Crude Oil Settles Above $56 Amid Supply Fears

Oil prices climbed by $1 a barrel to a 10-week high on Thursday as concerns about strong demand for gasoline dominated the market's psychology.

Traders dismissed OPEC's (search) decision on Wednesday to increase its output quota by 500,000 barrels a day, saying the higher production target was already being exceeded at a time when producing nations are eager to profit from high prices.

Light sweet crude for July delivery rose $1.01 to settle at $56.58 a barrel on the New York Mercantile Exchange (search). On the International Petroleum Exchange in London, August Brent gained 92 cents to $56.12 a barrel.

While oil prices are roughly $35 below the inflation-adjusted high set in 1980, they are up more than 50 percent from a year ago and at their highest level since early April.

The runup has been ascribed to scant excess production capacity around the globe, leaving the market with a slimmer-than-usual margin for error if there is a supply disruption. Analysts — and OPEC members — have also pinned blame on the world's limited refining capacity, particularly for heavy, sour crudes.

Oil analyst Carl Larry at Barclays Capital in New York said oil prices are destined to rise to $60 a barrel because demand is climbing and the world's producers and refiners are struggling to keep up.

Larry said it would take an economic slowdown in the United States, China and elsewhere to cause market sentiment to shift. "And it can't just be one bad month," he said. "It has to be three, four months."

The Organization of Petroleum Exporting Countries said Wednesday its output ceiling will rise from 27.5 million barrels to 28 million barrels as of July 1, and that it will consider another 500,000-barrel increase later this year if prices don't fall.

But analysts dismissed the move because the 10 OPEC members bound by the quota are already pumping some 28 million barrels a day. Including Iraq, which is not bound by the quota, OPEC's production was 29.3 million barrels a day in May, according to the International Energy Agency.

Many analysts exoect global demand to average more than 84 million barrels a day in 2005, maintaining pressure on producers, whose spare output capacity is roughly 1.5 million barrels a day.

Brokers also attributed higher prices to the government's latest petroleum supply snapshot, which showed dwindling domestic supplies of crude and rising demand for gasoline.

The Energy Department said Wednesday that U.S. inventories of crude oil fell by 1.8 million barrels last week to 329 million barrels, leaving supplies almost 9 percent above year-ago levels. The agency said gasoline inventories slipped by 900,000 barrels to 215.7 million barrels, or 5 percent higher than a year ago.

The supply of distillate fuel, which includes diesel and heating oil, grew by 2.5 million barrels to 110.2 million barrels, or 1 percent above year-ago levels, the agency said.

What stood out in the report to many traders, Larry said, was that gasoline demand over the past four weeks has averaged almost 9.5 million barrels per day, or roughly 3 percent above year ago levels in spite of retail gasoline prices averaging $2.13 per gallon nationwide.

Oil analyst Tim Evans at IFR Energy Services in New York said he believed the demand figure for the past four weeks was an aberration that reflected a build up of supplies among distributors and retailers, as opposed to a spurt of consumption by motorists.

"Retailers may have lived off stock when prices were falling in April and into May," he said. "Now they have replaced inventory and perhaps added some cushion ahead of the driving season."

Evans also suggested taking a longer-term view of the market, noting that demand is up just 1.4 percent over the past 13 weeks.

July gasoline futures jumped 3.53 cents to $1.5978 per gallon on Nymex, where heating oil futures were up less than a penny at $1.6255 per gallon.