Iranian Oil Exchange
                 …Declaration of War?

Opec tightens its grip as oil prices hit the roof
The Observer

Emboldened by global growth, the cartel believes it can squeeze supply - and control the market - for years to come, writes Heather Stewart

When oil prices shot up to $78 a barrel last summer, analysts calmly dismissed it as a 'demand shock': the by-product of a golden period of economic growth. Twelve months on, prices are painfully high once again - but this time strong demand is not the only explanation. Opec, the producers' cartel, has seized the moment to tighten its grip on the market, slashing production, squeezing supply and forcing up prices.

For cash-strapped motorists, and inflation-wary central banks, the fresh oil spike is bad news. But an alarming report from the Geneva-based International Energy Agency last week suggested there could be worse to come - it predicted a 'crunch' in the markets as Opec consolidates its power.
The 10-member cartel, founded in 1960, has been emboldened by the fact that, despite a prolonged period of eye-watering oil prices, global growth has kept going strong. Old assumptions about the devastating impact of energy price peaks have been overthrown, as the global economy has put in its strongest period of growth for decades, at the same time as the price of crude has been stuck above $60 a barrel.

'We know that nine out of 10 serious world downturns were preceded by a spike in the price of oil, but that relationship has let us down in the past two years or so,' says Professor Andrew Oswald, of Warwick University.

For Opec, it has helped to undermine the old logic - that if it squeezes supply too hard, and push prices too high, it soon becomes self-defeating because of the damage it inflicts on oil-importing economies. Today, it believes it can squeeze harder.

'After five years of increases in prices, the global economy is going strong,' says Kona Haque, senior commodities editor at the Economist Intelligence Unit. 'Opec are pretty confident of the demand picture.'

They can also be confident of their growing power to control the market. A few years ago, the influence of Opec's members - who are concentrated in the Middle East - was expected to wane as output from the non-Opec oil producers increased. However, more recently, energy nationalism, under-investment and faster than expected production declines in the North Sea have led to sluggish output from many of the non-Opec countries, particularly Russia.

'The problem is supply, because non-Opec oil supplies are reaching a plateau, especially given what's going on in Russia,' said Leo Drollas, an oil expert at the Centre for Global Energy Studies. 'Since Yukos was dismantled, the spectacular rates of output growth have collapsed. They're really not putting the resources in.'

The IEA expects output from the non-Opec countries to be flat for the next five years, then start to decline from 2020 - though it shies away from the emotive word 'peak', which arouses fears of wells running dry.

'Our forecast suggests that the non-Opec, conventional crude component of global production appears, for now, to have reached an effective plateau, rather than a peak,' the report said. Output from non-Opec countries has been around 40 million barrels per day since 2003. The IEA says it will still be at that level by 2012, while global demand, driven by fast-growing economies such as India and China, will continue to rise. 'It's not peak oil: it's in the ground, we know where a lot of it is, but it's getting it out,' said Drollas.

With little hope of Russia and other non-Opec producers turning on the taps, Opec feels safe to flex its muscles. The club became notorious when it cornered the oil market for political ends, holding the West to ransom over the 1973 Yom Kippur war, and sparking a devastating oil crisis.

These days, the language is much more conciliatory, but Opec is clear that its job is to prop up incomes for its member-governments. 'Energy security is a two-way street,' the organisation said in its latest analysis of the market. 'It is important to the economic growth and prosperity of consuming/importing countries, but also crucial to the development and social progress of producing/exporting countries.'

To that end, Opec countries agreed in Doha, Qatar, last autumn to slash production by 1.2 million barrels a day; and by another 0.5 million in the spring. 'What's happened is that they've panicked on a few occasions since the 1997 price crash. Every build-up in stocks, they see as a disaster. They pre-empt problems by rushing in and cutting production,' Drollas said.

Unusually, its members seem to have stuck firmly to their new production targets; and Haque says the key reason crude prices have shot up towards record highs again this summer is that those cutbacks have made supply painfully tight. 'For a long time, we were talking about geopolitical tensions and the risk premium;now it's the actual supply and demand tensions,' she said.

Even within Opec, analysts say there is little leeway for extra production, and many countries are failing to take advantage of the long period of high prices to invest in the future of the industry.

'The longer-term problem is that they are not really investing in new capacity,' said Drollas. 'Saudi Arabia is, but they're about the only ones. Iran is not doing anything; Venezuela is a basket case, they're just milking the revenues. It's all on Saudi Arabia's back, and that's dangerous.' In Iraq, too, output has failed to bounce back to anything near the levels hoped for by the US before the invasion in 2003; and ongoing security concerns make it tough to boost supply further.

Speculators have responded to this lack of leeway in the market by bidding up oil futures prices: even a decade out, prices are now close to $70 a barrel. But Opec may have become too confident about the world's ability to live with $70 a barrel - or even $80 - oil. With the sub-prime mortgage crisis still dragging on in the US, central banks determined to vanquish inflation, and destabilising ripples spreading out from the bond markets, this new price spike is coming at a much more wobbly moment.

Rising energy bills will be a fresh blow for consumers already tightening their belts and a renewed surge in inflation would tie the hands of Federal Reserve chairman Ben Bernanke, preventing him stepping in to cut interest rates if the housing downturn goes from bad to worse. As Oswald warned: 'It's dangerous to think that oil can't bite back on us.'