Reasons for oil not to hit $150

As the oil price continues to surge, hitting $109 a barrel, the oil price movement for 2011 has begun to look very much like that in 2008, when the price ended up hitting $145, and became a contributing factor to the slump.

But Leo Drollas, chief economist at the Centre for Global Energy Studies, thinks it won’t, even though there are many similarities with the situation in 2008, including high oil demand.

The main factor keeping a lid on prices, Drollas told an audience in London on Wednesday, is relatively low pure speculation compared to 2008. According to CGES’ indicator of pure speculation (which, for markets geeks among you is taken by measuring the positions of pure speculators that exceed those which merely match those taken by hedgers such as airlines), pure speculation is low and has been dropping since September.

The second reason Drollas mentioned was that spare capacity was higher than it was in 2008, when it was under 4 per cent of world oil demand. Currently, the outlook is being boosted especially by the prospect of much higher production from Iraq.

Of course, for this to be a significant factor, it would take a willingness by Opec to raise output, and there are few signs of that happening yet – although that position may change if the oil price threatens demand. (And, I should add here before the commenters pile in, you would also have to accept that Opec has the supplies it claims, and there are reasons not to.)

There are several other reasons the price could yet dip. High prices could reduce demand, China and India could be overtaken by inflation, Opec could lose control of production or climate change policies could fall by the wayside.

But the trouble in the Middle East is of course the great unknown here. Drollas believes that production in Libya, or any other major producer that is hit by revolution, will only remain interrupted for a short period of time, because the population will demand those revenues. But the risk is that in the long term, production will be limited by a lack of investment and expertise, as happened after the Iranian revolution. He says:

Everything is up in the air. Libya is the first major producer and exporter to be affected by the turmoil. Companies are pulling out. If all goes well they will be back soon, but production is being cut as we speak, so it could get worse. And if contagion spreads to the Gulf, it could get a lot worse. In that case, all bets are off.

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