BP adds fuel to the oil price debate

It's a great global debate. What has driven oil prices to their current dizzy heights?

According to the oil producers' cartel Opec, the blame lies with speculators in the international markets. But Tony Hayward, chief executive of BP, describes that view as "a myth".

He argues that the main cause is the tight balance between global supply and demand.

BP's new Statistical Review of World Energy - a key information source for many people in the industry - highlights what has been going on.

Falling production

According to BP, global oil consumption grew by 1.1% in 2007, while total production fell by 0.2% or 130,000 barrels per day - the first decline since 2002.

Production in Opec countries was cut in November 2006 and February 2007.

The largest production cuts last year were in Saudi Arabia - the country which has by far the largest oil reserves in the world and is normally the world's largest producer. But BP says Saudi Arabia's 12.6% of global output was almost matched by Russia.

In 2008, BP expects Russian output to fall by around 1%. And although Saudi Arabia has committed itself to some small production increases, the balance between supply and demand looks likely to remain extremely tight.

The rise in oil prices has been remarkable. In 1997 the average price of a barrel of Brent crude was $12.72. In 2007 it was $72.39. And earlier this month it touched $137.

Demand growth

Can such huge rises be explained by changes in supply and demand? In theory, yes they can. If there is even a small shortage of supply oil buyers will bid up the price to make sure that they do not end up with less oil than they want.

Read BP's 2008 Statistical Review of World Energy

That upward pressure continues until some market participants are forced out of the bidding because they cannot or will not pay the market price. In other words, demand for oil falls back.

But in spite of the price increases, demand for oil around the world has continued to rise. That overall rise masks some important regional variations.

In the European Union consumption of oil was 2.6% lower in 2007 than the previous year. But in China and much of the developing world, consumption continued to rise.

BP's Tony Hayward argues that demand growth is concentrated in those emerging nations that subsidise fuel prices, thus shielding consumers from the rising cost of oil. This year a number of countries including India and Indonesia have cut their subsidies.

Tight market

There is some evidence that the latest rises in fuel costs are at last beginning to reduce demand. But the extent of that reduction remains to be seen.

So the tight balance between supply and demand creates an environment in which even minor news stories about disruption to oil fields can cause sudden leaps in market prices.

Traders certainly try to make money out of the rises and falls. But BP's argument is that the markets reflect the underlying fundamentals and do not create them.

Opec is planning a meeting of heads of state from leading oil producing countries in Saudi Arabia later this month. There will be pressure from around the world to increase production.

No doubt the debate about who's to blame for high oil prices will resume.

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