Friday, May 23, 2008

New fears on long-term oil supplies drive prices higher

New fears on long-term oil supplies drive prices higher

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Worries that world oil demand will outstrip global supplies intensified on Thursday, sending ripples through the global economy as oil prices leaped above $135, a new record high.

The price spike occurred overnight, and by Thursday morning oil had fallen back slightly to $132.87, down 30 cents from its close on Wednesday.

But the leap capped a rally that has seen oil rise nearly $5 a barrel in two days, underscoring the dire implications of the current price run-up for businesses across the globe.

Ford Motor Company, the American auto manufacturer, said on Thursday it would cut vehicle production for the rest of this year and fall short of reaching profitability in 2009, a long-held company goal. In a statement, a top Ford executive said rising gasoline prices "are having a tremendous impact on our sales, our manufacturing operations and our profitability."

Meanwhile, Europe's biggest airline, Air France-KLM, warned of a profound reshaping of the world airline industry caused by what it called the "explosion" in the price of oil. And American Airlines said on Wednesday that it would slash flights and begin charging passengers to check bags, part of a company effort to cut costs in the face of skyrocketing fuel prices.

Gas prices are nearing $4 a gallon in the United States, partially as a result of a 39 percent rise in oil futures prices on the New York Mercantile Exchange since the beginning of the year. Oil prices have more than quadrupled since 2003.

Thursday's price gains came after a series of unsettling reports about supplies. The International Energy Agency warned about difficulties in expanding production.

On Wednesday, weaker-than-expected weekly inventory data in the United States stoked fresh worries over oil supplies in the world's biggest economy, sending oil prices up $4.19 a barrel on the day.

The latest supply worries arose after reports Thursday that the International Energy Agency, based in Paris, was considering reducing its assessment of the long-term world supply of crude oil after a study of depletion rates at the world's 400 biggest fields.

"Clearly this is the issue we have had for a while of an increased deficit in consumption versus production," said John Kilduff, energy analyst at MF Global in New York. "That's produced this creep up in the rise in oil prices. The market gets hit on a daily basis."

The energy agency has long forecast a slow but steady increase in production that would keep pace with demand. Output was projected to reach 116 million barrels a day in 2030, from 87 million barrels a day now.

"We are conducting a major study," Fatih Birol, the agency's chief economist, said in an interview Thursday, "and we are going to revise our oil supply prospects."

"We don't know the results yet," he added, which will be conducted "project by project and field by field."

"But there are difficulties in expanding production," he said, and the World Energy Outlook 2008 — which will be published in November — will take that into account. The IEA has expressed concerns for some time that the growth of new supplies may not keep pace with demand as oil companies struggle to find new sources of oil.

There are considerable signs of speculative froth in the market.

Michael Masters, a portfolio manager at Masters Capital Management, testified Tuesday to a Senate committee that while the most common explanation given for rising oil prices is the increased demand for oil from China.

But he cited data showing that the increase in demand from index speculators over the past five years is almost equal to the increase in demand from China.

Separately Thursday, Air France-KLM warned of a profound reshaping of the global airline industry caused by what it called the "explosion" in the price of oil.

The data on Wednesday, from the Energy Department, showed that commercial inventories of crude oil in the United States fell more than five million barrels last week; analysts had expected a modest increase. Gasoline inventories also fell last week.

The fall in inventories added to worries about oil supplies in the United States ahead of the busy summer driving season when demand usually rises, analysts said.

The massive earthquake last week in China has also been weighing on markets, Kilduff said. It has deepened the fears about global supply because the Chinese authorities are now diverting energy supplies for their own needs.

"China has reacted by holding supplies off the international market," he said. "We also saw them make a major purchase on the world market."

He said a number of China's coal plants had been temporarily shut down, which meant the country would start to increase its demand for diesel.

He said that the latest reports meant he would likely raise his forecast for the future oil price. "We are going to raise that. Clearly now the medium term favors a price of above $140," he said.

With crude oil prices passing $130 a barrel, a rise of more than 100 percent in a year, the business model airlines adopted a decade ago has been thrown into question. The International Air Transport Association said May 2 that growth in international traffic was slowing, and that "the fortunes of the industry have taken a major turn for the worse."

"Things are moving very quickly," Jean-Cyril Spinetta, the chief executive of Air France-KLM, told reporters Thursday before the company announced its first quarterly loss in five years.

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