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Oil prices surge on fears of supply shortfall

Crude oil prices jumped to record levels Wednesday as the prospect of a production shutdown by a major Russian oil company raised fears that already tight global supplies could be stretched even further.
A worker from Russian oil firm YUKOS looks over derricks at a major oil processing facility
A worker from Russian oil giant Yukos looks over derricks at a major processing facility in the Siberian oil town of Nefteygansk earlier this week. The core unit of Russia's largest oil company wants to boost output despite the threat of a forced sale, a senior manager said.Sergei Karpukhin / Reuters file
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Crude oil prices jumped to record levels Wednesday as the prospect of a production shutdown by a major Russian oil company raised fears that already tight global supplies could be stretched even further.

Strong demand and declining U.S. domestic production pushed oil imports to record levels last week, according to Dept. of Energy data released Wednesday. Despite increased imports, oil stock piles in the U.S. rose only slightly in the latest week, a sign that the demand for oil is continuing to rise. The report followed similar numbers released Tuesday by the American Petroleum Institute. Despite increased production by OPEC producers in the second quarter to 30 million barrels a day — the highest level since 1979 — increased consumption has taken up almost all of that slack.

“If we see that demand continue to go up and then we have an early winter and we see demand for heating oil rise as well, we're going to be looking at very high crude oil prices for some time to come, anywhere from $45 to $50,” said Raymond Carbone, an oil trader with Paramount Options. “It's the sky's the limit.”

That’s why news that Russian oil giant Yukos had been ordered to shut down production has the oil markets rattled. Russian bailiffs reportedly told the company’s four production units, which together pump 1.7 million barrels a day of oil, to halt sales of any property, including oil. Yukos faces bankruptcy as courts seek to enforce a $3.4 billion tax debt for 2000 on top of an earlier order freezing the company’s assets.    

The company has been at the center of a power struggle between former Yukos CEO Mikhail Khodorkovsky and Russian President Vladimir Putin that is widely seen as a Kremlin-led drive to thwart Khodorkovsky’s political ambitions and punish him for funding opposition political parties. Other analysts suggest that the move is aimed at consolidating the Kremlin’s control over the Russian oil industry.

“Whatever happens here the overall message is that the Russian government is going to have more authority over its oil and gas industry, which today provides something like 60 percent of Russian government revenues,” said oil industry analyst Daniel Yergin. “And in a sense, oil and gas today is the arena in which Russia is still a superpower.”

The loss of Yukos oil would represent a relatively small portion of global supplies. The company produces about a fifth of Russia’s roughly 9 million barrels a day, about half of which is exported. Global demand is currently running at about 82 million barrels per day.

But unlike previous supply squeezes that were artificially created by producing countries deliberately holding back output, today there is little spare oil production capacity available — by some estimates less than two percent of global demand. Iraqi oil production is still below pre-war levels and subject to interruptions from ongoing attacks on oil facilities and pipelines. Venezuela has not yet returned to production levels seen before a crippling strike in late 2002 brought thousands of layoffs at the state oil company, Pdvsa.

"Most of the (OPEC) countries are near their production limits," Venezuelan oil minister Rafael Ramirez told Reuters.

On Wednesday, U.S. light crude settled up $1.06 at $42.90. Earlier in the day, U.S. crude reached $43.05 a barrel, topping peaks hit in early June and the highest price since the New York Mercantile Exchange launched the contract in 1983. London Brent crude settled up 99 cents to $39.53 a barrel, its highest level since October 1990, ahead of the first Gulf War.

A further rise in oil prices could throw the expanding global economy back into recession; OPEC producers have vowed to avoid that by increasing production to try to ease prices. Though at record levels in current dollar terms, oil prices are about half the inflation-adjusted peak of nearly $80 a barrel reached in 1980 after the 1979 Iranian revolution interrupted supplies.

The jump in oil prices this week has renewed speculation that oil consuming countries may decide to dip into strategic stockpiles to help bring prices back down. The Bush administration has repeatedly said it would tap the U.S. Strategic Petroleum Reserve only in the event of a major supply disruption — not simply to drive prices lower. But that reserve represents about half of the 1.4 billion barrels of strategic reserves held by the 13 OECD nations that include European countries and Japan. In a research note Wednesday, Merrill Lynch energy analysts Michael Rothman and Steven Pfeifer told clients they expect those discussions are already underway, though there’s no indication that a decision to tap strategic reserves is imminent.

As higher oil prices continued to inflict pain on major consumers like airlines and trucking companies, oil companies reported big profit gains. On Tuesday, British oil giant BP, the world’s second largest oil company, posted a second quarter profits of $3.9 billion — a 23 percent jump from a year ago. The company said profits for the first half set a record.

On Wednesday, Houston-based ConocoPhillips' said second-quarter profits surged nearly 75 percent, to $2.1 billion. The company credited strong refining profit margins and high oil and gas prices. And Amerada Hess Corp. Wednesday said profits climbed 14 percent in the second quarter to $288 million. The company also cited by rising oil prices and surging refining profits.