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Oil prices fall on fears of oversupply

Oil shares came under renewed pressure yesterday after oil prices hit their lowest level for more than two years. The drop was prompted by fears of an oil glut after Iraq said it would start exporting immediately.

But traders are also worried that increased production from Opec and reduced demand as a result of the Asian crisis will keep oil prices low for the next few years.

Iraq suspended oil exports a month ago in protest at the slow distribution of the food and medicines it gets in return for its oil. Under a deal brokered by the UN, however, the country will now resume exports, which allow it to sell $2bn worth of oil every six months, boosting world production by 1 per cent.

Meanwhile, analysts are waiting to see whether Opec members, led by Saudi Arabia, will take advantage of the increased quotas they negotiated in November to boost oil production.

Combined with the lingering effects of the Asian crisis, which has undermined expected demand growth, and the build-up of stocks due to warm weather around the world, this could lead to chronic oversupply.

John Toalster, oil analyst at Societe Generale Strauss Turnbull, expects demand next year to fall to 1.5 million barrels per day, while production could reach 2 million barrels per day.

As a result, he has cut his two-year average oil price forecast to $17 per barrel. That compares with an average price of $19.30 last year and $20.80 in 1996. "This is not just a blip. This is a fundamental sea change," he said.

Other observers remain upbeat, however, pointing out that Saudi Arabia is unlikely to use up its full production quota if it undermines the oil price by doing so.

- Peter Thal Larsen