Oil may finally fall in line with reality

Higher Opec Output, Falling Demand Set To Keep Prices In $120-$130 Range

Soma Banerjee & Vinay Pandey NEW DELHI

    HIGHER oil prices are their own enemy: demand destruction caused by spiking energy costs will bring down global crude prices, with stepped up production lending a helping hand.
    Crude oil prices, which fell by almost 16% over the past few days, may soften further unless spooked by a disruptive geopolitical development. Increased Opec production, led by Saudi Arabia, coupled with a decline in demand in the developed world, especially the United States, is set to ease the tight demand-supply equation in the global oil market. Global crude oil prices, which were threatening to breach the $200 a barrel-mark by the year-end, are now likely to stay closer to the current price (between $120 and $130 a barrel), leaving aside a geo-political eventuality like an Israeli attack on Iran.
    In an exclusive chat with ET, British Petroleum group chief economist and vicepresident Christof Ruhl said: "Increased supplies from Saudi Arabia have already come into the market and the recent softening in prices is a direct fallout of that." Saudi Arabia had announced an increase in production by 700,000 barrels a day from July.
    On the demand side, growth in both OECD and non-OECD countries would be lower in 2008. While the US and European economies are facing a general slowdown, high oil prices are also beginning to bring in demand destruction in those economies where rising prices are passed on to consumers. Put simply, consumers are now beginning to go slow on demand (like SUV sales coming down in the US and growth of hybrid cars) as high energy bills are no longer sustainable. Demand is also expected to moderate in developing economies like China, India, Thailand, etc, because of lower subsidies and moderation in economic activity. "This year is thus expected to see softening in prices as tight market conditions ease," he said.
    "This year's Statistical Review shows clearly that markets do work, and that consumers and producers respond to changes in energy prices when given the opportunity to do so. However, in many places, policies interfere with market mechanisms. Further, in a number of countries, consumers are shielded from price increases via subsidies," Mr Ruhl said. Russia output fall unlikely to raise oil prices
    IN subsidising economies, consumption growth exceeded the 10-year average by 190,000 barrels/ day (b/d), while in taxing economies, it fell short by 360,000 b/d. Although production in Russia is expected to decline in 2008 by a marginal 50,000 b/d, after accelerating in the past few years, it would not have a major fallout as increased production from countries like Azerbaijan would net it out, Mr Ruhl said.
    Over a slightly longer time-frame of three-five years, Mr Ruhl feels prices could even moderate at $60-$70 a barrel. He also does not subscribe to the peak-oil theory. "There is enough material in the earth's crust to yield adequate hydrocarbon if we are willing to pay the price, monetary and environmental," he says. The rally in prices, which accelerated sharply in the second half of 2007 and over the first half of 2008, was largely triggered by a tight supply position, where growth in demand outpaced supplies. Production cuts by Opec in late 2006 and early 2007 reduced supplies by over 130,000 b/d, leading to higher prices.
    Global oil consumption grew 1.1% (1 million b/d) in 2007. Although OECD consumption dropped 0.9%, the steepest since 1983 due to high prices, the increase in demand from non-OECD countries — mostly ones that provide subsidies — by 1.4 million b/d led overall demand to remain high in 2007 despite high prices.