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Oil markets skittish after Iraq attacks

.  With the world’s production capacity stretched to the limits, an expected uptick in demand later this year could once again push oil prices sharply higher.  -- By John W. Schoen
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World oil markets Thursday turned skittish after initially taking in stride the loss of Iraqi oil supplies Thursday following this week's pipeline attack. Assurances of increases supplies from OPEC kingpin Saudi Arabia had also calmed oil traders earlier this week, and fears of just such an attack had already recently sent crude oil prices soaring over the past several months.

But with the world’s production capacity stretched to the limits, an expected uptick in demand later this year could once again push oil prices sharply higher.

News that oil major BP was forced to halt barge loadings from a big refinery in Rotterdam due to a fire added to concerns about steady flows of fuel to consuming markets. BP said, however, that fuel shipments could still be loaded out of the refinery by pipeline and sea-going vessels.

All of which sent oil prices higher Thursday on the second day after the Iraqi pipeline attacks. U.S. crude oil futures on the New York Mercantile Exchange settled $1.14 higher at $38.46 a barrel, reversing a 12 percent slide since early June when OPEC announced it would raise production to cool red-hot prices.

Iraqi insurgents Tuesday blew up a key pipeline connecting the nation’s southern oil fields with loading terminals on the Persian Gulf. A second pipeline was attacked shortly afterwards, according to Iraqi officials. The shutdown left Iraq with virtually no export capacity; earlier this month, insurgents attacked and shut down the main pipeline linking the northern oilfields in Kirkuk to loading facilities in the Turkish port of Ceyhan.

As of Thursday, officials were hopeful that the smaller of the two lines would be repaired by Friday and some oil could begin flowing again. Repair of the larger pipeline is expected to take several weeks.

In another blow to the Iraqi oil industry on Wednesday, gunmen killed Ghazi Talabani, a senior official in Iraq's in the North Oil Company, as he was being driven to work in the center of Kirkuk. Talabani, a 70-year Iraqi Kurd, was the latest of several oil officials who have been killed in Kirkuk since the Iraq war last year.

The loss of Iraqi supplies follows a June 3rd pledge by the Organization of the Petroleum Exporting Countries to increase production limits by two million barrels per day as of July 1, with another 500,000 barrels per day coming on line August 1.

Petrologistics, an industry consulting firm that tracks tanker shipments, estimates OPEC output for June at 27.4 million barrels per day from the 10 members with quotas, just 500,000 barrels per day short of what the International Energy Agency (IEA) says is the group's sustainable capacity. That surplus capacity amounts to less than one percent of current world demand of 80 million barrels a day – leaving little margin for any further supply outages.

"Iraq's exports were about 1.6 million barrels a day, that's what I guess the world's spare capacity to be at the moment," said David Thurtell at Commonwealth Bank of Australia. “So there's no fat left, there's no room for error, accident or more attacks.”

With so little excess capacity, OPEC Wednesday called on non-members to produce more oil. But with prices recently hitting 21-year highs, most oil producers say they’re pumping as fast as they can.

"We don't have a tap that we can just turn on and off. We are producing exactly as much as we can," Sergei Oganesyan, Moscow's number two oil official, told the Interfax news agency. Oman, which is struggling to stop a steep decline in output due to aging fields, has also said it had no spare capacity to increase output.

Non-member Mexico has said it aims to increase crude exports to 1.95 million barrels per day from 1.88 million by the second half of 2004.

In Venezuela, which as recently as 1997 sent more oil to the U.S. than Saudi Arabia, production is still recovering from a crippling strike in late 2002. That strike, and political unrest that followed, cut the workforce of its state-owned oil company in half. Last week, an election council ruled that President Hugo Chavez will face a recall Aug. 15th.

Production by OPEC member Nigeria had been threatened by a three-day strike that was resolved. But a new walkout threat emerged from Norway, where offshore oil workers threatened a strike on Friday they said could shut down at least 240,000 barrels per day of production.

As oil traders and buyers have begun to “price in” the risk of terror attacks, many are turning their focus to the traditional pricing impact of supply and demand.

Oil markets have been calmed somewhat by data showing a gradual rise in U.S. crude oil inventories. But U.S. government data released on Wednesday showed inventories rose by only 800,000 barrels last week, about half of what analysts had been expecting.

Demand for oil typically rises in the second half of the year, as the summer driving season keeps gasoline consumption high and refiners begin stockpiling heating oil for the winter. This year, strong economic growth worldwide has pushed demand forecasts steadily higher.

In its latest monthly report, the IEA last week boosted its demand forecast for 2004. The new numbers call for an increase this year of 2.3 million barrels per day, or 2.9 percent, bringing global consumption to 81.1 million barrels per day. With global production already near upper limits, it’s not clear where that additional oil will come from. And some traders think demand in the second half could be even higher than the IEA’s forecast.

“They’ve been underestimating demand all year,” said Phil Flynn at Alaron Trading in Chicago. “When you put the numbers together and you look at them, it’s going to be a very scary situation.”