Opec chooses to keep oil prices high

The immediate reaction of oil markets to last week's decision by Opec to raise formal output limits by two million barrels per day from July 1 was to actually increase oil prices. Quite simply this decision just brought limits into line with what oil members are actually producing.

It was only later in the day that markets began to reason that this still represented an easing of policy and that members with spare capacity have effectively been granted a license to pump whatever they like for the month of June. There was also unrelated better news on US gasoline stocks.

That sent US light crude down to $38.71 and Brent crude fell to $35.90 at the close of trading for the week. Traders feel that prices may not slide much further. There are reasons.

First, all oil producers, except Saudi Arabia, are now pumping at their maximum output. This makes supply and demand tighter and not weaker, with very little spare capacity to meet an emergency disruption of supply - such as we have seen many times over the past few years.

Second, the terrorist threat is far from over with the British Embassy in Riyadh, for example, warning that another attack like Al Khobar is a 'probability' and not a 'possibility'. Indeed, it was only a week ago that the attacks in Al Khobar sent US light crude to a 21-year high of $42.45.

Thirdly, Opec has kept some cards up its sleeve with the option to cancel a further planned 500,000 barrels per day output increase from August 1 if oil prices fall by more than $8 per barrel.

Overall, it looks as though Opec has moved to a new price band which will seek to maintain oil prices above $28 per barrel, and that used to be the top limit of the old $22-28 per barrel price band which is now dead.

It is thus perfectly possible that we may see oil prices fall back somewhat in the next few weeks. However, this is only on the assumption that there is no further terrorist activity in Saudi Arabia and it would be a brave man that risked too much money on that assumption.

Indeed, with oil markets now tighter than ever and very little spare capacity to meet a supply disruption, $40 a barrel for oil could look very cheap if the terrorists strike an oil installation.