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Last Updated: Friday, 4 June 2004, 07:24 GMT 08:24 UK
What's next for oil?
By James Arnold
BBC News Online business reporter

Saudi oil worker
Turning on the taps won't change much

Five years ago, pundits were worried that oil was getting too cheap. The $5 barrel looked a genuine prospect, heralding a wave of instability in producing countries from Venezuela to Iran.

Now, the graphs are pointing the other way. $50 a barrel is not too far off, and doom-mongers warn a terrorist outrage could push prices to $80 and beyond.

Attempting to predict the oil market, then, is a mug's game. But since things seem to have reached some sort of crossroads, it's at least worth trying out a few possible scenarios for the way prices could develop.

BBC News Online has this guide to the three most likely outcomes.

STEADY RETRENCHMENT

What's this?

A sizeable body of opinion thinks we're in the grip of temporary market madness.

The fever of wartime speculation will ease, and what analysts call "market fundamentals" will reassert themselves.

Historical oil prices
There's no reason for prices to crash, but they will drift back down - probably below $30 a barrel for Brent crude (currently at more than $38) by, say, the end of this year.

What effects would it have?

Really cheap oil is not a prospect.

With oil prices around Opec's target price of $28 a barrel, the market will return to the uneasy equilibrium of the past few years.

That sort of price is enough to keep producers ticking over, but not seriously enough to encourage major new sources of crude to be brought on stream.

With extraction costs in pricey places like the former Soviet Union at $15 a barrel and more, investing billions in ports and pipelines doesn't make a great deal of sense.

And that will keep the market tight, with possibly only 2 million barrels per day of spare capacity, in a global market of 80 million barrels per day.

How likely is it?

Less likely than many people seem to think.

Nymex oil traders
How do you value risk?
The retrenchment scenario depends on at least one major shift in the supply-demand balance - a definitive easing of Middle East tensions; a serious slackening in demand, especially in the US; or a major spurt in output among major producers like Venezuela or Russia.

None of these looks hugely likely in the near term.

Much hope is pinned on the gradual disappearance of the "risk premium", which has raised prices in response to fears of serious supply disruption.

Until this week, this premium was seen as being $4-8 of the oil price; now, estimates go as high as $12.

But oil has always carried a risk premium, the result of the fact that it tends to be produced in unstable countries. And eradicating what appears to be a speculative bubble will demand convincing the markets that the threat of terrorism has been eradicated for good.

ONWARDS AND UPWARDS

What's this?

Prices remain high, and may continue to march even higher.

Producers do their best to crank up production, but runaway demand combines with that persistent risk premium to ensure that demand outpaces supply.

In the very long term, wholly new sources of oil could be mapped, explored and exploited, but only after years of historically high prices.

What effects would it have?

A lot of effort has gone into drawing parallels between now and the oil price shock of the late 1970s.

Then, high oil prices battered the industrial economies of the developed world, and accelerated a structural shift away from traditional smokestack businesses.

US energy demand
This time, things may not be so bad.

In real terms, oil prices are not so high: crude would need to double in price to reach the same sort of levels seen in the early 1980s.

And today's economies are less dependent on oil than they were. The US, for example, now produces twice as much economic output per barrel of oil as it did in the 1970s.

Forecasting firm Global Insight reckons $40 oil would shave only 0.4 percentage points off US economic growth next year, and that the effect would moderate as time wears on.

Not everyone is so sanguine, however: the more fragile economies of Asia certainly have more to lose from long-term high oil prices.

But even there, the effects would be balanced by rising output in other areas, if oil-producing countries spend their extra petrodollars on more lavish imports.

How likely is it?

Given that this scenario depends largely on things staying as they are, it's probably the most likely of all.

Fuel price protester
And he's not the only one
Even if the risk premium moderates, there are many potential disruptions to supply on the horizon.

In Venezuela, for instance, once-plentiful production is being hammered by the weakness of state oil firm PDVSA.

Nor is it easy for production to grow in response to higher prices.

It can take up to a year to bring new output on stream even in established patches of production; opening up new areas - the Gulf of Guinea, for example - is the work of decades.

On the demand side, there is little hint of change. The US consumer is predicted to remain thirsty at least for the next two decades, counterbalancing predicted improvements in fuel efficiency.

INTO THE STRATOSPHERE

What's this?

A terrorist attack or war puts a serious crimp in oil supplies.

US oil imports
In Saudi Arabia, for example, it is reckoned that a really successful attack on the central oil-processing facility at Abqaiq could halve exports for up to a year.

All oil producing countries have their bottlenecks, key ports, pipelines or pumping stations whose elimination would cripple the industry.

The market result of such an attack is incalculable. But if Saudi exports were hobbled, $80 a barrel does not seem unreasonable.

What effects would it have?

Consumers can live with $40 a barrel; they can probably also come to terms with $50.

The question is what price level would start to make the global economy really hurt.

US analysts say the current fuss over the $2 gallon of petrol is a storm in a teacup, but that there would be genuine pain if the price approached $3.

Among developing economies, very high oil prices will have a devastating effect:

Energy use
Poor countries tend either to be very inefficient oil users, producing very little economic output per barrel of oil, or very sparing consumers, because their economies are primarily agrarian - in which case, high prices will prevent them emerging into the next stage of development.

Nor would oil producers benefit, if high prices push consumers toward seeking alternatives to oil.

At $40 a barrel, oil producers spread some of their wealth by buying in more imports; that trickledown would simply not happen at, say, $80.

How likely is it?

Who can tell? Terrorists are known to be targeting Saudi Arabia's oil facilities, but their chances of pulling off a real spectacular are unguessable.

The Saudi government says there have been five active al-Qaeda cells in the country, but that four have been broken up, and the last is now being dismantled.

Nevertheless, a recent study by the Centre for Strategic and International Studies concluded that "short-term successes have not removed cadres that are well equipped with arms and explosives, and past experience indicates that extremists and terrorists will soon change tactics, acquire better intelligence, and become far more sophisticated".

However clever the pundits may sound, the whole thing is pretty much anybody's guess.


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