The Speculative Premium Reaches Half The WTI Price.

*** ExxonMobil, Several Times Smaller Than LUKoil In Terms Of Oil Reserves, Is Worth More Than $430 Bn On Wall Street

*** This Must Show To What Extent Speculation Can Go, Not Only In Crude Oil Pricing

*** China's CNOOC Has Bid $19 Bn For Unocal, Against $17 Bn Offered By Chevron Earlier This Year, And Might Go Higher

*** One Wall Street Investment Firm Projects WTI At $45-60/B For 2007-2010

*** Iraq Is No Longer A Key Factor To Shot-Term Supply; It Won't Be Able To Reach Its Pre-War Level Of Output Before End Of Next Year; Saddam's Ghost Keeps Coming Through P/L Explosions Or Leaks

Commercial US inventories of crude oil and petroleum products now are more than 200m barrels higher than they were in one week during the spring of 2003. Front-month WTI then was trading at about $30/barrel, compared with $60/b at time in the past week. If one takes an objective look at the physical US oil inventories, there is no shortage to justify a WTI contract at more than $30/b. The only shortage in this market is financial - sellers of futures contracts.

Speculation in energy futures, particularly in oil and fuels futures, has become a big business. Investors in this speculation have become acutely aware of what makes futures prices go up or down, so acutely aware that they are focusing more on those factors which are likely to become important for further gain than the ones which are likely to cause a loss.

The focus is on the periods between now and early September, for gasoline and distillates, and between then and December for heating oil and other distillates. In both cases the focus is more on what may push WTI up than on what may pull it down.

In the process, however, the speculators have neglected many factors as if they no longer exist and concentrated on those which they know will keep pushing their futures prices up. Now these are limited to exporters of light/sweet crude oil like Nigeria, oil refineries and the weather - with a tropical storms season having begun.

Not only is Iraq out of the equation for the speculators, but also Iran, Saudi Arabia and other producers of sour and heavy crude oils. This means any crisis in either of such countries does not necessarily warrant an additional premium of $1 to $2/barrel. But a refinery accident in the US does.

Thus the oil market did not react to the June 24 victory of ultra-conservative candidate Mahmoud Ahmadi-Nejad over pragmatic former president Ali Akbar Hashemi Rafsanjani in the second round of Iran's presidential elections. To the US and the rest of the West, Ahmadi-Nejad would be worse than Venezuela's populist President Hugo Chavez. Nor did the oil market react to renewed violence in Saudi Arabia, by far the world's biggest oil exporter, earlier in the past week.

That up to half the current price of WTI is a speculative premium should be sufficiently worrying for speculators to sell their futures contracts. But this is a sellers' market, with many buyers scrambling for more contracts.

As soon as the price of front-month WTI drops, investors on NYMEX buy additional contracts of the crude, a light/sweet grades which does not trade outside the US but which influences prices of physical crude oils world-wide. The same happens at the International Petroleum Exchange (IPE) in London, when the price of front-month Brent drops.

Front-month WTI can rise above $70/b before the end of the coming winter. It did reach $60/b briefly last week.

In early 1981, the price of WTI rose to $35/b, because of oil shortages resulting from the Iran-Iraq war. In today's values, after adjustments taking into account inflation and the US dollar's exchange rate, that would be over 90/b. Technically, however, oil prices are high in relative terms because of structural problems in the petroleum industry. A quick tour of the various factors to market fundamentals shows the extent of the structural problems, such as a shortage of oil refining capacity in the US, Europe and Asia.

The high retail price of gasoline or distillates means higher tax incomes in rich consuming states and in those poorer states which have begun to tax such fuels. OPEC and other crude oil exporting states earn only a fraction of the tax-paid price of gasoline, or distillate. It is not only a matter of inflation and US dollar values. Engines and other energy dependent equipment and machinery are now far more efficient. With a litre of gasoline, or diesel, the vehicle now goes much further than it did in 1981.

Factors like these have led market analysts to believe that the price of WTI can go up to $70/b or higher, before it triggers economic problems and any serious consumer revolt. The industrialised world can afford it. It is OPEC and other crude oil exporters, as well as the poor countries, which cannot afford a high WTI price. The current oil price is high enough to make many alternative fuels competitive.

NYMEX will become more global from early 2006 as WTI futures will trade on the Dubai Mercantile Exchange (DME), which will become the first commodity futures exchange in the Middle East. Approval to open a crude oil futures trading floor in Dubai was announced in early June in a $50m project. The DME will combine traditional open-outcry trading with in-and out-of-hours electronic trade. Trades will be cleared through the clearing house of NYMEX in New York.

The DME will be a 50-50 joint venture between NYMEX and Dubai Holding, an economic development group sponsored by the local government of Dubai. The DME will trade in NYMEX futures as well as the Dubai crude, a heavy/sour grade which now trades at a differential of between $14-16/b lower than the front-month price of WTI.

DME trading in Dubai crude will be temporary, however, as its current output level has fallen to about 120,000 b/d, which means fewer cargoes a month can exchange hands than in the 1990s. This means Dubai as a Middle East benchmark is not liquid enough to support a sustainable futures contract.

A combination of Dubai and Oman crude, however, could be adopted as a marker for Middle East sour grades. The combination will have a sufficient volume and liquidity for it to trade freely as a base for a sustainable sour grade contract. This will depend on the government of Oman setting its official crude oil prices according spot market rates.

