Exactly a year after Goldman Sachs alarmed the markets with its forecast of a super spike in oil prices to above $100 per barrel, more analysts and investment banks have come out with similar forecasts. If the Goldman report was almost dismissed by independent analysts, this time around there are more takers for such alarmist predictions.

Oil prices declined after the Goldman forecast before picking up steam later in 2005 following the massive hurricanes in the Gulf of Mexico. After setting record highs, prices retreated again.

Supply concerns and steady demand growth have pushed oil prices to a new all-time record of over $75 per barrel this year. Worsening political situation in many oil-producing countries have heightened the supply concerns and oil at $100 per barrel does not sound incredible any longer.

Geopolitical supply shock triggers
Though the current oil boom is essentially a result of increasing energy demand from emerging economies like China and India, supply disruptions have played a significant part in taking prices to record levels.

The ongoing war of words between Iran and western countries over its nuclear programme could escalate further, leading to economic sanctions and even a military conflict. If supplies from Iran - the second largest oil exporter - are disrupted, crude prices are very likely to climb to $100 per barrel.

But will the two sides let it go as far as that? The US is wary of another military conflict in the Middle East while it is already embroiled, some say inextricably, in Iraq. It may not even allow Israel to go in for an air strike on Iranian nuclear installations, as some commentators believe.

A military strike on Iran and a runaway rally in crude prices would create a difficult domestic situation for any US administration. Even though it has not directly affected US consumers much, their support for US policy on Iraq has declined steadily. It is less likely that American public would support such an action against Iran.

US politicians are already worried about retail petrol prices of over $3 per gallon and it would be all the more difficult for them if prices rise to $4 or even more.

For all its sabre-rattling, Iran would also be extremely cautious about further escalating the dispute. The Iranian president has reportedly sent a letter to the US president - the first formal communication in decades - suggesting possible solutions to various disputes between the two antagonists. It would be in the best interests of Iran to keep the region peaceful and build its economic might with the significantly higher cash flows from record oil revenues.

Iraqi oil production has declined substantially over the last decade and even the unlikely scenario of a total shutdown following an all out civil war would only have a modest impact on oil prices.

However, such a conflict has the potential of sucking in neighbouring countries into it, which could destabilise the entire region. On the other hand, if the new government can restore the rule of law, increased supplies from Iraq would have a calming impact on prices.

The domestic political situation in Saudi Arabia - the largest oil exporter - has been a source of concern, albeit a mild one, for the oil markets. Recent developments in the kingdom have helped calm those concerns though long-term worries still remain. The transition of power last year following the then king's death was smooth and the country has initiated some political reforms.

South American oil producing countries, all of them have leftist rulers, are using high oil prices to score brownie points against the US administration. Flamboyant Venezuelan leader Hugo Chavez has become the cheerleader of this group as his country is the fifth-largest oil exporter and a major supplier to the US.

Last month, Bolivia surprised the energy markets by nationalising the oil and gas sector and sent troops to oil installations. Last week, Venezuela announced plans to increase tax revenues from oil production. These actions may lead to only short-term rallies in oil prices at present, but their impact would be considerably higher if prices move closer to $100.

The situation in Nigeria, another large exporter, remains volatile. Successive Nigerian rulers have appropriated for themselves or squandered the country's oil wealth for the last many decades. A former Nigerian military dictator built a personal fortune of more than $5 billion through oil deals.

It is estimated that more than 20 per cent of Nigerian production capacity is currently disrupted because of militant strikes. The situation may remain the same unless the country takes steps to ensure that at least a part of the oil wealth reaches the people.

Though any of these geopolitical developments can influence oil prices, only a military conflict involving Iran can possibly take prices to $100 all by itself. A combination of adverse developments in multiple locations also has the potential to cause such a spike in the medium term.

How long will the reserves last?
Oil reserves have always been a hotly contested topic among producers, industry experts and analysts. Total proven reserves across the globe, as per OPEC data, are around 1.14 trillion barrels - OPEC countries account for more than 78 per cent with their 897 billion barrels of reserves.

Sceptics argue that data on oil reserves, especially for OPEC members, are highly inflated. Production quotas allotted to OPEC members are linked to their reserves. Some analysts say this policy has prompted many producing countries to overstate their reserves.

The most optimistic forecasts are from OPEC and Exxon Mobil, as can be expected. According to these forecasts, oil production would touch a peak of around 115 million barrels per day between 2015 and 2025, maintain that level and start declining from 2050 onwards.

The International Energy Agency (IEA) expects a higher peak of 120 million barrels per day by around 2030. But the IEA expects the decline to start earlier by 2040, declining to as low as 70 million barrels by 2050.

More sceptical analysts estimate that global oil production would peak by 2010 at around 90 million barrels per day and then decline gradually.

These estimates are on the assumption that no new major fields would be discovered or significant technologies, which would substantially increase recoverable reserves, would not emerge. Typically, only 40 per cent of in-place reserves in a field are recoverable.

Shortage of refining capacity
Because of low margins, which prevailed for most of the '80s and the '90s, additions to refining capacity were very low. After a significant jump in the '90s, global refining capacity declined in the '80s before climbing again in the late '90s. Tough environmental regulation in western countries also contributed to this slow growth in refining capacity.

