Saudis to Boost Oil Production Capacity as Price Hits $50

September 28, 2004


PARIS, Sept. 28 - The price of oil, which has been rising for the last two years, broke through the $50-a-barrel mark today, reaching a new milestone as some analysts warned that there was nothing to stop prices from rising further.

Fueling these gains is an exceptional alignment of events: record high demand, historically low spare capacity, and a set of potentially destabilizing events in some of the world's top oil regions, including Iraq, Russia, Venezuela and Nigeria.

"The market is looking for a new equilibrium point and no one knows where that will be," said Jamal Qureshi, an analyst at PFC Energy, an oil consultant based in Washington. "We still have a way to go. I wouldn't be surprised to see $60 a barrel."

On the New York Mercantile Exchange, oil for November delivery closed at $49.90 a barrel today, a record high for a closing price when adjusted for inflation. Earlier in the session, futures rose as high as $50.47, setting a new record. Oil prices - up nearly 55 percent this year - have doubled in two years.

What pushed prices up this week was news of possible clashes between the army and rebel militants in Nigeria that could threaten the country's oil production, and the consequences of Hurricane Ivan last week in the Gulf of Mexico, a region that makes up a fourth of American domestic oil production.

At the same time, demand for oil is running at a pace not seen since 1978. The world is expected to consume nearly 1 billion more barrels of oil this year than it did last year, driven by strong and sustained demand coming from China, India and the United States.

Saudi Arabia, the world's top oil producer, responded today with a pledge that it would raise production capacity to 11 million barrels a day, from 9.5 million.

Ali al-Naimi, the Saudi Arabian oil minister, had mentioned the increase in capacity earlier this month while meeting with fellow OPEC oil ministers in Vienna. "The kingdom is ready and capable of making up for production shortfall occurring anywhere in the world," Mr. Naimi was quoted as saying by the official Saudi Press Agency.

This is the second time oil prices have hit record highs in recent weeks. On Aug. 20, crude oil futures touched $49.40 during trading but within days fell back to about $43 a barrel. Eric Bolling, an independent oil trader on the Nymex, said this rise might be different. He referred to the oil market as going through a "perfect storm."

After the passage of Hurricane Ivan over Florida, the cumulative loss of production from the gulf region had reached 11.8 million barrels, or about 1.9 percent of the yearly output there, said the Minerals Management Service, an Interior Department agency. A third of the region's production is still not making it to markets.

To make up for the shortage, oil companies in the United States have been drawing on their stocks, which are near 29-year lows. In turn, that leaves less oil to refine into either gasoline or heating oil necessary for the seasonal winter peak in demand. Mr. Bolling said: "There's underlying strength to $50 this time. A lot of things have happened since $40."

"I'm going to wait till the market gives me a signal we've reached a ceiling" before betting oil contracts will fall, he said. "We're not there yet."

Since most oil producers are pumping full out to meet record-high demand, little spare capacity is left in the system. High prices reflect the lack of any substitutes for any interruptions in production anywhere, analysts said.

OPEC's spare capacity - idle production that can be brought on when needed - has sunk from about 15 million barrels a day in the mid-1980's, to around 1 million to 1.5 million barrels today.

"The market is much tighter today than it's been since 1973," said Daniel Yergin, chairman of Cambridge Energy Research Associates. "Unlike 1973, 1979 or 1990, the market today is going through a demand shock, not a political shock. Also, the market is not thinking long term. It's thinking day to day."

Last month, oil traders were concerned that the fighting in Iraq would spill over and hurt that country's oil exports. Earlier this year, it was the continuing tussle between the Russian government and Yukos, Russia's top oil producer, that kept oil markets on edge.

Earlier still, bombings in Saudi Arabia reminded traders that the kingdom, which holds a quarter of the world's oil reserves, is still a terrorist target.

"What's unnerving the markets is that significant disruptions could come from a number of sources," said Steve Turner, an oil analyst at Commerzbank. "It's possible that prices could go substantially higher given the right set of circumstances."

Even OPEC cannot do much more to bring down prices. Members of the Organization of Petroleum Exporting Countries, which accounts for a third of the world's oil production, are pumping about 30 million barrels a day, the group's highest output in 25 years.

And the renewed Saudi announcement to increase capacity may not have much of an impact either, analysts said, because most of the additional Saudi barrels are of a heavy type that is less favored by refiners around the world.

Still, with the Qatif field coming online, Saudi production of Arabian light crude - a type that is in demand because it is well suited for gasoline refining - is expected to increase by 500,000 barrels a day.

"That should help on the margins," Mr. Qureshi of PFC Energy said.

So far, high oil prices have not hurt global economic growth. Both the Federal Reserve and the European Central Bank said recently that oil prices have not slowed the economic recovery or contributed to inflation in either regions.

Part of the reason is that modern economies are much less dependent on oil than they were in the 1970's. Also, adjusted for inflation, oil prices are still historically lower than their peak of March 1981, when crude reached nearly $80 a barrel in today's dollars.

Still it does not mean the world is immune to high oil prices. In France, Budget Minister Dominique Bussereau said Monday that French growth would slow by 1 percentage point next year if oil prices remained above $50 a barrel, according to Bloomberg News. The French government expects 2.5 percent growth in 2004 and 2005.

Hans Eichel, the German finance minister, also added his voice to warnings that global growth would be at risk if oil prices remained at current levels.

Higher energy costs could hurt company earnings, depress stock markets, curtail consumer spending and eventually slow growth. Analysts usually expect a $10-a-barrel increase in oil prices to shave off 0.3 to 0.5 percentage points in gross domestic product growth.

Not everyone is convinced that oil prices can stay high for too long. "Oil prices don't exist in a vacuum," Mr. Yergin of CERA said. "People generally underestimate the feedback effect on the economy. Markets adjust. The question is do they do it smoothly or painfully."

Part of the reason prices rose this year is that demand turned out to be much stronger than anyone forecast.

In December 2003, the International Energy Agency still expected global oil demand for 2004 to be 79.6 million barrels a day. By August this year, the I.E.A. had increased its estimates for global oil demand to 82.2 million barrels a day. The difference - 2.6 million barrels a day - is more than the daily output of an oil producer like Kuwait.

Much of the increase in demand comes from developing economies, particularly in Asia. China, for example, accounted for 40 percent of the growth in world oil demand over the past four years and last year surpassed Japan as the second-largest consumer of oil after the United States.

America's infatuation with sport-utility vehicles is also to blame for the increase in oil demand. The vehicles and other light-trucks account for half the car sales in the United States and are behind a 1.9 percent increase in demand for gasoline, according to the federal Energy Information Administration.

Oil demand in the United States this year is expected to be 2 percent higher than in 2003, averaging 20.4 million barrels a day.

This oil-price rally started in December 2002, when oil workers in Venezuela joined a nationwide strike against President Hugo Ch·vez. The protest movement eventually brought the country's oil industry to a halt - 3 million barrels of oil a day, or about 4 percent of the world's daily production, suddenly went missing.

Then clashes in Nigeria crimped production there. And in March 2003, the war in Iraq brought fears that Saddam Hussein would order the destruction of the Iraqi oil installations.

OPEC initially raised its output to make up for the loss of Venezuelan production. But it quickly started to worry that the return of Iraq's oil production after the war would flood the market with oil. In April 2003, OPEC called for a cut in production and then reduced its nominal output ceiling twice by February 2004.

By then, the Russian government had gone on the offensive against Yukos, prompting fears exports would be cut. Only in June did OPEC finally reverse course and increase its output ceiling. By then it was too late to stem the price rise.