Russia is the world’s 2nd largest oil producer. And it has been the main source of increased crude production in recent years. Its output rose 58% between 1999-2006, from 6.2mbd to 9.8mbd. Now Lukoil’s VP, Leonid Fedun, has told the Financial Times that he thinks 2007 output will be ‘the highest he will see in his lifetime’. He also believes that Russian oil production may now follow the sharp declines seen in the North Sea and Mexico.

Unsurprisingly, oil hit $114/bbl on the news, and seems set to move higher in the short-term, with $125/bbl now being talked as a target. Long-dated crude futures also moved above $100/bbl for the first time. The underlying problem is two-fold:
• Western countries have little scope for major short-term reductions in demand as prices rise. US gasoline demand was only down 0.1% in Q1 versus 2007. Large-scale reductions in US demand would require more fuel-efficient vehicles and major new public transport systems. Targets have been set for the former, but only by 2020, and the latter looks unlikely. So Americans will continue to have to drive to work or the shopping mall, as long as they have jobs, and money to spend.
• Emerging economies have seen major growth in oil demand as incomes rise. China’s demand rose 62% between 1999-2006, from 4.5mbd to 7.5mbd. Car sales rose 20% in Q1, and with a fuel price freeze imposed since January, demand is unaffected by today’s higher prices. The same pattern of rising incomes and fuel subsidy is true of many other Asian countries, and all OPEC countries.
It is fashionable in some quarters to ignore supply/demand as a driver for higher crude prices. Instead it is blamed on financial speculators. There is no evidence for this, as readers will remember from my report of the detailed research carried out by the Centre for Global Energy Studies.
The root cause is in the chart above, from Barclays Capital. This shows demand increasing, whilst net new supply is static. So news that Russian supply is now peaking is bad news for the chemical industry. And if oil prices do reach the $125/bbl level short-term, it will be very hard to pass this on to customers. End-user demand will also suffer, as Western consumers are forced to spend more on fuel and energy costs.