Oil prices:Businesses everywhere had to endure the impact of volatile oil prices throughout 2006, and 2007 appears set to pose similar challenges. To formulate a picture of the year ahead, it is important to understand the elements that have driven the prices throughout 2006.
Key to the oil price is the gap between supply and demand and, since 2002, price rises have been driven by strong demand. Emerging economies such as China and India have enjoyed buoyant growth, with demand for imported oil averaging a growth rate of 8 per cent per annum.
This has served as an amplifying effect to an already buoyant global economy, which has enjoyed a growth rate of around 5 per cent. The US economy has once again proved the primary engine of demand, consuming as it does around 25 per cent of the world's oil.
The buoyant demand for oil has squeezed the capacity gap, or cushion, to less than two million barrels per day (bpd) and 2006 has seen oil traders focusing upon supply factors which have proved the catalyst for high prices. Terrorist activity in the oil-rich Niger delta has interrupted some 25 per cent of output - around 500,000 bpd for much of the year.
Perhaps more significantly, the oil market spent much of 2006 concerned about the ongoing Iranian nuclear dispute: as the fourth-largest oil producer in the world, fears that sanctions designed to force Iran to cease uranium enrichment would result in Tehran turning off supply to the West saw oil prices driven up aggressively from May to July. This move was compounded by the conflict in Lebanon as tensions in the Middle East grew.
While neither Israel nor Lebanon produces oil, the conflict was played out in a region that accounts for the bulk of global oil production. Fears that the violence and unrest would spread served to push oil to a record high of $74.40 a barrel in mid-July.
Focus switched with the news that the gigantic BP Prudhoe Bay field in Alaska was to suspend production following the discovery of leaks in the pipeline system. The news raised concerns about the state of the world's oil infrastructure, which has seen little or no significant investment for more than 20 years: without serviceable equipment to extract and deliver the oil, the demand-supply gap would be squeezed further. In the event, production resumed relatively swiftly and a prolonged period of high prices was averted.
The US hurricane season, which had triggered a $25-a- barrel spike in oil prices in 2005 in the aftermath of Katrina and Rita, passed without incident and emerging data of plentiful stocks in the US and elsewhere injected bearish sentiment into the market. Prices slipped quickly back by around 25 per cent to settle around $55 to $57 a barrel.
Opec, the oil producers' cartel, stepped in to arrest the slide in prices by agreeing to cut production by 1.2million bpd in October and the price of crude oil has responded by grinding out a rally to sit in the mid-$60-a-barrel range as the year draws to a close.
The December meeting of Opec resulted in a compromise deal that will see production reduced by a further half a million barrels in February.
It seems certain that the factors that impacted the market throughout 2006 will continue to influence the market in 2007. The global economy will contract somewhat but the demand for oil will be maintained.
The importance of Opec should not be underestimated: the organisation is set to police markets tightly to maintain a floor of $60 a barrel and, in the face of continuing plentiful supplies, will not shy away from decisive action. The challenge for the cartel will be to achieve price stability without destabilising global demand.
On balance, it is clear that the market remains vulnerable to price shocks, injecting volatility. Against a backdrop of consistent demand the price of oil will drift upwards and an average price for the year of between $68-$70 a barrel is realistic although geopolitical risks mean spikes to $80 a barrel cannot be ruled out.
Paul Harris is head of energy and emissions at Bank of Ireland Global Markets
