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The High Oil Price in Europe

The High Oil Price - Background Information

Oil prices have increased from 25 $ per barrel in January 2002 to 45 $ per barrel in January 2005[1]. They now stand at around 70 $ per barrel. The EU has been partially shielded from the effects of a significant proportion of these price increases, due to a significant appreciation of the euro against the dollar between 2003 and 2004. This has not been the case, however, during the recent very rapid price increases.

The underlying causes of the recent price rises result from a series of factors, some long-term and structural in nature, others more short-term:

Structural factors result from the very considerable increase in demand for oil in recent years, which has outstripped increases in supply. The world demand for primary energy increased by 4.3% in 2004[2], the strongest incremental growth ever. In other words, it meant an increase in demand for oil of 2.4 million barrels per day (mbd) in a context of reduced spare capacities. Much of this additional demand came from China, where energy consumption over the past three years there increased by 65 %.[3]

At present it is generally estimated that the available reserves of oil that could be brought on stream in a short term are in the area of 2 mbd. Part of the increase in prices since 2004 therefore results from this tightening supply situation and uncertainty whether demand will continue to rise at current levels.

Furthermore, the lack of investment in exploration and refining capacity is among the factors which have contributed to the current shortage of oil products.

Because of the very tight demand/supply balance, short term factors have a major impact on prices. The tight demand/supply balance is best illustrated by the recent IEA recommendation[4] to release emergency oil stocks to cover the temporary shortfall resulting from Hurricane Katrina. In addition to a series of recent adverse weather incidents, other short-term factors include, in particular, political instability in the Middle East. It is such short term factors and the speculation as to forward prices that results, that is widely attributed to be the cause of the very recent extreme price rises.

In this context, it is very difficult, if not impossible, to predict future price levels.

The increase in oil prices has also had a significant effect on energy prices and in particular on those of gas and electricity. Gas prices, whilst not directly linked to oil, largely follow the same movements. Furthermore as some 30% of EU electricity generated by fossil fuels comes from natural gas, this has a significant effect on electricity prices.

[1] Brent, crude oil spot prices.

[2] Oil consumption in 2004 was 20,5 mbd in the USA, 6,7 mbd in China, and 14,6 mbd in the EU. World oil consumption amounts to 84 mbd in 2005.

[3] BP Statistical Review of Energy.

[4] “Initial assessment and recommendation for response by the Executive Director of the IEA on the impact of Hurricane Katrina”, 2 September 2005. In particular, the IEA Executive Director recommends that 60 million barrels, or an average of 2.0 mbd for 30 days, are made available to the market in order to address this significant, but temporary supply interruption.

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