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Markets & Stocks

Oil could touch $50
With spare capacity nil and the world a dangerous place, analysts see risk of higher crude prices.
August 5, 2004: 5:27 PM EDT
By Mark Gongloff, CNN/Money senior writer

NEW YORK (CNN/Money) - When the price of oil crossed $40 a barrel earlier this year, it generated nervous headlines and anxiety on Wall Street and likely threw cold water on the U.S. economy.

Now it seems that $40 a barrel may have been just a step on the way to even higher prices, with $50 or more a distinct possibility in the short term, according to some analysts.

Oil prices set yet another new record at the New York Mercantile Exchange on Thursday, closing at $44.41, the highest in the 21-year history of the NYMEX contract, and the third straight day trading above $44. They've been above $40 a barrel for 17 straight days and for 31 out of the past 60 days.

Forty dollars was a key psychological level for oil prices, and $50 is another one -- and many analysts were talking this week about the possibility that level could be reached fairly soon.

"I totally expect to see $50 a barrel, at least in a spike to that level, at some point in the near future," Jason Schenker, an economist who tracks the energy sector for Wachovia Securities, said on Wednesday. "We've been in an upward trend for several years, and I really don't see any indication of a reversal of that trend. $50 a barrel is a completely rational expectation."

Economists still doubt that $50 oil would cause a recession -- after all, the U.S. economy is the strongest it's been in years, and it's less reliant on oil than it was in the 1970s, when oil spikes caused more painful recessions. $50 is still not as high, adjusted for inflation, as the oil spike in the 1980s, when the Iran/Iraq war pushed inflation-adjusted oil to $80 a barrel.

Still, high energy prices act as a tax on consumers, who fuel two-thirds of the economy. They eat away at discretionary income, at a time when interest rates are rising and the effects of last year's tax cuts have worn off. Sustained high oil prices could sink economic growth back to closer to trend -- not a recession, but maybe not enough to help a still-healing labor market.

"If oil goes to $50 a barrel, I think we're talking about 3 percent economic growth, rather than 4 percent growth, possibly," said Sung Won Sohn, chief economist at Wells Fargo. "And the jobless rate could actually go up, not down, because the long-term potential economic growth rate is actually 3.5 percent -- we could actually be falling below potential."

Fundamentals not driving market

Though the Organization of the Petroleum Exporting Countries (OPEC), the cartel that supplies about 40 percent of the world's oil production, is likely pumping oil as fast as it can to get prices under control, the problem for the market is not necessarily one of supply and demand. In fact, oil supply in June exceeded demand by about 2 million barrels per day.

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What's keeping oil prices higher, analysts said, is a built-in premium to account for potential headaches, including terrorist attacks on major oil facilities, problems with the Russian oil firm Yukos, further political unrest in Venezuela, OPEC's No. 3 oil producer, and more.

"Fundamentals would suggest prices in the low-to-mid-30s," said Lawrence Goldstein, president of the Petroleum Industry Research Foundation, an industry research firm. "But fundamentals are not all that's driving this market."

Of course, the oil industry faces such headaches all the time. Most of the world's production capacity sits in the tinderbox of the Middle East, and bad weather, accidents and political upheaval cause endless supply headaches.

What's different this time, however, is that most of the cushions protecting the industry from such woes -- including spare production capacity, spare refining capacity and spare inventory -- have all disappeared amid an unexpected surge in global demand.

"The market has an asymmetrical bias towards upside risk because we've lost those cushions," Goldstein said.

The only curb left on prices, then, is demand. Ordinarily, a surge in prices will cut demand, which in turn will cut prices -- the market is somewhat self-correcting, in that sense.

But global demand, driven by a synchronized global economic expansion, has been exceptionally strong, with China and India -- economies growing like wildfire -- guzzling a good bit of the world's oil and showing little sign of losing their appetite for it.

"India and China are big importers of crude oil, and they're both at the stage of their development where they're energy intensive," Kevin Norrish, oil analyst with Barclays Capital, told CNNfn. "We have seen no pullback in demand in those countries, or in western countries --demand doesn't seem to be an issue that would help keep prices in check."

Help on the way?

Still, help may be on the way. The summer driving season is ending soon, which may help keep gasoline prices in check. Gasoline refining becomes easier in the fall and winter, when quality standards are lowered and overseas refiners can help out. There will soon be more clarity about the situations in Venezuela and Russia. If the U.S. election passes without a terrorist incident, traders could breathe a huge sigh of relief.

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Some analysts still believe that, since the price of oil is so bubble-like, driven more by psychology than by fundamentals, it's subject to sudden declines.

"We continue to believe that fundamentals of supply and demand will be in play, bringing oil prices down to approximately $35 per barrel by the end of this year, and to $25-30 per barrel in 2005," said Prabhas Panigrahi, managing director of research at Ehrenkrantz King Nussbaum.

But there's still a chance such a decline could be short-lived, since the lack of spare capacity will not go away any time soon -- it takes years to build new production capacity -- and the world will remain a risky place in which to pump oil.

Prices did drop sharply on Wednesday, after Saudi Arabia said it had brought new oilfields on line faster than expected, and Yukos said Russian authorities would allow it to keep operating. But those same authorities froze Yukos' accounts Thursday, and oil rebounded to a new record.

"I look at the futures curves, and they're shifting up; we're looking at, a year from now, the price being $40 a barrel," said Schenker of Wachovia Securities. "Oil won't be at $30 any more -- that's gone."  Top of page

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