OPEC drives up oil prices in a new way

By Jim Jubak

This time, OPEC really is to blame for higher oil prices.

In recent days, oil traders and speculators have forced the price of oil above $80 a barrel despite the Organization of Petroleum Exporting Countries' decision to raise production.

I fully expect oil prices to keep rising for the rest of 2007 and into 2008. The only thing likely to stop oil from climbing to $85 a barrel is profit-taking by speculators themselves.

Not every OPEC country is happy about this rise in oil prices. The Saudis, for example, have argued for increased production to hold down prices and keep demand from falling. But oil prices are headed up no matter what OPEC says or does.

And OPEC really doesn't have anyone else to blame for its inability to set prices. Runaway demand in the oil-producing countries themselves is the newest factor pushing up global oil prices.

Why prices are still rising

You can see where oil prices are headed in the reaction Sept. 12 to OPEC's announcement that it would increase production. Despite the news, prices went up that day. The price of a barrel of benchmark West Texas Intermediate crude climbed $1.68 to $79.91.

The next day, crude tacked on an additional 13 cents a barrel to close at $80.04. Speculators were ecstatic: Hedge funds and other traders have staked out big positions in the options market at $80 a barrel that are worth billions as oil climbs above that level.

So why were traders able to move oil prices up in the face of an OPEC production increase?

• A 500,000-barrel-a-day increase in production is little more than symbolic. If the Saudis, the driving force behind this increase, were serious about holding prices at this level or driving them down, they would have pushed through an increase of 1 million barrels or more. All an increase of this size does is ratify current levels of production, which are as much as 2 million barrels a day above the official quota.

• There's a huge debate inside the oil industry and in the commodity pits about the status of Saudi oil reserves. The Saudis, who produce 9.5 million barrels a day now, have announced they will boost production to 12.5 million barrels, a 32% increase, by the end of this decade and to 15 million barrels by the end of the next decade. However, some oil traders and industry analysts don't think Saudi Arabia can deliver and contend that the Saudis' big oil reserves are in far worse condition than they are letting on. The impact of any shortfall would be huge because the Saudis are the only likely global source of a major increase in oil production in the next five years, according to the International Energy Agency. Without that production increase, the world is headed for a very painful short-term oil squeeze, the agency has concluded. So you can think of energy traders' bets on oil climbing above $80 as a huge vote that the Saudis won't or can't deliver as promised.

• Traders and analysts also aren't convinced that OPEC as a whole wants to increase production. The Saudis carry great clout inside that organization, but they have faced fierce opposition this year from an OPEC faction headed by Venezuela and Iran that is adamant about keeping prices as high as possible. Both countries desperately need high oil prices: Oil revenue is the only thing that stands between the regimes that rule in Caracas and Tehran and huge, possibly uncontainable protests. Anything that cuts into revenue, endangering subsidies that keep gasoline prices in Iran near 40 cents a gallon and that fund cheap food and health care in Venezuela, would be a political disaster.

In the past, Venezuela and Iran probably wouldn't have carried the day. OPEC regularly raised production to modulate price spikes, so that peak oil prices wouldn't cut into global economic growth, leading to lower demand for oil and a plunge in oil prices.

In other words, OPEC felt it was in its own interest to avoid pushing the global economy into a slowdown with unsustainably high oil prices. Sometimes OPEC got it wrong and set prices too high or moved too slowly to lower them, but heading off an economic slowdown has been a fundamental part of OPEC policy.

Why higher prices haven't cut demand

But recently, higher global oil prices haven't reduced global demand for oil or pushed economies into recession. In its Sept. 12 projections, the International Energy Agency cut its estimate of global oil demand for the end of 2007 to 85.9 million barrels a day, but that is still 1.7% higher than demand in 2006. For 2008, the agency is projecting a 2.4% increase in demand.

Continued: We're less energy intensive

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