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Pressures Grow Over Oil Supplies Sharp Price Rises Are Sparking Global Concern and a Scramble for Assets, Writes Douglas Hamilton ANALYSIS

Posted on: Monday, 4 July 2005, 09:00 CDT

PREDICTING the future direction of the global oil market is a risky business at the best of times but City petroleum analysts are reasonably certain that two things will happen during the coming months - prices will remain above Dollars50 a barrel for some time and the international petroleum industry will face a new round of consolidation like the one seen about five years ago.

Oil hit record levels above Dollars60 a barrel recently and it was trading at around Dollars58 a barrel in New York on Friday. Commodity traders have warned that a cold winter in the northern hemisphere could send prices hurtling toward Dollars70 or higher. Petrol at [pounds]1 a litre or more may be just around the corner.

The sharp rise in the price of crude has policymakers rattled.

World leaders will be under pressure to respond to record prices when they deliberate on the state of the economy and trade at a Group of Eight summit in Gleneagles this week.

The Canadian delegation has confirmed that G8 leaders would discuss the risks of high fuel costs hurting US economic growth or smothering the already sluggish economies of much of continental Europe and Japan.

It is clear that alarm bells are starting to ring in chancelleries around the world.

James May, the US Air Transport Association chief, recently provided a dramatic example of how high oil prices are damaging his industry. He said American airlines are losing Dollars17,000 (about [pounds]10,000) a minute, which is roughly the same as one oil group, French-based Total, made in profit last year.

French president Jacques Chirac, losing popularity as well as the battle against unemployment at home, has condemned oil price swings, erratic currency exchange rate movements and other "imbalances" in the world economy. He called on the G8 leaders - who represent United States, Canada, Japan, Germany, Italy, France, Britain and Russia - to cooperate to address the threat of higher petroleum prices.

Crude oil futures are about 60per cent above year-ago levels, but would still have to top Dollars90 to reach the inflation-adjusted high set in 1980.

The Organisation of Petroleum Exporting Countries, which supplies around 35per cent of the world's daily consumption of 84 million barrels, has sought to bring prices down by raising production quotas, but the market, where highly-speculative hedge funds play a big part, has largely ignored its moves.

Venezuela's oil minister, Raphael Ramirez, said last Wednesday that Opec did not have much excess production capacity and that the main reasons for high oil prices were speculation by investors and bottlenecks in the world's refining system and red-hot demand - problems that G8 political leaders will find difficult to solve quickly.

Opec's members are all pumping oil as fast as they can.

Only Saudi Arabia has any spare capacity left. This leaves the world market with no safety net, making oil traders jittery and causing them to demand a risk premium.

There are large stocks of refined products in western industrialised countries. However, the existence of these supplies is not dragging oil prices down. The reason is that the types of crude available from the Opec cartel tend to be heavy, sulphurous grades that are complicated or costly to process. The global market, meanwhile, is demanding ever more clean diesel fuels and low- sulphur petrol.

Just how long the current rally lasts could depend on the final factor pushing up prices - demand. Chinese oil consumption grew by about 15per cent last year. Although that rate has not been matched in 2005, the world as a whole has continued to guzzle oil.

China and other energyhungry, fast-growing Asian countries fear their economies could tip into recession if prices do not recede. China has said it would soon use its national petroleum reserve, now under construction, to blunt the country's exposure to market volatility.

The reserves "will be used to cope with short-term f luctuations and maintain stability in the market, " Han Gensheng, vice- president of Sinochem Corporation, said.

The comments indicate that the world's number two oil consumer plans a much more active role for its reserves than those held by the US and Europe, which by policy use them only in the event of severe supply disruptions and not to affect prices.

China is also trying to obtain secure energy supplies through acquisitions of existing petroleum companies, a move that some City analysts believe may spark a scramble for assets like the one seen in the 1990s.

The China National Overseas Oil Corporation has made a Dollars18.5bn ([pounds]10.4bn) bid for the US energy firm Unocal Corporation.

CNOOC's chairman, Fu Chengyu, said late last week that the Chinese company will press ahead with its takeover bid for Unocal, despite a scheduled shareholder vote on a competing offer by Chevron.

Fualso expressed confidence that the Chinese firm will persuade Washington the proposed deal does not pose any risks to US national security.

Right-wingers on Capitol Hill are outraged that Unocal may fall into the hands of a company controlled by Communists.

Fu said: "I believe that our superior offer, which will help shareholders, will convince the US government this is a good offer."

His comments came after Unocal sent shareholders proxy materials on Wednesday with a letter reiterating its board's reommendation to accept a Dollars16.6bn offer by Chevron.

The Unocal saga could be the first in a series of takeover battles in the energy industry, according to Neil Perry, an analyst at investment bank Morgan Stanley.

He believes BG is ripe for a takeover, perhaps by Shell.

Shell said last week megamergers with oil near Dollars60 a barrel do not make sense but smaller acquisitions are possible.

Hunting, the UK oil services company, has said publicly it is looking at potential takeover targets and BP is believed to be looking at assets in Russia.

Source: Herald, The; Glasgow (UK)

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