Total global refining capacity is currently at around 88 million barrels per day. At average refinery utilisation of around 95 per cent, provided there are no natural disasters like last year's hurricanes in the US, actual throughput would be around 84 million barrels.

Global demand for the current year is projected at close to 85 million barrels, which would see a marginal shortfall in refining capacity. If there were any disruptions, the shortfall would go up.

To make matters worse, most of the refineries in western countries can process only lighter grades of crude oil. Availability of lighter crude has declined as most of the new oil fields produce heavier grades.

Modern refineries, like the Jamnagar unit of Reliance, are very complex and have the flexibility to process different grades of crude. That explains the interest shown by global oil major Chevron in the proposed Reliance Petroleum refinery, which would be more complex than the existing Jamnagar refinery.

Shortage of refining capacity has pushed up prices of refined products like petrol in recent years. As product prices rise, refiners would be willing to pay more for crude oil to ensure supplies.

This situation is expected to continue for the next few years as new refining capacities being planned would take at least three years to start production. Currently OPEC countries are planning capacity additions of close to 4-million barrels per day, which would come on stream by 2010.

Impact of speculation
Independent analysts and OPEC officials alike estimate that nearly 20 per cent of the current oil price surge can be attributed to heavy inflows from investment funds into oil futures. Trader activity in oil futures has more than doubled over the last couple of years as evident from the surge in volumes and increased volatility.

Interestingly, some of the investment banks making forecasts of high oil prices make a significant part of their earnings from trading activities. Among leading global investment banks, Goldman Sachs is one of the most active in commodity markets, leading to speculation whether its highly bullish reports are used to influence prices.

Speculative activity in commodity markets and the consequent price movements have a significantly higher impact on the economy than such activity in stock markets. Significant price volatility in commodity futures can throw the physical markets for those commodities into disarray.

While the participation of investment funds and traders do provide the markets with considerable liquidity, the extremely low participation of actual producers and consumers remains a concern. When crude oil futures were launched in India by MCX, it was declared that companies who are major consumers of petroleum products would benefit considerably.

However, the participation of even large professionally run companies with sufficient competence to hedge their future requirements remains low. This has made the commodity markets highly one-dimensional and volatile.

The push for more discoveries
New oilfield discoveries have declined steadily since the '60s when some of the largest fields in the Middle East were discovered. Most of the significant discoveries of recent years are extensions of the existing fields. More than 95 per cent of all discoveries in recent years have been of small reserves.

The more pessimistic among industry analysts believe that all large oil reserves have already been discovered on the simple premise that bigger fields are easier to spot. It is unlikely that large onshore reserves at accessible depths have been left undetected after decades of extensive exploration.

Hence the possibility of large discoveries exists only in deepwater offshore blocks. Exploration in these blocks is very costly and production is viable only if prices are sustained at these levels. As there is no certainty about prices, investments in deepwater exploration has been slow to pick up.

The five global oil majors - BP, Shell, Exxon Mobil, Total and Chevron - spent a total of $44 billion in exploration during 2004 as compared to $41.4 billion and $45.5 billion for the previous two years. As a percentage of total revenues, spending on exploration has declined steadily to 3.57 per cent in 2004 from 4.24 and 5.25 per cent for the previous two years.

These large oil companies made the mistake of overspending on exploration during the previous oil booms and paid for it when prices corrected. This time around, they cannot be blamed for being cautious even as their bottom lines hit record levels. Diminishing returns from exploration over the last couple of decades have made them all the more hesitant.

Till about mid-'80s, more oil reserves were being found than being consumed every year. This has changed drastically and currently new discoveries are at just one barrel for every four barrels of consumption.

Alternate energy sources
Development of alternate energy sources becomes a jmajor policy issue whenever oil prices surge. This time, the US government has already made considerable comments about other fuels like ethanol and is talking of a long-term strategy to reduce dependence on fossil fuels.

Consumption of natural gas has increased considerably in the last decade as improved technology and long cross-country pipelines made it possible to transport gas. The proportion of natural gas in the global energy basket is expected to steadily rise over the next decade as technology improves further and other sources of gas like coal-bed methane are developed. Natural gas production is expected to double to nearly 200-trillion cubic feet per annum by the year 2030.

Ethanol is attracting a lot of attention after the US president publicly supported it. Countries like Brazil, with large sugarcane production, have successfully pushed ethanol-blended petrol as a major auto fuel. In India, the government is planning to extend ethanol blending across the country from a few states as of now. The percentage of blending may also go up from the current 5 per cent to 10 per cent.

Higher usage of these alternate fuels would not lead to any decline in demand. However, it is possible that the rate of growth in demand for oil may decline which would ease the projected demand-supply gap. To what extent this happens is difficult to predict as a lot would depend on political commitment towards development of alternate sources.

To conclude, the demand-supply situation for oil is precarious and is most likely to worsen over the next few years. Any further worsening of the geopolitical situation in the Middle East, while the demand remains strong, could push oil prices to $100 per barrel. Nevertheless, the possibility of it actually happening still remains low.