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Interview: Oil Expert Explains What's Driving Record High Prices

(AFP) Oil prices have climbed steadily since 2004, and today they rose again to new record highs of more than $74 a barrel. What's driving prices -- and can they be brought back down? Government officials and oil executives from more than 65 nations will be asking those same questions when they gather in Qatar on April 22-23 at a meeting of the International Energy Forum. Among the factors driving prices up are fears over possible supply disruption in major oil-producing states such as Iran, Iraq, and Nigeria, where a rebel offensive has cut off one-quarter of output.

PRAGUE, April 20, 2006 (RFE/RL) -- RFE/RL spoke with Leo Drollas, the deputy director and chief economist of London's Center for Global Energy Studies.

RFE/RL: The price of oil continues to climb to record highs. Analysts say fears over the Iranian nuclear crisis is one of only several issues driving up prices. Iranian President Mahmud Ahmadinejad only strengthened those fears on April 19, when he said oil prices are still below their true levels. What's your take?

Leo Drollas: The first thing we must say is that these high prices are really paper prices, in a sense for paper oil, they're not the prompt market -- that is, for real wet barrels, as we call them. So they're obviously driven a lot by news and by sentiment, and they refer to oil that is bought and sold months ahead through paper contracts. And these prices move quite quickly on news, and the news is bad at the moment for oil because of the Iranian standoff, because of problems continuing in Nigeria, and many other factors in the market.

RFE/RL: So you're saying that, beyond fears over Iran or supply disruptions in Nigeria, the futures market is driving up prices?

Drollas: There's a lot of money that has come into the oil market over the last few years. The money that is now tracking commodity indices has increased from about $8 billion in 2001 to about $70 billion today. So we've got a huge influx of money into commodity-tracking indices, and a large part of those indices of course refer to oil. So we've got a lot of speculative money or hedge-fund money or other kinds of investors coming into oil, thinking they're on a roll now and that oil prices will forever increase. And in a sense, this tends to fulfill the prophecy, as long as the money keeps coming in.

RFE/RL: How does that drive prices, exactly?

Drollas: What tends to happen is that the futures prices, especially for months further out, tend to rise, and they create a difference between future prices for outer months and spot prices for oil, especially for "wet" barrels. And this differential encourages people to buy physical oil, and therefore, the pressure from the futures market is transmitted to the actual spot market for oil.

RFE/RL: But isn't capacity part of the problem as well, both in terms of the actual supply of oil and the fact that, particularly in the United States, refining capacity is down, with some refining facilities still not fully recovered from last summer's Hurricane Katrina?

Drollas: Well, this is the huge, unanswerable question as to what component of this price run-up is due to speculation, as we call it, or due to real fundamental factors. My own gut feeling is that maybe $15 [per barrel] or so at the moment is due to these kind of pressures from the futures market, from speculation if you like. In other words, the price should have been quite a bit lower than that, because there isn't actually a physical shortage of oil at this very moment.

RFE/RL: So this gets us back, perhaps, to emotions -- to fears over possible supply disruptions due to crises in key producing countries, such as Iran, Nigeria, Iraq.

Drollas: Of course, the fear is there because of these factors: Iran and Nigeria in particular, and also Venezuela to some extent in the background. But one must bear in mind that there is a physical problem too, in the sense that the spare capacity to produce crude oil in the world is under 3 percent of global demand for oil. And a business that runs with such little spare capacity is vulnerable to all kinds of events that make people worry or fear whether the system is able to cope with the pressures that are put on it in, let's say, the autumn or the winter that we have ahead of us.

RFE/RL: Now, what about demand? Isn't the growing thirst for oil from China part of what's driving prices as well?

Drollas: Well, demand triggered, of course, this crisis that started in 2004, but demand is growing, but a lot less than it did in 2004. So demand is still a factor, but it's not the driving force at the moment. We've gone back in the last few months to an old-fashioned supply problem with the loss of supplies from Nigeria and of course, the potential loss of supplies due to the Iranian crisis. So we've gone back in a sense to a real supply problem, although the demand side triggered the crisis.

RFE/RL: For oil-producing countries, the crisis appears to be a windfall. But are there any negative economic effects on major producers, such as Russia?

Drollas: First of all, we can easily say that this has been a tremendous boon to the Russian economy, and to Russian state finances. First of all, because of the high oil prices, secondly, because these high prices have pulled up gas prices, and Russia is a great exporter of gas also. And, thirdly, the state taxation system is progressive. So as the price of oil rises, so the revenues received by the state increase more than proportionately. So there's been a huge influx of funds into the state system. Presumably, it's spending it of course domestically, and that has helped the Russian citizen. On the other hand, the downside is that the Russian ruble has appreciated, and this of course harms other Russian exports. But at the moment, the benefits from oil and gas far outweigh any negative sides.

RFE/RL: Presumably, the same goes for the other oil and gas producers in the region?

Drollas: Kazakhstan, Turkmenistan, Azerbaijan -- all these producers of oil or gas would obviously benefit, just like Russia does. But other countries that do not have oil or gas who are in fact importers of oil or gas, would obviously suffer considerably. And that is the big downside, actually worldwide. And there are far more countries in the world that import oil and or gas than there are that produce them. So really, the impact is eventually negative on world economic growth, but it just takes time for it to appear.

RFE/RL: Given the duration of the current oil crisis, it would seem that we should probably just get used to high prices, perhaps indefinitely. Is this case?

Drollas: This year we'll certainly have prices high -- higher than last year. But this in turn creates its own solutions, if you like, and prices will be lower in the future. In the next three of four years, I would think they'll certainly be lower because demand will be curtailed sufficiently and supplies eventually will be forthcoming -- unless, of course, there's continuing political unrest that goes on for a decade, which would eventually cause a worldwide recession.

What Would Sanctions Mean?

What Would Sanctions Mean?

Economic sanctions could further undermine Iran's already shaky economy (Fars)

MOVING TOWARD SANCTIONS: If the United Nations Security Council imposes sanctions on Iran, domestic support for Iranian President Mahmud Ahmadinejad will wane, according to ALEX VATANKA, Eurasia editor for Jane's Information Group.
Vatanka told a February 24 RFE/RL briefing that "economic sanctions will hurt the average Iranian" and, consequently, many "will blame the ruling clerics" for making life difficult and "impairing the country's long term development."
Vatanka said sanctions would be a serious challenge to the Iranian government. If harsh economic sanctions were imposed, Iran's poorest population will be hurt the hardest -- and might react "as they did in the 1970s and protest in the streets." Sanctions on travel, Vatanka said, would hurt a many Iranians because "Iran is a nation of small traders" who depend on the ability to travel to earn an income. According to Vatanka, unemployment in Iran is estimated at 30 percent, "so small trading is essential to survival." Although current U.S. sanctions "haven't worked," he said, "Iranians fear an oil embargo." He stressed that "oil revenues are a major part of the economy, so it is critical to look at this sector."
Should negotiations with the European Union and the UN fail, Vatanka believes that Iran would follow a "North Korea model," since Ahmadinejad's base of support among the "Islamist militias" has been "urging withdrawal from the NPT [Nuclear Non-Proliferation Treaty]." The Iranian government's "tactic" so far, Vatanka said, is governed by the belief that "by shouting the loudest, you'll get concessions [from the West]."


Listen to the complete panel discussion (about 60 minutes):
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THE COMPLETE STORY: RFE/RL's coverage of the controversy surrounding Iran's nuclear program.


An annotated timeline of Iran's nuclear program.