Oil prices set to jump again as industrial demand keeps rising

Business is being warned to expect no relief from the high price of oil, which was above $70/barrel at the start of the week and could be close to record levels by the end. The International Energy Agency (IEA) has raised its forecasts of average annual rise in the oil demand to 2.2 percent per year for the next five years, up from 2 percent in its previous assessment. The upward revision is mainly due to faster-than-expected demand growth, with particular contributions from budget air travel, power generation, petrochemicals, and continued emerging-market industrial growth especially in Asia.

Crude oil supply will also be constrained by declining flow from OPEC nations as their older wells decline, with downstream products supply further held back by shortage of refining capacity. Russia, Venezuela and other large producers are restoring state control over previously privatised operations, while others have imposed tax increases that producers can easily pass on in prices with the market at its present strength. Though new discoveries are still being made, many of the world’s major fields have now passed peak production, and even Middle Eastern output is widely forecast to start declining soon.

Hopes of supplementing or substituting lots of oil with crops and other biofuel are downplayed by the IEA, which forecasts a contribution of no more than 2% of total fuel use even in 2012. But increased cultivation of crops for biofuel is already being blamed for raising the price of another commodity, wheat, an increase about to be felt in supermarket bread and pasta prices. The IEA goes as far as suggesting that a severe supply shortage could fuel a new burst of inflation and disrupt world growth after 2010. With the gas market heading for a similar tightening, the agency is keen to point out that fuel supply remains a sometimes unacknowledged weakness behind recent buoyant forecasts for global growth.

By Alan Shipman, for FinanceWeek [1]