Geopolitics and strong demand to keep oil prices high (page 2 of 2)

As in the Middle East, an upsurge of terrorism has swept through Central Asia and Russia over the last year.

In addition to increasing instability, the Putin government is also very concerned about U.S. plans for permanent military bases in Uzbekistan and Kyrgyzstan, and Washington's influence over Georgia, a key transit point in the Caspian oil pipeline.

Though Presidents Putin and Bush may be "friends," its unlikely that Putin would be thrilled about a second term for Bush and the implications this would have for instability around and within Russia. Over the past year, the Putin government has consolidated its command over the country's oil companies, giving Moscow effective control over oil production and exports.

Like the Gulf countries, Russia can also have modest influence over the U.S. economy and the outcome of the U.S. presidential elections via its ability to withhold oil supply, pushing international oil prices higher.

President Hugo Chavez of Venezuela is definitely not a friend of President Bush. Venezuela's government remains adamant that the Bush administration covertly supported the coup which attempted to topple Chavez in April 2002. Chavez has suggested that the Bush administration also supported the oil sector strike in late 2002, as well as the recent recall referendum in Venezuela.

Chavez even threatened to stop Venezuela's oil exports to the United States if Washington continued to interfere in Venezuela's highly fractured political morass. Venezuela accounts for 14 percent of total U.S. oil imports and eight percent of OPEC oil production. Chavez would probably relish the opportunity to undermine President Bush's reelection chances by restricting oil imports or oil production, or both.

Even a minor decline of oil production, of a further 1 million barrels per day, in Saudi Arabia, Russia and Venezuela would push international oil prices well above $40 per barrel. Reduced oil production in these countries cannot be offset by increased production in other countries. World spare oil production capacity is estimated to be only about 2.5 million barrels per day.

Nearly one-half of this spare capacity is held by Saudi Arabia, Russia and Venezuela. Because only a small decline in production would have an inordinately large impact on oil prices, these countries would all benefit more from withholding production than increasing it. Against the backdrop of tightening oil supply, demand is expected to remain quite firm.

World oil demand is expected to increase by about two percent in 2004. Demand in both North America and Europe is expected to increase by only about one percent. In contrast, oil demand in Asia is expected to grow by four percent this year, led by nearly 11 percent growth of oil demand in China.

This is very significant because China is the world's second largest consumer of crude oil after the United States. China's crude oil consumption was equivalent to nearly 70 percent of the combined crude oil consumption of France, Germany, Italy and the U.K. last year. Though economic growth is expected to slow marginally in China this year, oil demand growth is expected to remain underpinned by the country's insatiable energy demand.

The high degree of energy price subsidization in China suggests that higher international oil prices will not significantly impact economic growth there. The main impact of continued high international oil prices will be on China's fiscal accounts. In the rest of Asia, the sustained strength of international oil prices will restrain economic growth by an average of about 0.5 percent this year.

Tightening world oil supplies and continued strong demand for oil will push oil prices above $40 per barrel (WTI basis) this year. However, in the short-term, oil prices could slide. In addition to building oil stocks in the U.S., which recently reached a 19-month high, speculative long positions in oil derivatives are very large.

At some point these speculative positions will shake out, pushing prices lower. Nonetheless, any downward correction in prices will probably be short-lived. Only significantly weaker than projected oil demand growth in China could lead international oil prices on a sustained downtrend this year.