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Oil's Recent Rise Not as Familiar as It Looks

What makes the scenario more plausible than ever is that the world is consuming 85.9 million barrels of oil a day, but there are only about 2 million barrels a day of extra production capacity, almost all of it in Saudi Arabia. Much of that excess is a low-quality crude oil that can be used only in the most modernized refineries. That leaves the oil market sensitive to threats that might have been disregarded in earlier years.

Some experts say that high prices will change the balance, creating new supplies and lower demand.

"It's hard to keep in mind that things do move in cycles and that the laws of supply and demand are unlikely to have been abolished," said Daniel Yergin, chairman of Cambridge Energy Research Associates. "High prices, particularly if they become very high prices, will catalyze responses in supply and demand, and innovation," he said.

Indeed, just five years after their 1981 peak, oil prices slumped, prompting then-Vice President George H.W. Bush to lament to Saudi leaders about how that was hurting the Texas economy. Eight years after Iraq's invasion of Kuwait drove prices up again, the Asian financial crisis pushed them to new lows.

But many oil experts say that this cycle isn't like earlier ones. A few argue that world oil is running out. Others note that China and India's economic advances and the growth of U.S. suburbs and exurbs have built in oil demand, even at high prices. Moreover, between 2005 and 2015, China and India's populations are expected to grow by about 240 million. That could soak up new production capacity that Saudi Arabia is currently adding.

In addition, countries rich in oil have not been fully exploiting their reserves. War-torn Iraq is producing almost 2 million barrels a day less than its 1970s peak. Production has declined in Venezuela because of government disputes with workers and foreign oil firms. Insurgents in Nigeria's oil-rich Niger River delta have kidnapped foreign oil workers and attacked installations, forcing companies to suspend about 700,000 barrels a day of production. In Mexico, United Arab Emirates, the Caspian Sea and elsewhere, maintenance and weather has at times curtailed production.

Supply and demand might not respond as usual. Ironically, high taxes in Europe that helped reduce consumption in past years now dilute the effect of rising crude oil prices. And high taxes in producing countries mean that oil firms don't get much more incentive to explore as prices rise. At a recent conference in Moscow, one oil executive said that, above certain thresholds, Russian taxes siphon off $19.15 of a $20 a barrel price increase.

OPEC may have also miscalculated. Its most moderate members -- Saudi Arabia and Kuwait -- trimmed production a year ago to prop up then-sagging oil prices at $55 to $60 a barrel. According to the International Energy Agency, Saudi output has been running about half a million barrels a day lower than last year. Saudi Arabia may have delayed a production boost this fall out of fear -- wrong so far -- that the recent credit crisis would slow the U.S. economy.

OPEC countries maintain, however, that the recent run-up in oil prices isn't their fault and point to speculators. "What more can we do?" asks Nader Sultan, an oil consultant and former president of state-owned Kuwait Petroleum Corp. "The taps are open."

The power of traders and investors over the vast oil market has been growing since the early 1980s. Until then, international oil companies had long-term contracts with exporting countries that established prices and volumes. Relatively modest amounts of oil were traded daily on what was known as the spot market.

But after the two 1970s oil shocks and outbreak of war between Iran and Iraq, that system broke down. An ill-disciplined OPEC stopped setting prices and struggled to stick to output quotas to manage prices. Gradually prices declined, because of more efficient use of oil in industrialized countries and extra output from non-OPEC countries and OPEC's swing producer, Saudi Arabia.

In March 1983, the century-old New York Mercantile Exchange started a market for crude oil that has grown steadily. Now most major oil companies simply peg their sales and purchases of crude oil to the fluctuating prices on the exchange.

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