energy --------------------------------------------------------------------------------

Can we afford oil at $30 a barrel? Published: August 31 2000 20:16GMT | Last Updated: August 31 2000 22:59GMT

The price of oil is beginning to hurt. The blockades of the Channel ports by French fishermen are the latest eruptions of a surge of protests against high fuel costs from Britain to Bangladesh, from Thailand to Zimbabwe.

Governments in oil-consuming countries are getting worried. The comfortable certainty that oil prices would soon head back towards $20 has been shaken. Many analysts now suspect that prices are heading higher: Goldman Sachs has suggested the $50 barrel as a possibility.

Even if there is a further increase in output from the Organisation of Petroleum Exporting Countries, it may not have much immediate effect on fuel prices.

The fundamental problem is that there is little leeway in the production chain that takes oil from a hole in the ground to consumers' cars and homes in Europe and the US.

Most Opec countries, with the exceptions of Saudi Arabia, Kuwait and the United Arab Emirates, are already producing at or close to full capacity. The world's tanker fleet is operating at 97 per cent capacity for the first time since 1973. Refineries, in the US at least, are working flat out. US crude stocks are at their lowest for 24 years and developed country stocks of petroleum are as low as they were in 1996, which in turn was the lowest level since the mid-1980s.

The upswing of oil prices is not just the result of Opec's supply restrictions. There has also been strong global demand, as the world economy has had its best year since the 1980s. As in the classic business cycle model, supply fell when prices were low and is taking time to respond now they are high.

"It is pure economics," says Susan Graham of Merrill Lynch. "Ten dollars a barrel oil means people don't produce, so you get a lack of capacity in Opec."

Refining, too, has been unprofitable as margins have been squeezed and construction has ground to a halt in the US and Europe. The US has run a structural deficit in petroleum for several years.

Although there is still some spare refinery capacity in Europe, analysts say it is uneconomic to use, and is of little help to the US. Shortages may well persist into the winter and as demand rises price spikes for some products are a distinct possibility.

For the moment there is still little chance that stocks will be built up again to provide the cushion the market needs for stability.

"Right now the spot price is higher than the futures price. So you lose money simply by holding stocks," says Leo Drollas of the Centre for Global Energy Studies. "If stocks are to be restored, we have to see spot prices falling below futures prices."

Given the nervous state of the market, some analysts think that is most likely to be achieved by the futures price rising above $30 a barrel. Mr Drollas thinks the spot price will fall if Saudi Arabia continues to raise production, but that may take some time.

Whatever the politics may be, Saudi Arabia's economic interests are clear. It gets the most benefit from an oil price that is as high as possible without either stimulating increased use of alternative energy and increased exploitation of other oil reserves, or tipping the world economy into recession.

The effects of the oil price are more severe in Europe, where the rise has been much steeper in own-currency terms because of the fall of the euro against the dollar. But for all the protests, the developed world seems to be coping reasonably well with oil at $30 a barrel. That is probably the best reason for thinking that, for the time being, prices are unlikely to fall.

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-- Martin Thompson (mthom1927@aol.com), August 31, 2000

Answers

Can we afford $30 barrel oil? Its no problem if you're driving a Geo or similar econobox. I'd hate to be driving a gas hog though.

-- Guy Daley (guydaley@altavista.com), September 04, 2000.