$70 oil: Get used to it

[notiCIas]

With little spare capacity and strong demand from the U.S. and China, markets are more vulnerable than ever before.
By Steve Hargreaves, CNNMoney.com staff writer
July 11 2006: 1:33 PM EDT


NEW YORK (CNNMoney.com) -- Oil prices may fall if progress is made in talks with Iran over its nuclear program, but things like surging auto sales in China and record gasoline demand in the United States mean that oil prices near record highs are probably here to stay.

Oil hit a fresh trading high of $75.78 Friday, pushed up by strong U.S. demand over the holiday weekend and ongoing tensions with Iran.


Prices could fall later this week as talks, which many expect to be constructive, continue with Iran over it's disputed nuclear program. But few think they'll fall too far.

"If there's a breakthrough, we could head back to around $70," said Nauman Barakat, an energy trader at the investment bank Macquarie. "But fundamentally, it's difficult to make a bearish case."

That's because Barakat keeps getting information like this: Despite national average gas prices of nearly $3 a gallon, near the inflation-adjusted high of $3.18 a gallon from the early 1980s, Americans used more gas in June than in any other month, according to preliminary data from the Energy Information Administration, the statistical arm of the Energy Department.

It is true that high prices are eating into demand growth for gasoline, with the latest EIA numbers showing the growth rate slowing to 0.5 to 1 percent per year from 1.5 to 2 percent a year. But the fact remains that demand is not dropping.

"Price is causing some substitutions, but in my opinion it's not enough, " said Peter Tertzakian, chief energy economist for ARC Financial and author of the book "A Thousand Barrels a Second."

Enough, that is, to significantly bring down prices, although those high prices have so far shown little ability to cut into economic growth as the economy is more efficient than it used to be.

And it's not just the United States that's eating up world supply.

Although the country uses about 20 million barrels of oil a day, more than three times the 6 million barrels used in China, the No. 2 consumer, demand is growing much more quickly in China.

Chinese consumption is growing at about 500,000 barrels a day each year versus growth of about 200,000 in the United States, according to Tertzakian.

By 2030, EIA estimates China will use 15 million barrels a day.

That's no doubt helped by China's new-found love for the automobile. Just Monday a news report said car sales in the country surged nearly 50 percent in the first half of 2006.

But there's more. Growing demand in other developing countries, notably India, the lack of big new oilfield discoveries, and the soaring cost of getting oil out of the ground are a recipe for sustained high prices.

Tertzakian said most people just won't make the necessary sacrifices to significantly cut energy use. For any meaningful conservation to take place he said prices would have to rise to somewhere around $130 a barrel, although an economic slowdown would probably happen before prices reached that high, which would itself reduce demand.

Instead, he said, barring a drop in prices from a recession, people will simply deal with paying more, hobbling along until a new energy source or sources begin to replace oil, a transition process that he said was just starting and could last for decades.

In the meantime, any hint of political instability or supply disruption will move oil prices in a market hypersensitive to any piece of news.

Why are markets so sensitive? The world's easy to get light crude oil has been mostly gotten, so big oil-producing nations can't easily boost production when local supplies are disrupted.

Worldwide spare production capacity dropped from 5.5 million barrels a day just a few years ago to around 1 million in 2006, said Doug MacIntyre, a senior oil market analyst with EIA.

"That's not enough to cover a full disruption from Iran or Nigeria or Iraq or even the hurricanes," said MacIntyre. "So the market is going to become a lot more volatile on a day-to-day basis."