’s highways.

This has driven a growing need for the high-quality light, low-sulphur crude that is good for making gasoline. Most of OPEC’s crude is heavy and high-sulphur.

– Scarcer oil

Big oil reservoirs are becoming harder to find and more expensive to develop. Many of the oil provinces outside OPEC are mature, which means that finds are now smaller, need more costly technology to develop and fall faster from peak production.

Oil companies have also been cautious on spending since the ‘97-’98 price crash slashed their share prices and forced them into a spate of mergers. They have focused on large-scale projects, which will give them good margins.

Many of these ventures are in remote areas, which demand expensive equipment and are more susceptible to delays. Forecasts of non-OPEC supply growth — especially when the rebound in Russian production is stripped out — have consistently been overstated, giving OPEC much more room for manoeuvre.

The increased cost of finding and developing non-OPEC oil has fuelled speculators convictions that oil markets are a good long-term bet. Royal Dutch/Shell ’s reserves troubles have reinforced the view that oil is becoming harder to find.

In OPEC, which holds around two-thirds of the world’s oil reserves, many nations either do not allow foreign investment in oil, or have unattractive investment and legal terms.

This has slowed down production capacity growth in most OPEC nations, meaning that most are producing flat out to meet current demand. Only Saudi Arabia holds substantial spare capacity, giving it even more leverage over prices.

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