The steady increase in oil prices over the past five years has led to a surge in oil and gas investments worldwide. Most oil producers have been eager to increase output up to capacity to take advantage of these high prices.

But for a few oil exporting countries these record high prices can have an opposite effect and reduce their incentive to sell more oil or to expand their production capacity rapidly.

The average price of crude rose by almost 300 per cent between 2002 and 2007.

The largest price increases occurred in 2004 (47 per cent) and 2005 (36 per cent). In response to this positive price shock, however, global oil production rose by only 10 per cent during 2002-05 to average 84.6 million barrels per day in 2005.

Furthermore, during 2006 and 2007 the price of crude rose by an additional 17 per cent and 10 per cent respectively but daily oil production remained unchanged (based on Energy Information Agency data).

While this lack of growth in oil supply is mostly due to capacity constraints and declining yields in some mature fields, lack of interest in boosting exports might also have played a role in some countries. And if the price of oil continues to grow, this later cause might gain more significance.

The conventional economic wisdom argues that when the price of a commodity increases, the suppliers have an incentive to produce more or at least maintain their current production levels.

However as the price keeps rising there can come a time when a producer decides that he is earning enough and decides to sell less. Such behaviour will result in a market situation that economists refer to as the "backward bending supply".

Such logic might affect the supply decisions of some oil exporting countries. This can happen in countries where oil resources are under government control and exports are a main source of revenues.

After a steady increase in oil revenues for several years these countries might conclude that their economies can not absorb the rapidly increasing additional oil revenues and decide to reduce output or forgo any production increases. This phenomenon, known as the target revenue theory, was the subject of several studies in the 1980s and 1990s but has received little attention in recent years.

As the price of oil increases, exporting governments generally tend to use the additional revenues to reduce their public debt (if is has accumulated any) and increase public spending. Algeria's external debt stood at $40 billion in 2002 but the government managed to pay it off ahead of schedule by 2007.

Data also shows that government spending in most oil exporting countries has steadily increased in the past five years. However, there is a limit to how fast large sums of oil revenues can be injected into these economies without causing inflation and other economic imbalances.

These economic pressures have been most visible in GCC economies such as Saudi Arabia, Qatar and the UAE which have experienced rapid increases in public and private spending since 2003.

To remedy these problems most oil exporting countries have put their excess oil revenues in government-owned wealth management funds to be invested in foreign assets. These are known as sovereign wealth funds (SWF) and some of them such as the Abu Dhabi Investment Authority (owned by the UAE government), are worth well over $400 billion.

However, the foreign assets of SWFs are subject to many risks and managerial challenges. Even a highly diversified SWF can not escape the risk of a major financial crisis similar to the 1997 Asian crisis that can erode a sizable portion of asset values worldwide.

Sovereign funds

Furthermore, large and visible SWFs also face political risks and restrictions in many countries. In 2007 the United State approved the Foreign Investment and Nnational Security Act which will impose more regulations on how much and where the sovereign wealth funds can invest there.

European countries and Japan are also likely to impose similar restrictions in the near future. The risks and restrictions that are often associated with the creation of a large foreign asset portfolio might further raise questions about the wisdom of boosting exports among some oil producing governments.

If additional oil revenues can not be injected into the domestic economy or efficiently invested in appropriate foreign assets, some oil exporting countries might conclude that there is no need to increase their oil output or spend billions on additional capacity.

- The writer is the Henry J Leir chair in Economics of the Middle East at Brandies University's Crown Centre.