The up and the down of it on oil

So what's it all about, this sudden oil surge? Benchmark prices have flirted with the $100 level, but shied away as the moment has approached.

Of course, it's only a number, although one with psychological resonance.

According to Simon Wardell, oil analyst at Global Insight in London, prices are now approaching the inflation-adjusted record highs seen in 1980-81, which roughly equate to $101-$107 a barrel today, depending upon the calculation used.

The upward price spiral of recent weeks seemed to develop into a craze, related to the downward spiral of the dollar.

"Traders in London said you could ignore anything else," says Francis Osborne, chief economist at PEL, a London consultancy. A persistent downtrend in US inventories provided underpinning, and then political tensions over Turkey's threatened incursion of Iraq added a twist.

As to what changed when prices slipped back into the low $90s, "that's hard to say", says Osborne. "It just seemed to suddenly be a lack of appetite to move higher, a sort of collective vertigo: profit-taking mainly, with some rushing [by traders] to make sure they were first through the exit." That would make sense, knowing that many would consider the triple-digit level some kind of trigger point.

From this region's perspective, the institutional dimension has a particular interest. Opec accounts for around 40 per cent of world crude production, and remains a locus of media attention. Current circumstances prompt the query whether Opec has lost control of prices, and indeed Mohammad Bin Dha'en Al Hamili, UAE Energy Minister and the current Opec president, has said precisely that, mentioning geopolitical events and the growing relevance of financial investors.

Kate Dourian, Editor of Platt's Middle East, believes this idea has credence. "Opec does not set prices nor does it declare what its price target is. The group dropped its price band a few years ago because it was unrealistically low, and also because its members did not want to be accused of behaving like a cartel and setting the price of the world's most vital commodity. As a result, no one really knows where Opec as a group would like to see prices go."

Presumably, however, Opec producers would still prefer prices neither too high, for fear of encouraging alternative energy sources, nor low, if the world is growing sufficiently well to accommodate the cost burden.

"The trick for Opec is to know at what point oil prices start impacting energy consumption patterns, shrinking demand for fossil fuels," Dourian says.

"There is no sign of significant weakening in demand in the major consuming countries. China, which is set to overtake the US as the world's biggest energy consumer in 2010, is still buying crude at high prices and filling up strategic reserves. The wilting US dollar has mitigated the impact of the oil price rise, giving Opec another excuse to refrain from acting on supply."

Spare capacity

But it is Opec which has the spare capacity which can affect price over time. That is located especially in Saudi Arabia. "The kingdom is truly the global oil warehouse, with its 1.5 million barrels of excess capacity," says M.A. Ramady, Associate Visiting Professor at Riyadh's King Fahd University of Petroleum and Minerals.

There's a paradox, though, since it's a contingency that only works if it isn't used. "An erosion of such spare capacity, without a compensating new capacity build-up, would only raise prices further unless the underlying causes of current high oil prices - geopolitical, commodity speculation and stoppages in some oil producers - are resolved."

Opec argues that consumers have not invested enough in refineries, and even if they were to put more barrels on the market, there is nowhere for them to go to be converted into refined products, explains Dourian. Besides, the type of oil pumped by Middle Eastern producers is of the heavier, sour type rather than the sweeter type such as the oil produced in the North Sea that is needed.

In which case, how might Saudi Arabia act in these confused circumstances? Historically a moderating influence, it might still be flexible on production.

"This is despite the fact that, in real terms, the current oil pricing is still unfavourable compared with the dollar's past purchasing value," Ramady says.

Given the structural characteristics, however, there is some scepticism as to the efficacy of such action. "Opec has considerable influence to the downside of prices, but is almost completely incapable of influencing anything to the upside," Osborne claims. The world doesn't need more oil, he adds. "Inventory tightness in the US is only in heating oil and gasoline; the crude inventory is entirely comfortable."

More influence

Franscisco Blanch, Head of Global Commodity Research at Merrill Lynch, takes a similar line. "On our estimates, Opec cohesion has increased during the last 10 years, measured in the correlation of each member's daily oil production with Saudi Arabia's.

This means that Opec has probably more influence to stem sharp oil price drops than it did in 1998. Whereas, Opec's ability to limit price increases is lower than in the 1990s due to the global refining bottleneck issues."

How now, then, for prices? "It wasn't much of a retreat. $100 was going to be a difficult number to crack, but I think the market would head back that way [anyway] if Opec doesn't raise production at the next gathering," says Dourian.

Gulf oil ministers will hold an extraordinary meeting on December 5 in Abu Dhabi. Will it stay above that level? "It will depend upon the severity of the Northern Hemisphere winter, continued speculative activity and the number of unexpected supply threats or disruptions," says Wardell of Global Insight. For the medium term, "fundamentals indicate that prices should fall back next year, [with] a demand response and significant new production due to be added".

Historically, though, that sort of prognostication amounts to anybody's guess.

Back to the dollar, whose extension of its lows against the euro seems to have provoked the latest ratcheting in oil. Will the supposed tie with oil last? It certainly seemed like a 'flavour of the month' viewpoint when it was initially doing the rounds.

Osborne nods to that idea. "In the past the market has linked oil to the dollar, and then that argument has miraculously vanished, only to be dusted off at a later date."

It's the cry of the world-weary: seen it all before. Even the $100 barrel is nothing new, as long as your mindset is inflation-adjusted.