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Wed Aug 4 11:20:15 PDT 2004

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PUMPING ALL THEY CAN
Aug 4th 2004  

The oil price has risen above $44 a barrel amid concerns about supply.
Last week, there were worries about the battle between Yukos, Russia's
biggest oil producer, and the tax authorities. This week, OPEC's
president said the oil producers' cartel is unable to pump more oil and
thus bring down the price. So, is expensive oil here to stay?

ANYONE who expected that the invasion and occupation of Iraq would lead
to a sharp decline in the price of oil has been sorely disappointed.
Instead of falling, the price has risen sharply, and this week West
Texas crude rose above $44 a barrel for the first time since New York's
Nymex exchange started trading oil 21 years ago.

Not only has Iraq's oil industry, hampered by creaking infrastructure
and sabotage, been unable to pump anything like its potential capacity,
but supply elsewhere is under pressure too. Last week, it appeared that
Yukos, Russia's biggest oil producer, might be forced to stop
production, as part of its ongoing battle with the country's tax
authorities. That fear proved unfounded, but oil traders remain nervous
about the capriciousness of the Russian state. They are also worried by
the apparent impotence of the Organisation of the Petroleum Exporting
Countries (OPEC). On Tuesday August 3rd, Purnomo Yusgiantoro, president
of OPEC and Indonesia's oil minister, stunned observers by saying that
the cartel would be unable to pump any more oil to alleviate the
pressure on prices. "The oil price is very high, it's crazy," he said.
But, he added, "there is no additional supply."

Like the oil market, the money markets are fretting that the high price
could hurt the world economy. Mr Yusgiantoro's comments sparked a
sell-off on America's stockmarkets, which were already worrying about
America's flagging economic performance--GDP growth slowed to a
lower-than-expected 3% in the second quarter, on an annual basis. Alan
Greenspan, chairman of the Federal Reserve, has said the high oil price
is partly to blame for weakening consumer spending, which fell by 0.7%
in June. Dresdner Kleinwort Wasserstein, an investment bank, reckons
that half a percentage point could be knocked off American growth in
2006, and 0.7 added to the inflation rate, if oil remains above $40 a
barrel. 

OPEC's power has been on the wane since the oil crises of the 1970s,
when the cartel was able to triple prices almost overnight by
restricting supply to western consumers. Since then, industrialised
economies have reduced their dependence on oil, but it is still a
crucial commodity, and OPEC still accounts for around 40% of world oil
production. Moreover, Saudi Arabia, OPEC's leading member, alone
accounts for a quarter of the world's proven oil reserves. It has been
able to influence prices simply by turning its taps on and off.

In the recent past, it has been OPEC's ability to turn the taps off
that has been in doubt. Members tended to exceed the production quotas
set at the cartel's regular meetings, in the hope that other members,
especially Saudi Arabia, would keep to their limits, and thus support
the price. The incentive to cheat grew even stronger as non-OPEC
suppliers, especially Russia, grew in importance. (Russia's output has
increased by 2m barrels per day, or bpd, every year for the past three
years.) OPEC's current production of around 30m bpd (including Iraq) is
well above its official quota of 26m bpd.

But now it is OPEC's ability to open the taps further that is in
doubt--and at a time when the antics of Russian prosecutors are also
raising questions about supply from that country. OPEC's spare capacity
is now thought to be 1-2% of global demand, well under the 4% that is
thought necessary in order to influence prices. That gap cannot be
closed quickly, since the oil-production business has long lead times
and any new oil will take a couple of years at least to come on stream.
In his comments on Tuesday, Mr Yusgiantoro hinted that that went for
Saudi Arabia as well as the rest of OPEC.

Saudi production in July was 9.25m bpd, well above its 8.45m quota, but
below its 10.5m official capacity. Following Mr Yusgiantoro's comments,
Saudi officials insisted that they could indeed raise output quickly.
Saudi Arabia is close to opening two new production plants at Abu Safah
and Qatif, which will pump close to 1m bpd. However, these are meant to
replace production from older facilities, not to add new output.

In addition to OPEC's attempts to increase supply, the International
Energy Agency also expects non-members to boost output by a combined
1.2m bpd over the coming year, of which around half will be from the
former Soviet Union. But that figure is hostage to events in Russia. At
1.7m bpd (more than is pumped from all of Libya's wells), Yukos's
output makes up 2% of global oil production and thus has a noticeable
effect on the price. With Russian officials now attempting to sell the
company's prize subsidiary, Yukanskneftegaz, oil traders are likely to
remain jittery. 

Another factor adding to nerves in the market is the new alert about
more attacks from al-Qaeda, issued by America's homeland-security chief
on Sunday. This came as a stark reminder of the dangers facing America
(the world's largest oil consumer) and the instability in the Middle
East (home of much of the world's oil reserves), and helped push the
oil price up. With this uncertainty likely to continue, OPEC likely to
keep brushing up against its capacity limits, and Yukos certain to
remain under fire, the world may just have to get used to oil of $40 or
more a barrel.

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