The Organization of the Petroleum Exporting Countries (OPEC) said yesterday (Thursday) that it would keep production quotas at 24.845 million bpd and urge members to adhere to targets, as global demand has yet to return in full.

However, a report from the International Energy Agency (IEA) indicated that demand is recovering more quickly than previously thought, and that OPEC may be playing catch-up as the global recovery gathers steam.

The IEA increased its outlook for global oil demand by nearly 500,000 barrels per day (bpd) for 2009 and 2010, to 84.4 million and 85.7 million bpd respectively.

Perhaps the biggest reason for the increase was surging demand in China, where the Red Dragon’s $587 billion (4 trillion yuan) stimulus plan has resuscitated manufacturing and helped China grow into the world’s largest auto market.

China’s imports of oil hit a record high in July, soaring 18% from the month prior to 19.63 million metric tons, or about 4.64 million barrels a day, according to the nation’s General Administration of Customs.

China’s economy grew by 7.9% in the second quarter, and Beijing estimates 8% growth for the year, compared to an expected 3% dip for the United States.

Chinese demand for oil this year will grow by 2.8%, according to the IEA.

“I am more confident today than what I was back in May,” about China’s economic recovery, Saudi Oil Minister Ali Naimi told Bloomberg.

The rise of China has been a tremendous boon to OPEC – which controls 40% of the world’s oil supply – particularly since the financial crisis has crimped oil demand in developed nations around the world.

“We’re looking East more these days,” said Kuwaiti Oil Minister Sheikh Ahmad Abdullah al-Sabah.

The IEA expects demand for oil in North America to plunge 4.4% this year. However, that figure is an improvement from last month’s forecast of 5.1%, and could accelerate further as the recovery gains momentum.

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Data for gasoline and heating oil consumption in June showed a “hefty” increase in demand the IEA said. That data was further substantiated yesterday when the Energy Department reported a larger-than-expected drop in inventories.

Inventories dropped by 5.9 million barrels for the week ended Sept. 4 – more than three times estimates of analysts surveyed by Platt’s, the energy information arm of McGraw-Hill Cos, according to The Associated Press.

Indeed, even Saudi oil minister Naimi has acknowledged the bullish shift in the market.

“You guys must realize that there is a fundamental change in the market,” he told reporters ahead of the night-time meeting that agreed to keep supplies officially unchanged.”Economic growth is the name of the game, that’s what’s going to drive the price. As long as economic growth is there, the price is going to go up.”

Still, OPEC remained cautious, opting to keep production level until demand in the West returns to its pre-crash levels. Of course, that means the cartel will likely be playing catch-up, boosting production behind price increases as the economic recovery gains momentum.

Oil prices have more than doubled from their February lows, closing yesterday at $72.17 a barrel on the New York Mercantile Exchange (NYMEX).

Goldman Sachs Group Inc. (NYSE: GS) has raised its 2009 oil price forecast to $85 a barrel from $65 and said prices would reach $95 a barrel in 2010.

News and Related Story Links:

• Bloomberg News:
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• Money Morning:
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• Money Morning:
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• Bloomberg News:
  IEA Raises 2009, 2010 Oil Demand Forecasts on Growth
• Money Morning:
  Oil Prices Due for a Short-Term Setback, Although Long-Term Outlook Remains Bullish
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• Fortune Magazine:
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• BusinessWeek:
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Exxon Mobil Corp. (XOM) reported the biggest annual corporate profit in U.S. history on Friday, even as crude oil prices plummeted from summer highs, pummeling comparable fourth-quarter earnings by 33%.

Exxon reported profits of $45.2 billion for 2008, continuing an epic run that investors have almost come to expect from the petro-giant. The previous record for annual profit was $40.6 billion, set by Exxon in 2007.

“The results speak for themselves,” Fred Burke, president of Johnston Lemon Asset Management in Washington, D.C, told Reuters. “I still think Exxon is a low-cost producer, and at some point the price of oil will increase. They are doing all the right things right now.”

Of course, that doesn’t mean Exxon is wholly insulated from the global slowdown that has caused crude prices to plummet 70% from last year’s record high $147 a barrel.

