A combination of events seem destined to maintain high prices and market volatility throughout 2005.

For one, Opec has raised the possibility that it may actually cut production. Its meeting in Vienna this weekend may finalise a one million barrel per day (mbpd) cut in production.

This would put stated production at 27mbpd, firming up prices. This despite the current price of around $48 being way over their stated preferred price of $35.

The reality of Opec production is, of course, shrouded in secrecy. In December, Opec's output was 29.5mbpd according to the International Energy Agency (IEA).

World 'oversupplied'

The production cut muted by Opec would mean it would produce only 27mbpd, in effect a 2.5mbpd cut. No one expects member countries to do that, no matter what they announce.

Opec already admits its members routinely bust quotas.

The dollar's devaluation gives oil
producers less purchasing power

For another, it does appear that the 11 Opec members, with the possible exception of Iraq, are determined to keep prices high.

Iran's Oil Minister Bijan Zanganeh has actually stated that the world is oversupplied.

"They say it is over one million (barrels per day). Everyone agrees there is over supply." Everyone in Opec that is.

Other members such as Algeria, Venezuela and Saudi Arabia have also stated a price crash is out of the question.

Cash windfalls

In part this is due to the devaluation of the dollar, which means oil producers get less buying power per barrel. But the major reason is that the Opec countries' governments are basking in cash windfalls, in just the same way as the British and US corporate giants such as BP and Exxon.

Estimated profit increases ran at
43% last year for Opec nations

Estimated profit increases ran at 43% last year for Opec countries. They are unlikely to choose to forfeit those same levels of revenue in 2005 by over-production.

But another more fundamental reason may be that they are simply unable to pump any faster, even if they wanted to.

Kenneth Deffeyes of Princeton University is one of the leading sceptics about international oil reserve figures. Especially those of Saudi Arabia and its mega-field, Ghawar.

"Saudi Arabia could increase production, but they would soon regret having done so. An abrupt increase in their production rate would pull water up through the Ghawar field, like a teenager sucking on a soda straw."

No surplus

The water Deffeyes talks of is that injected into the oilfields by Saudi engineers to keep pressure up. This maintains higher production levels, but can also mask dwindling reserves.

"Saudi Arabia was supposed to be the world's last source of unused production capacity. At this point, there seems to be no surplus oil production capacity anywhere in the world," Deffeyes says ominously.

"(Saudi Arabia) could increase production, but they would soon regret having done so"

Kenneth Deffeyes,
professor, Princeton University

As well as the Opec supply conundrum, one of the single biggest reasons for the increase in oil prices has been the growth of consumption in China.

The government in Beijing announced last year that it was going to slow its growth in order to ease stresses on the world economy. Especially on oil prices. However, that stated slowdown is yet to materialise, as China announced a new set of industrial figures this week.

The Chinese economy grew by about 9.5% in 2004: capital goods and fixed assets up 21.3%, heavy industry was up 18.2% and light industry by 14.7%. Crucially power generation increased by 14.9%. All of which adds to large leaps in demand from China for oil.

The China factor

In fact, a demand increase for 2005 at more than 11% is predicted by the Chinese National Petroleum Corporation (CNPC). This on the back a 14% rise in 2004.

The exact phrase used by the Chinese government to describe this level of economic growth was "stable and rapid". It is the rapid part of that statement that worries analysts.

China's rapidly growing economy
is pushing up global oil demand

China has also been pro-actively sourcing outside oil in order to fuel itself and cut repeated power outages. To do this it has moved into areas previously regarded as the property of the United States.

In December, President Hugo Chavez of Venezuela visited China and announced that trade would boom to $3bn in 2005. Mostly on the back of energy-related agreements.

Venezuela has traditionally been a supplier of about 15% of US oil imports.

However, in what some analysts see as a pre-emptive move by the Latin American nation, Chavez agreed to $410m worth of investment from China in developing oil and gas fields inside Washington's traditional ally. At the same time China agreed to buy $250m worth of oil from Venezuela in 2005, roughly six million barrels.

Main wild card

Add to this the reported Chinese desire for Canadian oil supplies, parts of the crumbling Russian Yukos corporation and an audacious $13bn bid for the US oil company Unocal.

"They say it's over one million barrels per day. Everyone agrees there
is oversupply"

Bijan Zanganeh,
Iranian Oil Minister

These events have created a strong impression in the market. Mainly that China is set to compete openly with the US over the world's remaining oil.

The International Energy Agency calls China "the main wild card" in forecasting 2005 prices.

It predicts that world oil demand will increase by about 1.44mbpd in 2005 to 83.6mbpd. But the IEA has consistently underestimated demand growth in successive years.

With the possibility of recession as the only market method of shorting demand and therefore price, 2005 may prove to be another volatile year for oil. Prices of anywhere from $35 to $55 are not out of the question.

But while producer governments, oil majors and market traders rake in the cash, it may be the unprepared consumer who ends up hit the hardest.