Why oil prices are stubbornly high

OPEC is likely to announce Thursday that it will increase production, but traders may wait until they see the oil pumped.

By , Staff writer of The Christian Science Monitor

Show me the oil!

That, in essence, is what the markets are likely to say about OPEC's professed intention to increase production in an attempt to lower oil prices.

In the past, mere words from OPEC ministers were enough. Oil prices shuddered and fell at the merest hint of opened spigots.

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But no longer. As the 11 oil-producing and exporting nations meet Thursday in Beirut, a different factor is in play: Spare production capacity is now at one of its lowest points since the early 1970s.

Tight inventories and rising demand in parts of the world, most notably China, have forced the world to operate on an unusually low margin. And any disruption could have serious consequences.

Thus energy analysts believe that OPEC will have to back up its statements by pumping oil out of the ground. "It will take a physical presence of oil to deflate expectations," says Michelle Billig, a fellow at the Council on Foreign Relations and a former analyst at the Department of Energy.

The bulk of any increased output is expected to fall on Saudi Arabia, but skeptics wonder if the oil kingdom can keep its oil infrastructure secure while it pumps an extra 1.5 million barrels of oil per day. Wednesday the United Arab Emirates, the only other nation with spare capacity, said it would produce an extra 400,000 barrels of crude oil per day.

There will be even more urgency to the Beirut meeting because high oil prices preceded the last several recessions. And oil ministers are mindful of the fact that after similar run-ups, the price of oil has plunged as the world sought alternative energy sources. "The Saudis have an interest in seeing the price of oil fall," says Robert Hormats, vice chairman of Goldman Sachs International. "They don't want to price oil out of the market."

Next week, when the major consuming nations meet for their annual G-8 summit, energy is likely to be high on the agenda. "It has to be," says Mr. Hormats, noting that the oil crisis of 1973 was the catalyst for the summits to begin with. "Here we are 30 summits later, and we're still relying on imported oil."

In fact, the G-8 has invited two OPEC members - Nigeria and Algeria - to be guests at the meeting in Sea Island, Ga.

If Saudi Arabia does increase production, it wouldn't be the first time it ramped up before an election, says Gary Taylor, a principal at the Brattle Group in Cambridge, Mass. "The Saudis love to help us before the elections," he says. [Editor's note: The original version misspelled the name of Taylor's company and located the company in the wrong city.]

But Mr. Taylor says it's likely that OPEC will abandon its goal of keeping oil between $22 and $28 a barrel. He thinks the new range will be between $30 and 32 a barrel. "If OPEC can produce another 2 million barrels of oil per day, this will bring the price down some," he says.

Wednesday, the price of oil retreated slightly in morning trading. However, on Tuesday, it hit a record high of $42.33 a barrel. "It's all event psychology," says Mike Fitzpatrick, a trader at FIMAT USA, a commodities brokerage in New York. "There is no real shortage. The price is just based on what might happen," he says.

Yet Ms. Billig of the Council on Foreign Relations says the instability among some of the world's important oil suppliers is a troubling development. Although the attacks in Saudi Arabia have yet to hit at oil facilities, she says, "They are coming closer to the heart of production."

Saudi Arabia is not the only oil producer struggling with turmoil. In Nigeria, some oil production has been reduced because of unrest. In Venezuela, production has still not recovered from strikes and political upheaval. Although Iraq is exporting oil, insurgents are getting better at hitting the oil infrastructure.

"If any one of them has a serious problem, it stretches oil supplies to the limit," says Erik Kreil, an analyst at the Energy Information Administration.

In the past, there was skepticism over whether OPEC nations would cut production when oil prices fell. "This skepticism that they can produce more is relatively new," notes Adam Sieminski, an energy analyst at Deutsche Bank in London. "I think in June we'll see 1 million more barrels of oil per day being pumped compared to May, and that will take some of the steam out of the price."

The nervousness over supply coincides with a growing global thirst for petroleum. A whole new middle class in China and India is buying automobiles - absorbing much of the extra oil production and resulting in low worldwide inventories. "One-third of the new demand might be China," says Mr. Fitzpatrick. There might also be some official stockpiling as some nations seek to guard against an emergency. "Asian buying for strategic reserves - including China, Korea, and India - could be significantly impacting the level of apparent demand," says Mr. Sieminski.

The US, in fact, is continuing to buy oil for its Strategic Petroleum Reserve. Some analysts believe the US is adding between 50 cents and $1 to the price of crude with its program, which is taking in 125,000 barrels of oil per day. Some members of Congress have pressed the administration to suspend the buying while the price remains high. Sieminski thinks suspending the program makes sense: "Why are we buying oil at $40 a barrel when most people think it's going back to $30 a barrel?"

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