Net income slid sharply to $7.8 billion, or $1.55 a share, in the October-December quarter. That compared to $11.7 billion, or $2.13 a share, in the same period a year ago, when Exxon set a U.S. record for quarterly profit.

Still, as other smaller oil companies struggle with crude prices that are well below the cost of production, Exxon continues to make the best of a bad situation. 

The company posted stellar results at its refining and marketing unit, where earnings jumped 6% as result of low crude prices and higher profit margins.

Exxon ranks third in U.S. refining capacity, and could fast become a global leader as it plans to build on its overseas operations. 

“The companies that have significant overseas refining can capitalize because outside the U.S., diesel demand has remained relatively strong,” Douglas Ober, who manages $540 million, including Exxon shares, as chairman of Petroleum & Resources Corp., told Bloomberg News. “It was an impressive quarter in a difficult environment.” 

The energy sector has been hit hard by the twin blows of the global credit crunch and oil and gas prices selling off. But large companies like Exxon, with piles of cash and diversified operations, are better suited to weather the downturn.

Exxon’s results are also a signal that oil majors in general are holding up well in the amid the current financial chaos, said Ted Harper, who helps manage $9 billion at Frost Investment Advisors in Houston.

“It signals that these guys operated relatively well in what is probably going to be the first of several difficult quarters,” Harper told Bloomberg. “You’ve got a pretty decent place to park some money for the time being.”

Last year, Exxon spent almost $16 billion on capital expenditures ­and $32 billion on share buybacks. That has helped buoy stock prices over the past 12 months.

Shares of Exxon are have shed just 9% of their value in the past year. By comparison, the Dow Jones Industrial Average and Standard & Poor’s 500 Index are down 36% and 38% respectively during the same period.

Exxon Mobil Chief Executive Officer Rex Tillerson said his company will buy back $7 billion in shares during the current quarter and boost capital spending by as much as $5 billion this year.

Industry analysts say Exxon is known for running its finance department with the same rigor it runs its offshore rigs.

“It has inherent efficiencies no other company can touch,” Fadel Gheit, an oil analyst at Oppenheimer & Company, told The New York Times. “Exxon is the gold standard of the industry.”

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In the face of the worst worldwide financial crisis since the Great Depression, the Organization of Petroleum Exporting Countries (OPEC) is expected to cut crude-oil output and raise prices at an emergency meeting in Vienna tomorrow (Friday). But even with crude oil prices down more than 50% from their July record highs, friction between cartel members has analysts wondering just how big the prospective cut will actually be.

Oil prices continued their downward slide yesterday (Wednesday), dropping $5.22 a barrel, or 7.2%, to $66.96. Prices are down about 55% from the record high of $147.27 a barrel reached July 11. Crude’s dramatic plunge now has OPEC members scrambling to cut production and at least stabilize prices. The cartel members all agree that the outlook for demand has declined significantly. But there is a considerable amount of discord over the size of that cut.

OPEC members called for the emergency meeting – the cartel had originally been set to meeting Nov. 18 – so it might settle any of the production disputes between cartel members, even as it prepares for a global recession.

That will be easier said than done. Different OPEC countries have different economic models – with different oil-pricing floors – to keep their trade balances in check. PFC Energy estimates that Qatar, which imports just about $15 billion worth of goods a year and has little government spending, only needs oil to trade at $10 a barrel to keep its trade balance from sliding into the red.

At the other end of the spectrum, however, are Iran and Venezuela, which rely heavily on petrodollars to finance social programs and infrastructure development, meaning they need crude oil to trade at $100 a barrel or better. Little wonder those two countries have been the most vocal proponents of a large cut in production.

However, OPEC’s most productive and influential member, Saudi Arabia, has based its budget on an average oil price of $50 a barrel, according to PFC. The Saudi government in Riyadh also has political motives for wanting to keep oil prices in check. Saudi policymakers have routinely expressed concern about high oil prices leading to demand destruction. Oil is the primary source of energy in the developed world and the world’s leading crude producer doesn’t want that to change.

