Why are oil prices so high?

What is driving oil prices so high?

The recent jumps in oil prices can be linked to four things - fears over supply shortages, political tensions, a weak dollar and strong demand.

Reports from America's Energy Information Administration have revealed that oil stocks in the US are much lower than expected, sparking concern over a lack of supply ahead of the winter months.



And bad weather conditions in the Gulf of Mexico have forced Pemex, Mexico's state owned oil company to halt a fifth of its production.

Meanwhile a series of events have led to strained relations in the oil-rich Middle East.

America, the world's largest oil consumer, has accused Iran's Revolutionary Guards of supporting terrorism by backing Shia militants in Iraq and imposed economic sanctions on Iran - the world's fourth largest oil producer. The move could trigger a confrontation between the two countries rattling supply of oil which is already scarce.

The tensions add to other fears that military action between Turkey and Kurdish rebels in northern Iraq could disrupt supplies from the world's third largest oil reserves. Conflict between Israel and Lebanon has also sparked worries that hostilities in the Middle East may affect oil output in the wider region. Iraq, Iran, Kuwait and Saudi Arabia between them account for 20% of global supplies.

The US's crumbling housing market and the knock-on effect on the economy has pushed the dollar to record lows against the pound and euro this year. This has pushed up speculative buying of oil by investors trying to hedge their losses. Analysts say that another interest rate cut by the US Federal Reserve this week, as is expected, will place further downward pressure on the dollar and drive up oil prices even higher.

Volatility in financial markets from the credit crunch has also increased demand for oil. Much of the money poured into markets by central banks to ease the liquidity crisis has found its way into energy and commodity markets.

Will demand continue to be this strong?

There does not seem to be any sign of easing in demand. Rapidly growing economies like China and India continue to suck in oil at a soaring rate. China is the world's second largest consumer of the fuel, overtaking Japan in 2003 and closing in on the US with demand for oil growing at about 15% a year.

The International Energy Agency says that demand will rise by an average of 2.2m barrels a day next year, compared with the 1.5m barrel rise seen this year. It adds that annual demand will rise 2% up to 2012, while other projections suggest demand could from about 90m barrels a day to as much as 140m over 25 years.

This will put more strain on prices amid supply concerns.

Is there anything that can be done to boost supply?

Markets are constantly looking towards the Organisation of Petroleum Exporting Countries - the world's leading oil supplier, to raise production in order to deflated the price bubble.

It recently bowed to pressure by raising its production quotas by 500,000 barrels a day from November 1.

However, Opec has said that the recent spike in oil prices is down to geopolitical factors and the oil market is well supplied, dashing hopes that it may pump more oil.

But critics say Opec needs to act more aggressively to bring prices down.

Who are the winners from high oil prices?

Oil-rich countries reap huge income from rocketing oil prices. Wealth generated from oil has supported president Hugo Chavez's efforts to reshape the Venezuelan economy, by funding extensive social programmes and rejecting US criticism of his policies.

In Russia, high oil prices have underwritten president Vladimir Putin's attempts to exert state control over the country's sector.

Companies like ExxonMobil and BP are also making large profits.

Who suffers from costly oil?

High energy prices make life more expensive for consumers and businesses and could spill over to other areas of the economy.

Petrol prices have already risen significantly this year. The price of diesel in the UK is over £1 a litre, while petrol is at around 98.39p, in touching distance of the 98.54p peak in August 2006.

Competition between supermarkets has helped hold back price rises but this is unlikely to last and a new all-time high for petrol prices could be set very soon. Some rural areas are facing £1 a litre for petrol at the pumps and this could become a reality for many others.

Petrol prices have increased by more than 10p a litre this year, meaning that UK drivers are spending nearly £7m more each day on petrol than at the start of the year. The average UK driver spends £13.29 more a month on petrol than last year.

Utility bills are also likely to rise as suppliers face higher costs due to increased oil prices.

The higher costs may translate into price rises on the high street, which would come as a blow to households already feeling the pinch from higher interest rates and modest growth in earnings.

Higher energy bills, petrol and high street prices may lead to increases in the government's consumer price measure of inflation.

A string of interest rate rises by the Bank of England has helped bring the inflation rate down to 1.8%, below its 2% target, having hit a decade-high of 3.1% earlier this year.

In terms of the wider economy, there are fears that high oil prices could push a country into a recession. This is what happened to the US in 1980 and the what caused world downturns in 1975. The Bush administration has expressed concern about the high oil prices at a time when the US economy is already expected to slow significantly next year.

Where will the oil price go next?

In 2005, investment bank Goldman Sachs predicted that oil prices could eventually top $100 a barrel. This now appears to be a real possibility if the current market conditions and political situation hold. However, analysts also say that the market remains very volatile.

Furthermore, the International Energy Agency also points out that after taking inflation into account, oil prices are still below the levels seen in 1980 when a barrel of oil - in today's prices - was over $101