Comments: Oil prices are gushing but could soon plunge

David I agree that "demand destruction", or at least a serious slowdown in demand growth, is a likely outcome. Indeed in the US, demand has actually fallen in recent months owing to the disruption caused by Hurricanes Katrina and Rita. And in China, oil demand is hardly growing because refiners cannot afford to supply the domestic market. China and the US accounted for half the growth in world demand last year, and there is little scope for growth elsewhere.

Additionally, non-Opec supply should increase this year, making it harder for Opec to defend the price.

But we should not forget that some of the factors driving the oil bull market have not been "solved." Principally, the limitations of global refining capacity. The extraordinary refining margins in the wake of the hurricane season led refiners to run flat out for the remainder of the year, and many have pushed back essential maintenance shutdowns. But there is only so long that refiners can keep the pedal on the floor, before stoppages both planned and unplanned start to happen. As refinery runs return closer to historic and sustainable norms, tightness will again start to be felt in the products markets, with a knock on effect on crude prices (even though it seems to some counterintuitive that crude prices should rise while refineries are running less crude - oil markets are funny in this respect).

Add to this the fact that global production is getting heavier and sourer - which means that it will yield less of the valued light products - and you have a recipe for continued strength.

Posted by El Pirata at January 16, 2006 10:50 PM

I agree with the comments above. There is more to oil than just oil demand and supply. There are production constraints, complicated by the light/heavy crude issue. There is also the refining constraint. I understand no refining capacity has been added in America or Europe for over 20 years.

The combination of the above, coupled to inelastic demand, political instability in many oil exporters, potential bad weather... oil is an accident waiting to happen. Lower oil prices may have led to inflation falling to 2% in December, but as noted above, petrol prices are rising already, so those interest rate cuts anticipated in Spring may not materialise.

America will change its reserves reporting requirements in July 2006, which will be interesting.

Posted by David Goldfinch at January 17, 2006 08:35 PM

Very interesting ariticles. Wish to recevice articles from you. Thanks!

Posted by Irene Ng at January 18, 2006 04:58 AM

It is a question of degree. I don't dispute that the sustainable price of oil has gone up for all the reasons you outline. I do dispute that it has trebled. Three years ago, the sustainable price was thought to be in the low to mid-$20s. If it is going to stay at $60-plus, that's a huge change. Even if $35-40 is the new level, as I believe, that's a big increase.

Posted by David Smith at January 18, 2006 12:38 PM
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