“We are concerned about the permanent destruction of demand," a senior Saudi official told BusinessWeek. "Those who buy hybrid vehicles are not going back to SUVs."

Iran and Venezuela don’t have the time, or the money, to worry about oil demand a decade from now.

“The divisions arise in OPEC because what countries need and want varies,” Gareth Lewis-Davies, an oil analyst at Dresdner Kleinwort Ltd., told Bloomberg News.. “The Saudis are playing a long-term political game. Other countries have higher costs.”

Oil accounts for 50% of Venezuela’s government revenue and 95% of the country’s export earnings. Crude exports make up 85% of the Iranian government’s revenue.

"Venezuelan fiscal profligacy and its huge off-budget populist programs have left it very little room for error," the PFC report said.

Iran and Venezuela also have political agendas. Iranian President Mahmoud Ahmadinejad and Venezuelan President Hugo Chavez both use oil as a bargaining chip and a rhetorical weapon in their venomous assaults on the United States. But Saudi Arabia, Kuwait, Qatar, and the United Arab Emirates are all on much better terms with Washington, and don’t want to alienate a new U.S. administration or jeopardize relations with their best customer.

The division within OPEC has been particularly evident over the past few months. At a June 22 meeting in the port city of Jeddah, as the price of oil skyrocketed, Saudi officials unilaterally announced a 200,000 barrel-per-day (bpd) increase in production on top of a 300,000 bpd hike issued just a few weeks earlier.

Later, as OPEC members rallied to halt oil’s price decline in September, Saudi Arabia remained hesitate to accommodate the hawkish chorus. Instead, Riyadh conceded to vague language promising a production cut, but offered private assurances to customers that it had no real intention of honoring it.

"Except for Iraq and new members who are outside the OPEC quota, the rest of the members should produce in the framework of their committed quota," Iran’s oil ministry news agency Shana quoted Algerian Oil Minister and OPEC President Chakib Khelil as saying.

Saudi Arabia produced 9.45 million barrels a day in September, according to Bloomberg estimates. Its output target is set at 8.94 million barrels.

Iran’s energy minister said earlier this week that OPEC could slash output quotas by 2.5 million barrels a day. But, again, there’s a question of whether or not Saudi Arabia will accept such a sizeable reduction.

“I don’t think we’ll see a 2 million-barrel cut, given the reaction that this will have both by the market and by politicians,” John Sfakianakis, chief economist at The Saudi British Bank in Riyadh, told Bloomberg.

Regardless of what Iran, Venezuela and others desire in the way of a production cut, the ultimate decision will rest with Saudi Arabia, which is the world leader in oil reserves, with about 260 billion barrels of oil in the ground. Iran is third with 136 billion barrels in reserves, and Venezuela is seventh with just 80 billion barrels.

Sfakianakis expects a 1 million-barrel a day production cut, Friday.

News and Related Story Links:

• PFC Energy:
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• BusinessWeek:
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• Wikipedia:
  
  Hugo Chavez.

• Wikipedia:
  Chakib Khelil.

• Washington Post:
  Tough choices for Venezuela as oil prices fall

• Bloomberg:
  OPEC Risks Split on Cuts as Economies Reel, Oil Drops

• Money Morning:
  
  Saudi Arabia Hesitant to Join OPEC in Production Cut.

• Wikipedia:
  
  Mahmoud Ahmadinejad.

Iraq recently signed its first oil deal in 35 years with a foreign company.

And – quite surprisingly to many observers – the company wasn’t one of ours.

Not surprisingly, the U.S. news media barely acknowledged the deal – even though the agreement was major news throughout the rest of the world.

According to reports from Baghdad, the 22-year deal between the Iraqi government and the China National Petroleum Co. involves $55 billion, or 87% of Iraq’s current total revenue at a conservative long-term estimate of $100 a barrel.

The deal is actually a renegotiated version of a 1997 agreement between China and a Saddam Hussein-led Iraq. That original deal included production-sharing rights, but under the new contract China will be paid for its services, but will not share in profits,
The New York Times reported. The payments will be made in cash – and won’t be “in kind” payments of crude oil, the newspaper said.

