So just where are oil prices going?

There may be a relief rally in oil prices this week because Hurricane Rita turned out to be less devastating than feared as she approached. Yet this sense of relief will be rather misleading.

Energy Associates President Herman T. Franssen told a conference in Abu Dhabi this week that as much as 20 to 30 per cent of US refining capacity might have been damaged by the two hurricanes:

'In today's tight market this will have a significant impact on US and EU markets for refined products.'

Lest we forget, current high oil prices are mainly due to a shortage of worldwide refining capacity. 'Opec is not to blame, it has done everything possible,' said Mr. Franssen.

Opec blameless

So whatever Opec producers do or do not produce this is not going to bring the oil price down. What is needed is more refining capacity to convert this crude oil into useful products. More crude is no use to anyone.

But refining capacity takes many years to build. Constructing a major oil refinery is not like putting up a garden shed. It is a hugely complex structure and also very expensive and difficult to locate.

Not that this is the only factor keeping oil prices high. There is very strong demand from the booming economies of China, India and Russia whose very large populations have a growing desire for the affluent, energy-consuming lifestyles of the rich countries.

Mr. Franssen added a third factor, that the poor recent performance of global stock markets was encouraging speculators to move liquidity into oil futures. This clearly increases upward momentum to the supply/demand problem based around refinery capacity.

Recession scenario

What could pull oil prices back? The only scenario that could depress oil prices at present - except for a very temporary trading setback - is a worldwide economic recession which would hit demand.

If oil prices spike too high then they could spark a collapse of already high world stock markets as the fear of inflation and its impact on profits would panic investors. Ironically such a shock to the financial system and its fall-out might be the very thing to cool oil prices.

But we do not seem to be close to this sort of a collapse just yet. However, financial crashes do not usually have warning lights ahead of them, and the situation in the oil market is potentially very unstable this autumn.

No period of high oil prices has ever ended without a recession, so why should this one be an exception?