Oil Prices Will Continue To Rise; OPEC Decisions Will Have Short-Term Impact:.

*** In Recent Months OPEC Has Been Producing About 28M B/D Of Crude And Almost 4M B/D Of NGL, With Non-OPEC's Supply Of Oil & Gas Liquids Now Averaging About 49.2M B/D

*** IEA Has Revised Its World Demand Projection For 2004 Upward To 80.6M B/D; The 2.5% Surge From 2003 Is The Highest Since 1988, When Demand Rose By 1.98M B/D After The 1986 Oil Price Collapse

*** The Current Crude Oil Price Has A $12/B Premium That Reflects Middle East Uncertainties, Including Civil War In Saudi Arabia & Blasts In Iraq; The Real Market Fundamentals Are Reflecting Shortages In Refining, Storage And Shipping Capacities In The US & Asia

Strong demand, mainly in the US and China, has made crude oil prices above $40/barrel sustainable in recent weeks. Accounting for 38% of world oil output, OPEC can only prevent a fall in prices below $25/b for its basket of seven crudes. It cannot control prices when they are above $30/b. So the June 3 decision of OPEC's ministerial meeting in Beirut will make no lasting difference to a US consumer paying $3/gallon for reformulated gasoline (RFG) or to an energy-intensive industry in China forced to burn anything it can get.

OPEC's Beirut move had no lasting effect on the market. World oil demand this year is rising by 2m b/d, as in 2003. This puts the oil industry close to capacity. But the market is tight more because of a decline in world oil production capacity than as a result of strong demand, although prices are being raised more by the buyer than by the seller.

Even if the US dollar keeps falling, however, OPEC's new "price opportunity" - as distinct from a $22-28/b price band it had been defending until late 2002 - is exposing conventional oil to serious risks. Already alternative sources of energy are competing with conventional oil.

In the east of Venezuela, where fields have not been properly maintained since a general strike began in late 2002, the cost of producing conventional oil has risen to more than $12/b, while the cost of producing synthetic crudes from Orinoco bitumen averages less than $10/b. This is close to the cost of producing synthetic crude from tar sands in Canada, where the recoverable reserves are estimated at 180 billion barrels. Venezuela's bitumen reserves are believed to exceed 2,750 billion barrels.

Although the current crude oil prices are high, in real terms oil remains relatively cheap. According to Petroleum Argus, prices at $40/b adjusted for inflation are as high as in 1974-78; and "there are fears that disruptions in Iraq could bring further rises, echoing the 1979 Iranian crisis, when prices hit $70/b (in today's money)".

In their new book, The Oil Factor, Stephen and Donna Leeb float the possibility of crude oil prices reaching $100/b or more. They say China's shift to energy-intensive manufacturing will spur rapid growth in oil demand. China's demand in 2004 is rising by 720,000-740,000 b/d, which is more than the whole growth in the rest of Asia.

Yet the Leebs do not expect a major shift to alternative sources of energy soon as a result of high crude oil prices. They argue that alternative sources of energy will not be developed on a big scale until conventional oil has passed the $100/b level.

In the US, on the other hand, the gas-guzzling SUVs are no longer popular and are not selling even at a discount. This will cause the US market for gasoline to shrink and the result will be a fall in oil prices after the summer, with additional supply from OPEC to help build up stocks for the winter (see following pages & Downstream Trends).

Matt Simmons, an energy financier, says OPEC states' wish for higher living standards will force oil prices further up. He believes Saudi Arabia, now facing civil war (see News Service of this week's APS Diplomat), would need to export 6m b/d at $50/b to get its per capita GDP as high as Spain's $15,000 per annum. But the reality on the market is that high stocks could bring prices down in the short term.

The most influencing factors to high oil prices at present are the market fundamentals: low inventories with backwardations discouraging companies from building up stocks, a shortage of oil refining capacity in the US and Asia, strong demand in the US and China, a shortage of storage and oil shipping capacities, and the demand for non-IEA countries building up strategic oil stocks. The factors adding a $12/b speculative premium to the crude oil prices are the psychological effects of instability in the Middle East - sabotage in Iraq and Saudi Arabia, the violence between the Palestinians and Israel and a dangerously mounting anti-Americanism in the Middle East.