While this deal, on its face, appears to be just another global oil-services contract, it’s actually a very significant development in the hunt for long-term energy supplies. In fact, it actually demonstrates that – when it comes to nailing down those long-term oil supplies – China is an expert, and is playing a very deep game. And the outcome of that game will certainly have substantial long-term implications for consumers and investors both here in the United States, and in markets abroad. Here’s why:

• With estimated reserves of 115 billion barrels, Iraq is tied with Iran for the world’s No. 2 position, trailing Saudi Arabia, which has estimated reserves of 264 billion barrels, according to estimates from the Energy Information Administration.
• In a country where electricity is in short supply, the oil produced from the Ahdab Oil Field will help fuel a planned power plant that would be one of the largest in Iraq. By helping Iraq with this key initiative, China can expect to gain a solid foothold in one of the most oil-rich nations in the world, analysts say.
• At the end of the day, the deal clearly highlights something that most U.S. investors haven’t focused on yet – namely that the eventual winners in this game may not be such well-known giants as Chevron Corp. (CVX), ExxonMobil Corp. (XOM), or other household names. Deals like this one and the host of others that are undoubtedly close behind suggest that tomorrow’s winners may have names most English-speaking investors can’t pronounce, since they’ll be distinctly Arabic or Chinese in nature. [Two recent installments of Money Morning’s popular new “Buy, Sell or Hold” feature have focused on Chevron. Take some time to peruse the original story, as well as the update.]

China’s Shrewd Long-Term Oil Plan

The important thing for investors to understand now is that oil ownership, as I have said for many years, is an illusion. It does not guarantee price, nor profit. What really matters in the end is having secure supply lines and sources from the Middle East (and other parts of the world).

Under this new contract, CNPC will provide technical advisors, oil workers and equipment to help develop the Ahdab oil field southeast of Baghdad, said Assim Jihad, a spokesman for Iraq’s Oil Ministry.

While China won’t participate in the profits from the oil it helps pump, it is shrewd enough to realize there will be long-term benefits. Analysts who see the bigger picture here agree with our view.

“There are some political profits for China,” Ibrahim Bahr al-Ulum, a former Iraqi oil minister, told The Times. “They need access to Iraq, and when they need oil, at least the Iraqi people will feel that China has done something for them.”

And that’s not all. Before 2003, Iraq had oil agreements with China, Russia, Indonesia, India and Vietnam – three of which included production-sharing agreements, The Times reported. But the big jump in oil prices, the new government and a myriad of other changes that have taken place since that time prompted Iraq to reconsider the terms of those deals, Iraqi officials said.

Iraq continues to negotiate other service contracts with ExxonMobil, Royal Dutch Shell PLC (ADR: RDS.A, RDS.B), Total SA (ADR: TOT), BP PLC (ADR: BP), Chevron, and some smaller oil companies. The deals have been reduced in length from two years to one after Iraq took a lot of flak for not putting the contracts out for competitive bidding.

But China’s contract was the first major one to be completed – and for one simple reason, Jihad, the Iraqi Oil Ministry spokesman, said. CNPC had “wide experience in this field,” and because many foreign oil companies were not willing to come to Iraq.

China has apparently learned how to play the global oil game with a pro’s touch. Ironically, it was the United States that crystallized this vision.

By invading Iraq, the United States dealt China’s central planning commission an embarrassing wakeup call when the second Gulf War summarily wiped out China’s oil interests in Iraq.

When that happened, China’s central planners realized two things:

• The status quo in the global oil game had changed.
• And China’s double-digit economic miracle could not be sustained with only a few oil suppliers.

What China fears most is that there will not be enough oil to go around in the very near future and that a U.S.-dominated supply chain could effectively “strangle” China’s growth.

So, it has done what the United States and other great powers have done at other times in history and gone on a buying spree from Darfur to Peru that’s turned heads and ruffled feathers all across the world.

What’s been especially frustrating for hapless Western leaders who do not understand that their actions caused this in the first place, is that China’s not afraid to do business with rogue nations like Iran, Sudan and Burma. It has even gotten chummy with Venezuela and Russia – much to the consternation of our present administration.

