Supply fears drive oil to record prices

Oil prices surged to a record high yesterday on the back of tension between Turkey and Iraq, adding to concerns over global supplies before the northern winter.

The oil price has risen steadily in recent months after dipping below $50 a barrel at the start of the year. After its recent gains, the crude price has quadrupled since 2002, although it still trails the inflation-adjusted peak of more than $90 a barrel set in 1979 during the Iranian revolution.

However, the price is seen as likely to match that record in coming weeks as several factors drive up the cost of crude. On the New York Mercantile Exchange (Nymex), crude prices soared past $85 a barrel for the first time to trade at $85.44. In London, the benchmark Brent crude closed at a record $82.75, passing $82 for the first time.

Citigroup, the US investment bank, said that a run at $90 a barrel is now seen as "reasonable" due to the weakness of the US dollar and resilient demand. James Neale, an analyst with Citi-group in London, said: "The higher near-term oil price reflects the current macro cocktail of tightening inventory balances in crude and particularly refined products." The bank raised its Brent oil price forecasts for the second time this year, adding $10 a barrel to its 2008 and 2009 forecasts to $70 and $65 a barrel respectively.

Analysts attributed yesterday's rise to the threat of conflict between Turkey and the PKK Kurdish separatists in northern Iraq. The Turkish parliament is expected this week to approve the use of military force against Kurdish rebel camps in northern Iraq after claiming that the Kurdish separatists have killed 30 Turkish soldiers and civilians over the past two weeks.

Although the vast majority of oil pumped out of Iraq is from the south of the country, there are fears that conflict could further destabilise the region.

The oil price reached record highs last week after the US Energy Department said supplies in the country declined in the first week of October, when they had been expected to rise. Meanwhile, the International Energy Agency said that oil reserves held by the largest industrialised countries had fallen below a five-year average. Demand from emerging economies such as China, as well as from the US, continues to grow rapidly.

Supply concerns have been building all year after the Organisation of Petroleum Exporting Countries (Opec), which accounts for around a third of the world's oil, began reducing output late last year in response to falling prices. Last month, Opec agreed to up its output by half a million barrels a day from Nov-ember, easing supply concerns.

However, Opec warned yesterday that production from other oil-producing countries is set to decline. It said that non-Opec members are likely to produce up to 110,000 fewer barrels a day than was previously anticipated, heightening concerns of a tight supply market given that demand has grown by around 100,000 barrels a day compared with last year.

Oil supply from Nigeria, the world's eighth-largest producer, has been hit due to attacks by militia on production facilities, while concerns remain over supply from Iran due to tension with the West over the country's nuclear strategy.

Yet it is not only supply concerns that have pushed the oil price higher; the weakness of the US dollar is also driving investment in commodities such as oil and gold, with a wave of buying by the likes of hedge funds and pension funds looking to buy into the commodity as a hedge.

Shares in European oil giants such as BP and Shell rose on the back of the record prices, but Citi-group analysts warned that cost inflation in the oil sector could dampen impact in the long term.