Oil: does anyone know which way the wind blows?

As Opec hosts a meeting of global leaders, Mark Leftly sees if sanity can be restored to a world where predictions lurch from $80 to $250 a barrel and from stability to catastrophe

Sunday 15 June 2008 00:00

Abdullah al-Badri is about to become a very familiar name – as familiar as the redoubtable Sheikh Yamani was in the great oil crisis of the 1970s. As the secretary-general of Opec, Mr Badri is in the position to guide the production of about one-third of the world's oil supply. With the black stuff selling in excess of $130 a barrel, and predictions that this could soon double, Opec has not held such influence since Sheikh Yamani's leadership during the 1970s.

Next Sunday, Mr Badri and the Saudi Arabian government will host a meeting of oil companies, global leaders – including Gordon Brown and US Energy Secretary Samuel Bodman – and investment banks to address the world's concerns. For his part, Mr Badri has claimed the world is "panicking too much" and that there is "no shortage" of oil. It seems, then, that Opec is unlikely to signal a significant increase in its output at the meeting.

That won't lighten the mood of two of the banks at the meeting, Morgan Stanley and Goldman Sachs, where analysts have predicted that the price of a barrel will move to $150 over the course of the summer – possibly as early as next month. Alexei Miller, chief executive of the Russian energy giant Gazprom, even suggested oil could reach $250 by the end of next year.

The causes of this surge are hotly debated. Geopolitics, environmentalism and demand from emerging markets all have their advocates, though most commentators seem to agree that all these issues are entwined to some extent.

Then there are the knock-on effects, ranging from the difficulty in completing oil company mergers to the queuing of motorists in forecourts, exacerbated by this weekend's strike by tanker drivers. As the surge continues, these effects will become even more acute.

One of the more dire predictions comes from Jeff Rubin, chief economist at Canadian bank CIBC: "Four to five years from now, airports like Heathrow and Gatwick will be half-empty. North American airlines are already passing on fuel surcharges to customers. People ain't going to be flying because of the fuel costs, so half the airlines are going to go bankrupt."

Mr Rubin says the only solution is for "people to get off the road". With supply not growing and the "world thirstier for oil than six years ago", he forecasts $225 a barrel by 2012. At that price, American motorists will pay the same amount to fill a tank as their British counterparts do today.

In emerging markets, the price of fuel is negligible. In Caracas, Venezuela, for example, a litre costs between 5 and 25 cents. Some analysts blame governments for providing gasoline subsidies that remove a natural cap on demand. Simon Denham, the director of spread-betting firm Capital Spreads, says: "Those governments, such as Egypt and India, which subsidise so the price ends up well below the cost of fuel don't dare remove their aid as it could lead to social unrest. But it is driving prices up [round the globe]."

He adds that because of the volatility of the oil market, he advises his clients to steer clear of betting on the sector. "But it's like a red rag to a bull," he chuckles. "Clients love trading things that move quickly, but that means they have the potential to lose large sums very, very quickly."

Even so, Mr Denham believes the fundamentals of the market – even in the North Sea it costs less than $20 a barrel to extract the oil – are such that the price will settle back to $80 next year. Improvements in Russian infrastructure and untapped reserves in North America and the Arctic should also provide long-term supplies, though Mr Denham adds: "The environmentalists are putting up a good battle" to stop many of these projects.

One area in which environmental groups have been particularly dogged is Alaska. According to the pressure group Arctic Power, "more than 75 per cent of Alaskans support exploration and production on the Coastal Plain" of the Arctic National Wildlife Refuge. The US Department of Energy suggests production there would only cut world oil prices by 75 cents a barrel and the Senate has repeatedly blocked plans for development.

But Kara Moriarty, deputy director of the Alaska Oil & Gas Association, points out that development would increase the state's production by one million barrels a day, more than doubling its current rate of 750,000. The British Treasury estimates that world oil demand will have grown by 12.7 million barrels a day by 2015, meaning Alaska alone could quench 8 per cent of this thirst. Ms Moriarty concedes, though, that environmental groups have been "active in Alaska and are very effective".

With no squeeze on the oil price, it is becoming increasingly hard to value the companies involved in exploration and production. David Waring, head of energy for Europe, the Middle East and Asia at investment bank UBS, points out that British giant BG Group failed to snaffle Australian rival Origin last month because rising oil prices meant its $13bn offer suddenly looked rather paltry. "As oil goes up, it becomes so hard to price deals and agree terms."

But there are also benefits to the corporate world. Mr Waring is working on the initial public offering of Cadogan Petroleum, the oil sector's first full listing on the London Stock Exchange since 2006. "The IPO sector has opened up – oil looks positive against a falling market," says Mr Waring, adding that a second float, OGX in Brazil, is heavily oversubscribed as investors look to tap rising oil profits.

Kevin Broger is another who has benefited. He is chief executive of Chariot Oil & Gas, an exploration group that listed on the junior Alternative Investment Market last month. While conceding that May's price surge made it "the perfect time" to list, he says price hikes will have to be tackled long term. He suggests supply will inevitably increase as the market grows.

Mr Broger adds that at today's prices, wells could be "switched on" for poor-quality oil that would previously have been uneconomic even at $80 a barrel. The key, he argues, is investment in refineries, as there are few that are capable of cleaning up so-called "heavy oil". Mr Broger also points out that technology has "come on leaps and bounds", to the extent that some drills can reach depths of 2,000 metres, whereas half that was once the norm. More oil is becoming accessible.

And there are signs that some Opec countries are willing to increase output. Mohammed al-Hamli, the United Arab Emirates energy minister, admitted last week that prices are "crazy" and said he was "quite happy" to increase supply if necessary.

All it will need is a nudge from Mr Badri to his Opec members to turn the taps on the wells and help contain the growing crisis. Hopefully, he won't get too much of a taste for his new-found power and surprise delegates in Jeddah by offering them some black gold.

World's richest nations gather as fears mount over the fallout from oil hikes

Top of the agenda at this weekend's summit of G8 nations in Osaka was the spiking oil prices.

Finance ministers including Alistair Darling were expected to discuss the inflationary pressures caused by the commodities price surge and the difficulties this causes the world economy.

Oil dropped below $135 a dollar on Friday, providing some hope of respite. The price of oil has increased by nearly a quarter since the last G8 meeting two months ago. Some observers worry that this rise has been caused by speculation rather than the underlying performance of the commodity, but there is widespread disagreement over whether this is the case.

The fear in the UK is that comparatively slight hikes in the oil price can lead to a hefty cut in consumer spending. It was reported on Friday that Ian McCafferty, the chief economic adviser to the CBI, said that every $10 increase led to a quarter percentage point cut in spending.

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