It’s a virtual certainty that China will maintain this policy going forward. My contacts in China and Africa have told me point blank that China’s leaders “don’t care about human rights or nukes or hostile governments. What matters is anyone who provides oil to China no matter what the rest of the world thinks.”

So, in as much as the U.S. media has dismissed this deal as only one in a long string of recent Chinese oil purchases, it’s arguably the most important deal yet. The reason: It suggests that China will go to extraordinary lengths to obtain the oil it wants and needs.

To add to its stable of captive oil suppliers, China will pay far more money, endure limitless criticism for ignoring human-rights issues and endure harsher business conditions than our companies can or will undertake. While U.S. firms must worry about sanctions, bad publicity or simply security, China worries about one thing, and one thing only – getting oil.

It’s a lesson initially learned from us. Then they refined it. Perhaps it’s time we re-learned this lesson from China.

[Editor's Note: With the U.S. financial markets in such disarray, Money Morning is looking for profit opportunities beyond U.S. borders: For instance, just check out this new report on a Wisconsin-based company we've discovered that's posting quarter after quarter of earnings surprises - while the rest of Wall Street tanks. Not only does this company have a lock on China - the fastest-growing market on the planet - this corporate gem is also riding the profit wave of the most-powerful global trend that we're following right now. If you act on this opportunity now - as an added bonus - you'll also receive a free copy of investing guru Jim Rogers’ best-seller, “A Bull in China,” which includes research reports on that country’s key profit plays.]

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Oil prices dropped yesterday (Wednesday) as news that oil majors’ Gulf of Mexico facilities were unscathed coupled with the dollar’s seven-month high against the euro sent crude futures lower.

Light sweet crude oil for October delivery dropped 86 cents to $108.85 per barrel on the New York Mercantile Exchange (NYMEX) yesterday. Oil had traded as low as $107.60 earlier in the day.

Oil prices are down 7% over the past four trading sessions, according to MarketWatch data, and are down 26% from their July 11 record of $147.27.

Back in Production

“With Gustav out the way, investor focus is shifting back to weakening demand for energy and other commodities and the broad strength in the U.S. dollar,” Andrey Kryuchenkov, an analyst at London-based Sucden, told the Bloomberg.

Royal Dutch Shell PLC (ADR: RDS.A, RDS.B) and ConocoPhillips (COP) reported no damage to oil platforms in the Gulf and Exxon Mobil Corp. (XOM) announced workers would be returning to oil platforms outside Gustav’s path. The reports of little to no damage put downward pressure on oil prices that had inflated prior to Gustav’s passing.

Also, yesterday, the U.S. government released some of its oil reserves in order to make up for any potential shortfall from decreased Gulf oil operations as Hurricane Gustav passed. Late Tuesday, the government announced it was releasing 250,000 barrels of crude stock due to the shutdown.

Oil firms had shutdown their Gulf of Mexico facilities on Tuesday, as a precautionary measure during the storm. The region normally accounts for 25% of U.S. oil production.

“The release of the oil will prevent any shortage and that will, of course, help calm the market,” Victor Shum, an analyst with energy consultancy Purvin and Gertz, told AFP.

Stronger Greenback

Meanwhile, the dollar’s climb against the euro is making oil more expensive in the 15-nation Eurozone, leading many to think European demand could weaken as the Eurozone economy recorded a decline in gross domestic product in the second quarter.

“The U.S. economy is now looking stronger than Europe’s, which is giving the dollar strength and reducing the appeal of commodities,” Rick Mueller, director of oil markets at Energy Security Analysis Inc. in Wakefield, Massachusetts, told Bloomberg News.

The euro declined to $1.4385, its lowest level since Jan. 22, before trading at $1.449 at 2:00 p.m. in New York.

The strengthening greenback is making commodities such as oil less attractive to investors as an inflation hedge.

Ospraie Management LLC, at one time the largest commodities-focused hedge fund, announced it would be closing after losing 38.6% this year. The news could prompt other funds to pare back on commodities holdings, causing oil prices to sink lower.

