China's oil thirst will squeeze market -funds

Tue Oct 25, 2011 1:38pm EDT

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* Doubt voiced Iraq will meet oil targets, Libya ramp up fast

By Claire Milhench

LONDON, Oct 25 (Reuters) - China's thirst for oil will squeeze prices higher and destroy demand in developed economies if world oil supply growth does not exceed current trends, said senior commodity fund managers who did not expect fast oil output rises in Libya and Iraq.

"In the last 12 months China's demand for diesel for power generation has been one of the major drivers (of the market)," Tony Hall, chief investment officer of the Duet Commodities Fund, said at a conference in London on Tuesday.

"They do tend to step in and stockpile," he said.

Hall did not see any prospect of the much-debated economic "hard landing" in China and said supply would not be able to keep pace with the fast-expanding economy's need for oil.

"We are not seeing any significant squeezes yet but this is a supply side story - if we carry on with this current trend we will have some problems in the light, sweet products," he said.

He highlighted a projection of global oil demand growth of 1.4 million barrels per day for next year. "I don't believe supply can keep pace."

Hall's comments were supported by Todd Gross, chief investment officer of Hudson Capital Group, which runs an energy-focused fund.

With spare capacity at just two million barrels per day, he saw little slack in the system. "That's a critical level," said Gross. He argued that Iraq's production increases would have to accelerate to make sure the market was balanced.

"It's likely that prices will just go higher and ration demand at some point, largely in the OECD (Organisation for Economic Co-operation and Development) countries."

Michael Rothman, president of Cornerstone Analytics, a research firm, said oil is used differently today than in the 1970s, when some 30 percent of the barrel went into heating and power and it was relatively simple to substitute oil with coal or gas.

Now transport is a much bigger part of the barrel and there are few alternative fuels. As a result, a much higher oil price will be required to ration demand, and that demand destruction is likely to be felt in the OECD rather than nations where oil is subsidised.

IRAQ DISAPPOINTMENT

All three panellists, who were speaking at the World Commodities Week conference, expressed doubts that Iraq would meet its targets and that Libya would be able to ramp up production quickly.

"The amount of crude coming out of Iraq will be disappointing," said Hall. "And Libya won't come back for six months to a year."

Rothman said that even though ousted leader Muammar Gaddafi had been killed, the biggest concern in Libya was still civil war.

"The companies that have a strong vested interest in maintaining their presence there are putting on a hopeful face but the reality is that things will be slower."

Even if Libya were able to get to one million barrels per day by the middle of next year, the effective OPEC spare capacity would still be between zero and 1 percent, he added.

With Iraq, he said anyone who argued there would be a sharp rise in oil output was being unrealistic. "They are still producing less oil than they were before the war," he pointed out.

"They were supposed to be at 3.5 million by 2005, 5.5 million by 2008 and 8.5 million by next year. We're at 2.7 million and over the last several months we have seen arms flowing in from Iran."

With the U.S. troop presence dropping to zero next year, he said there was a high risk of civil unrest.

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