Released on November 7, 2007
(Next Release on November 15, 2007)

Why Are Oil Prices So High?
One of the most discussed topics in the media today, besides the 2008 Presidential races, is the high price of oil. Crude oil prices have increased dramatically this year, with West Texas Intermediate (WTI) prices climbing from an average of nearly $55 per barrel in January to over $95 per barrel at the beginning of this month. EIA believes that supply and demand fundamentals, including strong world economic growth driving growth in oil use, moderate non-Organization of the Petroleum Exporting Countries (OPEC) supply growth, OPEC members’ production decisions, low OPEC spare production capacity, tightness in global commercial inventories, worldwide refining bottlenecks, and ongoing geopolitical risks and concerns about supply availability, have been the main driver of oil price movements over the past year.

With the rapid rise in prices, oil markets have been drawing increased interest and participation from investors and financial entities without direct commercial involvement in physical oil markets. The role of these non-commercial futures market participants in recent price developments is difficult to assess, particularly over short time intervals. However, general principles favor a focus on fundamentals, rather than consideration of alternative price drivers, when the explanatory power of fundamentals is high.

Strong world economic growth has resulted in strong world oil demand despite higher price levels. China, the United States, and the Middle East countries are the main drivers of consumption growth, and China and the United States alone are projected to account for half of world oil consumption growth in 2007 and 2008. The Chinese economy has shown few signs of slowing down, and the economies of oil exporting countries in the Middle East and Russia have also benefited from higher oil revenues, boosting oil consumption. In addition, the decline in the value of the dollar against other currencies supports continued oil consumption growth in foreign countries because oil is traded globally in dollars, and a declining dollar has made the increase in oil prices less severe in foreign currencies.

A key factor contributing to high prices has been the inability of non-OPEC production growth to keep pace with global oil consumption growth. Non-OPEC production increased by 0.2 million barrels per day (bbl/d) in 2006, and is projected to rise by 0.6 and 0.9 million bbl/d in 2007 and 2008, respectively, significantly less than the increase in global oil consumption. Non-OPEC production growth remains concentrated in a few areas, and has experienced some downward revisions in recent years due to project delays and growing decline rates in some non-OPEC nations, especially Mexico, the United Kingdom and Norway.

When non-OPEC supply growth is less than growth in global consumption, the gap needs to be filled by OPEC members’ production increases or draws from global inventories will result. OPEC’s decisions to cut production in November 2006 and February 2007 played a critical role in reversing the oil price slide at the end of last year. OPEC’s announcement that it would increase production this month has not yet dampened upward price pressure, and it is unlikely that these higher volumes will be enough to halt the downward trend in commercial inventories over the next several months. In addition, fairly low OPEC surplus production capacity (concentrated in Saudi Arabia) leaves the market with little flexibility to respond to surprises in supply and demand. EIA’s outlook for continued rising oil consumption and moderate non-OPEC production growth suggests that world surplus production capacity will remain fairly low at around 2-to-3 million bbl/d.

OPEC’s production cuts, in combination with continued strong demand growth exceeding the growth in non-OPEC production have led to declining commercial oil inventories (see chart below). While OECD commercial inventories were 150 million barrels above their 5-year average at the end of September 2006, EIA projects that OECD commercial stocks will be about 10 million barrels below the 5-year average by the end of this year. EIA projects that inventories will continue to decline relative to the average in the first quarter of 2008, and will move toward the lower end of the 5-year range through 2008.

The margin for error has also declined in the downstream sector, as excess capacity in the refining industry has been shrinking with the growth in demand for refined products. Low excess refining capacity leaves less of a buffer for periods when the supply and demand balance becomes unusually tight. Furthermore, low excess refining capacity leaves little flexibility to accommodate unplanned refinery outages.

Geopolitical instability in many OPEC, as well as non-OPEC countries, has put additional upward pressure on inventory demand and crude oil prices. A lack of political stability continues to threaten production in several OPEC nations, including Iraq, Nigeria, Venezuela and Iran. The threat of a possible Turkish incursion against Kurdish rebels in Iraq has added to supply worries.

All of these factors, have combined to cause oil prices to rise significantly in 2007. How high prices ultimately reach will depend not only on these factors, but also the market’s perception of these fundamental factors in the future.

Residential Heating Fuel Prices Increase Sharply
Residential heating oil prices attained greater heights during the period ending November 5, 2007. The average residential heating oil price jumped 15.7 cents last week to reach 311.0 cents per gallon, an increase of 72.8 cents from this time last year. Wholesale heating oil prices increased by 13.9 cents, reaching 263.5 cents per gallon, an increase of 87.6 cents compared to the same period last year.

The average residential propane price increased 8.3 cents to hit 233.1 cents per gallon. This was an increase of 39.7 cents compared to the 193.4 cents per gallon average for this same time last year. Wholesale propane prices rose by 6.6 cents per gallon, from 157.5 to 164.1 cents per gallon. This was an increase of 62.1 cents from the October 30, 2006 price of 102.0 cents per gallon.

Diesel Price Sets National and Regional Record Highs
The U.S. average retail price for regular gasoline soared to 301.3 cents per gallon as of November 5, 2007, 14.1 cents over last week and 81.3 cents higher than last year. Gains were recorded in all regions with the largest increase in Midwest which rose 17.3 cents to 303.7 cents per gallon, 85.0 cents above a year ago. The East Coast price climbed 14.1 cents to 297.4 cents per gallon while the Gulf Coast rose 15.8 cents to 289.3 cents per gallon, still the lowest regional price. The Rocky Mountain region increased 9.9 cents to settle at 297.2 cents per gallon. The highest price in the country was on the West Coast, 316.5 cents per gallon, a jump of 7.4 cents this week. The average price for regular grade in California was 323.1 cents per gallon, up 7.2 cents from last week and 83.5 cents per gallon over the previous year.

Ascending to both national and regional record highs, retail diesel prices skyrocketed 14.6 cents last week to reach 330.3 cents per gallon, surpassing the previous record high price by 14.6 cents. All regional prices peaked to unprecedented highs as the East Coast climbed 14.2 cents to hit 329.0 cents per gallon. The Midwest price moved higher to 327.8 cents per gallon, increasing by 15.6 cents. The Gulf Coast gained 15.7 cents per gallon to 321.9 cents per gallon. The Rocky Mountain price increased to 341.1 cents per gallon, a gain of 13.0 cents. The West Coast tallied the highest regional price, hitting 350.8 cents per gallon after jumping 11.4 cents. California prices were up 11.8 cents to 352.4 cents per gallon, another record price for the State.

Propane Inventories Post Small October Gain
Much warmer-than-normal temperatures during the month contributed to a small 2.4-million barrel stock gain recorded for total propane inventories during October, a level that nearly matched the most recent 5-year average of 2.6 million barrels. However, the final week of October saw inventories fall by 0.4 million barrels, positioning the Nation’s primary supply of propane at an estimated 61.5 million barrels as of November 2, 2007. East Coast and Midwest inventories posted declines of 0.2 million barrels and 0.1 million barrels, respectively, while inventories in the Gulf Coast remained relatively unchanged during this same period. The combined Rocky Mountain/West Coast region saw inventories decline by 0.1 million barrels last week. Propylene non-fuel use inventories rose by 0.1 million barrels last week to account for a 3.2 percent share of total propane/propylene inventories, compared with 3.0 percent from the prior week.

Text from the previous editions of “This Week In Petroleum” is now accessible through a link at the top right-hand corner of this page.