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THE BUSINESS: Oil heads for $70 a barrel: Sunday August 14, 2005


By: Allister Heath, Fraser Nelson and Richard Orange 


OIL prices are set to break the critical $70 a barrel level, leading analysts are warning this weekend. This further surge in the price, caused by mounting supply problems, geopolitical tensions and strong demand, will hit world economic growth, put pressure on inflation and send petrol prices soaring. The surge will also deliver a windfall to the UK Treasury, with Gordon Brown, the Chancellor of the Exchequer, collecting at least an extra £1.6bn (E2.3bn, $2.9bn) over two years thanks to the sustained rally in crude.


Last week, the price of oil hit a record $67.10 a barrel before closing at $66.86. Deborah White of SG Cowen said: "Now that prices have broken through the psychologically significant $65 a barrel mark, it seems inevitable that they will test the $70 a barrel level before the year is out." Paul Horsnell, of Barc-lays Capital, one of the few to predict last year's oil-price surge, argues that $50 has replaced $20 as the sustainable long-term oil price, with even higher prices likely until 2009 or 2010. He said: "Our view is that the sustainable level of long-term oil prices is that which creates enough investment to maintain a reasonable degree of spare capacity. That would argue for a long-term price of at least $50 with a higher price needed into the medium term to allow for some catch up."


Zeigham Khokher, of the University of Western Ontario, thinks the price could rise as high as $80 a barrel before demand falls. He said: "It'll take another 20% or 25% before people let it affect their behaviour."


With prices now at $66 a barrel, the UK Treasury is set to collect an extra £700m for 2005-06 alone, having made its original forecasts at a stagnant $40.80 a barrel. The Institute for Fiscal Studies (IFS) is forecasting that North Sea oil revenues will be £6.1bn for 2005-06, from £5.2bn, and £7.8bn for 2006-07, up from £7.1bn. But road hauliers are warning that petrol prices have now broken well through the levels that provoked fuel protests five year ago and are demanding that Brown rethink fuel tax.


The Road Hauliers Association (RHA) warned that immediate pain is being felt by drivers and called for Brown to use the extra fuel proceeds for a fundamental rethink on how he taxes motorists. An RHA spokeswoman said: "When fuel leaves the refinery, excise duty is charged. When it comes out of the petrol pumps, VAT is charged on the excise duty. On which other commodity do we pay tax on a tax?" She added that her members have lost patience. "There is a tremendous unrest among out there. It will soon get to the stage where there will be calls for measures to support the haulage industry."


Unleaded petrol is now 90p a litre in several parts of the UK, well above the 85p limit that sparked protests five years ago. The price includes 60p tax. In the United States, unleaded petrol retails for 0.61c (36p) a litre. The Treasury said it will save its views on fuel tax for the Pre-Budget Report due in November, when it will make a decision on the inflation-linked fuel tax increase, which has already been suspended twice.


But it pointed out that sustained oil price rises can hurt the Treasury by dampening economic growth and cutting the tax haul. It profits most from a short- to medium-term spike, too short to affect growth, it claimed.


At least 14 refinery units in the United States have been shut since 20 July, increasing concern about fuel supplies. Refiners, which produce more petrol in the summer to meet greater demand from motorists, have been operating at 95% utilisation rates, leading to a string of shutdowns, accidents and fires.


But the big oil companies are finally beginning to raise their exploration spending to help add extra oil production capacity. Industry analysts John S Herold have found that upstream capital spending is set to rise by about 15% this year.


A survey of 19 oil companies showed they planned to spend $94bn on the upstream, $12bn more than last year. ExxonMobil is spending $2bn more, BP $500m more, Total $2bn more and Royal Dutch Shell's spending will be roughly stable. Jamal Kureshi at Washington's PFC Energy said: "They're pretty much spending everything they can. Once you're over $30 a barrel [planning assumptions] pretty much every project is viable."


But Herold's Nicholas Cacchione said some of the extra spending would come from the higher cost of hiring drilling rigs: "People would love to increase their level of activity but the number of drilling rigs is a severe constraint. They can't just go and spend more money because they lack the rigs."


Analysts at Citigroup last week increased earnings estimates for the big European oil companies by 13% for 2005 to reflect a more bullish oil price outlook. Citigroup believes Brent will average at $54 a barrel in 2005, up from $48, and sees $48.50 in 2006, $45.50 in 2007 and $42.50 in 2008. This has filtered into spending.


Though western companies are investing more, facilities in Opec and developing countries are suffering. Geopolitical tensions are mounting in all the main producers, leading analysts believe, and this is helping to fuel tensions on the oil markets.


Policymakers in Washington, who used to assume there was a 50:50 chance that the Saudi regime would survive the next 10 years, have now cut this to five years. In Venezuela, President Hugo Chávez is continuing his extreme anti-American rhetoric, claiming that the US is the most evil empire in history and that he is preparing to repel a US invasion. Chavez is also using his oil revenues to fund Fidel Castro's dictatorship in Cuba, leading analysts believe, and trying to sell oil that previously went to the US to China and Latin America. The national oil company, packed with his political cronies, is inefficient and reducing the amount of oil available for exports.


In Russia, the confiscation of Yukos and general uncertainty has made it harder for the oil industry to expand production. Iraq is unable to protect its pipelines and facilities. Production remains below pre-war levels. 


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