The futures price of the Dubai/Oman contract will be set at a differential below that of WTI. The differential will be widened or narrowed according to the availability of light/sweet crude oils; the bigger the volume of supply of this grade, the narrower the differential, or vice-versa. The differential reflects the cost of refining a heavy/sour crude to yield clean fuels; it takes more barrels of this type of crude to produce such fuels than in the case of a light/sweet grade.

In the end, however, it is the NYMEX value of WTI which will set the prices for other crude oils worldwide. The market value of Brent, a light/sweet crude which can trade physically worldwide, is influenced by that of WTI. This is not only because of the two crudes' similarity, in terms of quality, but in view of Brent's dependence on trans-Atlantic oil trade.

Two additional factors have made WTI futures a global benchmark already: First is the shortage of oil refining capacity in the US. The second is the competition for West African light/sweet crudes between Asia and America. These two factors have been relatively recent: The shortage of oil refining capacity in the US has been felt in WTI pricing since 1999, with no grassroots refinery built in America since 1976.

Competition for West African light/sweet crudes between Asia and America began in 2003, as US oil demand increased in a big way and coincided with a rapid rise in China's oil consumption. Now India has joined the competition for these grades. Asian competitors for these grades from West Africa reached a high point in late 2004, when Nigeria and other exporters of such crudes were sold out in view of aggressive buying by China and India, in addition to other Asian buyers of West African crudes such as South Korea, Taiwan, Japan, etc.

The volume of West African crudes being purchased by US refiners on the basis of term contracts - rather than spot deals - has rise over the past year from about 60,000 b/d to almost 200,000 b/d. As US buyers are willing to pay a government selling price for term crude oils, the national oil companies (NOCs) of West Africa are officially pricing their term exports above spot market rates.

As a result, spot prices keep rising to maintain pace with official selling prices (OSPs). Thus there is a steady, self-propelled spot price/OSP-and-OSP/spot price cycle. The resulting price spiral is kept because of political instability in Nigeria, the biggest among West Africa's oil exporters. The slightest accident or upheaval in Nigeria causes the price to go up - in addition to what causes WTI in the US market to go up, such as a refinery accident, a pipeline bottleneck or a tropical storm.

Investors in oil futures trading on NYMEX or elsewhere in the world have all these factors in mind when they put more money into contracts for WTI, US gasoline, diesel or other distillates. The same goes for European and Asian investors in the oil futures contracts.

The Chinese are so eager to secure supplies of light/sweet crudes from West Africa that Sinopec has recently agreed to consider investing heavily in Nigeria's oil refining and electric power businesses in return for a long-term crude oil supply deal. Other Chinese companies have shown interest in doing the same.

US weather forecasters are predicting a more active Atlantic hurricane season this year than in 2004, when the disastrous Hurricane Ivan caused 45m barrels of crude oil output in the Gulf of Mexico to be shut in. The mere appearance of tropical storm Arlene in the eastern part of that Gulf recently caused WTI to go up quickly.

The shortage of oil refining capacity in the US has caused American bankers to project higher WTI prices for the rest of 2005 and in 2006 as well as offer competitive project finance rates for new refinery ventures in any part of USA. Thus, Banc of America has recently raised its 2005 WTI price estimate from $47/b to $49.50/b. JP Morgan and Citigroup have done the same. Sanford Bernstein, a Wall Street investment firm whose forecasts are taken seriously across the globe, has raised its WTI estimates to $53/b for 2005, $55/b for 2006 and a $45-60/b range for 2007-2010. Its oil price analyst, Neil McMahon, has said: "The outlook for oil prices appears to be a one-way street".

Those Asian monitors who look at the US market to find clues on oil price projections for east of Suez consumers are watching investors in new American oil refining capacity. One US company, Clean Fuels, is trying to have a new 150,000 b/d refinery built and ready by 2009 - the first such plant since 1976.

Clean Fuels, however, is unable to find a suitable site for the plant in the metropoli-tan area of Phoenix, in south-west Arizona near the border with Mexico, where gasoline prices have been particularly high since August 2003. That was when a supply pipeline broke down and caused a severe shortage of fuels. The project has been facing a number of challenges from lobbies concerned about such issues as the environment, disruption of native American land use, endangered species, archaeological zones and local land use.

The least of Clean Fuels' worries was finding finance for its $2.5 bn project. As oil refining profits have been unusually high in the past two years and are expected to remain so in the near future, there has been no shortage of banks ready to fund the project at competitive lending rates.

Because oil prices are high, the market value of major oil companies has risen sharply. ExxonMobil by end-2004 had overtaken General Electric (GE) as the world's biggest and most profitable among the listed private corporations, then valued at about $390 bn. By March 2005, however, ExxonMobil's market capitalisation had risen to $410 bn - an increase of $20 bn such a short period. But ExxonMobil, capitalised at several times over the market value of LUKoil, is several times smaller than the Russian oil firm in terms of oil reserves. This is not to mention Saudi Aramco which holds by far the world's biggest oil reserves: about 263 bn barrels.

Another example is the high price, $19 bn, which China's CNOOC has bid for Unocal and a for a break-up fee, because the former was short of petroleum reserves and the latter had a lot of natural gas. Chevron had agreed on April 4 to pay about $17 bn for a friendly takeover of Unocal, whose reserves then were valued at about $12/b of oil equivalent. The price of such reserves used to be less than $4/boe not many years ago.