Higher oil prices here to stay (page 4 of 4)

The bottom line on oil exports from so-called New Iraq is therefore that world supply has lost at least 1.25 Mbd at a time when demand is increasing by about 1.7 Mbd per year.

At the same time many analysts in consumer countries repeat the unsubstantiated claim that OPEC's export offer capacity is as high as 31.9 Mbd when more realistic data suggests it will be difficult to achieve, then maintain more than 28.5 Mbd in the next 5 years, assuming very large investments.

Given the actual trend of investment cuts, notably in Venezuela and Nigeria due to economic and social difficulties, and uncertainty concerning oil prices, OPEC's real maximum supply capacity may remain set in the 26 - 27.5 Mbd range as a 5-year average.

The fact that very large investments are needed if OPEC suppliers are to maintain export capacity itself argues for significantly higher oil prices.

While there can be legitimate concern that over-rapid and overlarge oil price rises can trigger a defensive strategy of interest rate hikes, to strangle economic growth and oil demand in the OECD countries, this does not prevent prices from moving to higher, firmer and justified price bands.

The fragile supply environment is itself a permanent risk of runaway price rises when or if there is a supply interruption or cut of no more than about 4 Mbd, maintained for a few weeks.

In the present context it is highly unlikely that substitute supplies could be made up, and prices might be bid up through successive 'barriers' such as $50/bbl and $75/bbl, before defensive interest rate hikes were decided.

Oil price collapse due to recession would then freeze investment for maintaining world export capacity, leading to faster loss of world capacity. This would shorten the time interval before the next "demand shock" resulting in runaway price rises.

Much better, both for world economic growth and for increased investment in the oil and energy industry, is stabilized oil prices in a range of around $36-$45/bbl over the next 12 months. This pricing level, it can be noted, was surpassed in constant dollar and purchasing power terms through 1975-78, in which OECD country oil demand growth rates averaged about 3.75%-4% annual with oil prices, in 2003 dollars at $38-$55/barrel.

Suggesting a price level somewhat lower than that of more than 25 years ago is difficult to call 'radical', more especially because economic growth rates for major oil importer and consumer countries at that time were around 2 - 3 times higher than today, while inflation was about 6%/year on average for the G-7 economies.

Moving up to this new price band can be the focus of serious and committed international attention to the risks facing both oil producers and consumers at this time. Runaway price rises in a free-for-all bidding process following supply loss of no more than 5% is the worst possible scenario.

Concertation and communication based on energy economic reality and emerging challenges to world oil supply from depletion are positive and pro-active responses to increasing needs for resetting oil prices.