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How High is Too High For World Oil Price?

Source: Reuters 4/21/2006, Location: Middle East

The $70-a-barrel mark for oil, decisively breached this week, is seen by many analysts as a danger level. But some argue sustained prices of well over $60 have inflicted surprisingly little pain and done some good. Ministers from 65 countries and executives from the likes of Exxon Mobil, Royal Dutch Shell, BP and Chevron meet in Doha over the weekend, agreed today's record prices are too high but split over what is a fair level.

Among other things, it depends on the escalating costs of extracting reserves, the value of the dollar in which oil is priced, and above all on how high a level the world can stand before recession hits and demand for fuel collapses. "$60 did not bring a recession ... It's dampening oil demand growth and having a positive effect on the environment," said Nordine Ait-Laoussine, former Algerian energy minister and president of energy consultancy Nalcosa.

"On the supply side, it's stimulating the growth of global output capacity, both in conventional and non-conventional supplies. As a result, it provides a security against future energy crises," he told a conference this month.

Oil prices have more than trebled since the start of 2002, but so far the impact on gross domestic product has been only around one percent, OPEC said in its Monthly Oil Market Report.

Despite record nominal oil prices, finance ministers and economists are predicting continued growth. In its world economic outlook published on Wednesday, the International Monetary Fund (IMF) revised upwards its 2006 global growth forecast to 4.9 percent from 4.3 percent. But it warned the full effects of surging energy prices may not yet have been felt.

Rich Poor Divide

Even if the bigger economies are still thriving, poor countries are struggling to cope with rising fuel costs. Burkina Faso, ranked the third poorest country in the 2005 U.N. Human Development Index, is totally reliant on imports of transport fuels.

"To tell you the truth, when the price goes up, we just get hit. That's it. There is no advantage," said Benoit Sampo, secretary general of the National Hydrocarbon Company of Burkina Faso, a state-owned body that imports and stores fuels.

Indonesia, the Organization of the Petroleum Exporting Countries' only net importer, has also been paying the price. Asia's fifth biggest oil user, Indonesia doubled retail prices last October to try to cut its fuel subsidy bill. The increase sent inflation to its highest level in more than six years, slowed economic growth and slashed consumption as Indonesia's poor opted to travel less rather than pay more.

Big Revenues, Big Costs

Even OPEC's net exporters are beginning to worry high oil prices have the complication of also increasing the cost of projects to bring on extra production.
"Cost is a problem," said Qatari energy minister Abdullah al-Attiyah. "Costs can sometimes kill the project."
For OPEC producers, expenses are offset by high earnings.

Leading exporter Saudi Arabia is expected to earn record oil revenues of nearly $160 billion this year, some of which will fund a $50 billion plan to boost its production capacity. The IMF has voiced concern about global imbalances as oil producers reap huge current account surpluses, while the biggest energy consumer the United States sinks deeper into deficit. Any negative effects are less obvious than during the previous price shocks triggered by the Arab oil embargo of 1973 and the 1979 Iranian revolution when, in real terms, price levels were much higher than today's nominal records.

"The price of oil deflated by the U.S. consumer price index would have to be above $110 a barrel to match the prices seen in the early 1980s," said Richard Batty, analyst at Standard Life bank. "So say $55 a barrel today would be the equivalent in real terms to a price of less than $20 in the early 1980s."

Another difference is that previous price shocks encouraged energy efficiency, making the world much less energy intensive. The inflationary impact has also been muted, partly because oil has been translated into a kind of tax on us all.

In a global, competitive business environment, manufacturing companies absorb the rising cost of raw materials by cutting back on labor costs, rather than increasing the price of their products for fear of losing market share to much cheaper manufacturers from China, India and eastern Europe.

"If the oil price moves up, companies will be cutting back on labor costs," said Batty. "Corporate behavior and individual behavior seem to be a lot different."

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