OPEC's decision to cut production will give support to oil prices

The impact of the credit crisis has led to falling demand for oil and oil prices have halved since their peak in mid July to around $70 a barrel. UK consumers have benefitted although the effect on UK pump prices has not been as marked as many would have hoped. A litre of unleaded petrol has fallen 9p since April to average 99p/litre. This is mainly due to the strength of the US dollar relative to sterling and high government taxation levies since duty and VAT make up 65% of the current pump price.

Commenting on today's decision by oil producers group OPEC to reduce supply by 1.5m barrels a day, Alliance Trust Global Oil and Natural Resources Analyst Angus McPhail says, "While consumers have been getting a breather at the pump, this is likely to be temporary. A lower oil price will merely sow the seeds of its own solution and a normalised price of around US$80-100 a barrel is more likely to emerge in 2009. Not good news for UK drivers, so the message is clear - enjoy the pre-Christmas sale!"

He said, "OPEC's decision to cut quotas by 1.5 million barrels a day will help to shore up three quarters of the current oversupply in the market, and with no firm evidence of oil demand falling in China yet this will justify OPEC's reluctance to opt for a further cut. This may come in the New Year and if properly adhered to would result in oil prices remaining within OPEC's desired price band level of US$80-100 a barrel."

"The other factor at work is that oil prices have a naturally in-built floor of around US$80 a barrel which is the average cost of producing crude oil, or the marginal cost of supply. The longer oil trades below this the greater the incentive there is for oil companies to either stop production or plan longer lead times into existing projects."

"As oil companies rein in expenditure to combat falling crude oil prices, marginal projects - such as satellite fields in the UK North Sea - are more likely to be deferred. This effect will lower global supplies from non-OPEC producers which have struggled to achieve meaningful growth anyway given their difficulties in getting access to new resources."

McPhail says, however, that he does not agree that the world is running out of oil. He said, "There are 1,238 trillion barrels of proven oil reserves, which is equivalent to just over 41 years of production. On top of that, there are unproven reserves and these are consistently rising as technology improves. The problem for oil companies is that 61% of the proven reserves are situated in the Middle East, which has been keen to open its doors to oil service companies to improve oil extraction rates but not to international development by Western oil majors."