“The next number we are going to test is $100,” Chip Hodge, a managing director at MFC Global Investment Management in Boston, told Bloomberg. “One hedge fund has shut down and the demand picture here has been ugly, so the market will remain under downward pressure.”

News and Related Story Links:

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China and Iraq will sign a deal next week to develop the Ahdab oil field, 100 miles southeast of Baghdad, at time when political gridlock and security concerns have cast doubt over several pending short-term contracts.

The new agreement, valued at $1.2 billion, is a variation of a deal struck with the state-owned China National Petroleum Corp. in 1997, when Iraq was in the clutches of Saddam Hussein.

“The Chinese contract was signed with the former regime,” Hussein al-Shahristani, Iraq’s oil minister, said in an interview that appeared on Iraqi news Web site al-Noor. “It’s valid. It was unfair because it was a production-sharing contract. We have negotiated with them for a year. It was turned from a sharing contract into a service contract.”

Al-Shahristani, will put the finishing touches on the deal during a visit to China early next week, when he is joined by Latif Hamad, governor of the Wasit province – where the Ahdab field is located.

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“The governor will discuss the logistic cooperation with the Chinese company, especially the security side,” provincial spokesman Majid al-Atabi, told The Associated Press.

The deal with China is one of several contracts Iraq is touting in an effort to boost oil production by roughly 500,000 barrels a day, from 2.4 million barrels to 3 million barrels by the end of 2008. Iraq then hopes to increase production to 4.5 million barrels a day by 2013.  As it stands now, the country sits on estimated 115 billion barrels of reserves, but exports a meager 2 million barrels a day – 10th in the world.

Thirty-five foreign oil majors were invited to bid for contracts to provide technical support and help boost production in eight oil and natural gas fields last month. However, it was recently reported that oil majors are balking at the commitment, as the terms of the contracts have been shortened, and security concerns and political gridlock have undermined any progress.

“It appears that on present form (the Iraqi government) probably won’t proceed with most of these or all of them,” Charles Ries, coordinator for Iraq’s economic transition at the U.S. embassy told reporters earlier this week. “But I think that some of the companies are open to continued discussions even on relationship grounds, and some of the companies… don’t think it’s worth their time.”

Ries said that the contracts lost much of their appeal when Iraq reduced the length of their terms from two years to one, and when it became clear that companies who signed wouldn’t be given any preferential treatment for future long-term deals. Ries added that the deals, worth about $500 million apiece, “were never going to be hugely lucrative.”

Iraq has been negotiating with Royal Dutch Shell PLC (RDS.A, RDS.B), BHP Billiton Ltd. (ADR: BHP), BP (BP), Exxon Mobil Corp. (XOM), Chevron Corp. (CVX), Total S.A. (ADR: TOT), and a consortium of smaller firms led by Anadarko Petroleum Corp. (APC),  according to Reuters.

Anadarko has already pulled out, but officials insist negotiations are ongoing. An anonymous Iraqi official responded to reports that talks had disintegrated Wednesday, telling the AP that deals with Shell, BP, Exxon, Chevron, and Total were “still on the table,” and “none of them has pulled back.”

Development of the energy sector will be crucial to Iraq’s reconstruction and development, as oil accounts for 90% of export earnings and 70% of the country’s gross domestic product.

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• The Associated Press:
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Oil prices have plummeted 24% from the record high levels achieved in July, but the sell-off that sparked a stock-market rally over the last four weeks may not last since the Organization of Petroleum Exporting Countries (OPEC) is already gearing up to cut production.

OPEC, the cartel that controls roughly 40% of the world’s oil supply, pushed its production to the highest level in its 48-year history in July after being criticized for doing too little as the oil bull went on a year-long rampage – causing oil prices to reach an all-time high of $147.27 on July 11.

The production increase was led by Saudi Arabia, which – after a visit from U.S. President George W. Bush – boosted its production from 9.4 million barrels per day (bpd) to 9.7 million bpd, the highest level in 30 years. Higher production from Iran also helped push OPEC’s total output to 32.8 million bpd.

However, as economic growth stagnated in the developed world and cash-strapped American consumers cut back on expensive gasoline purchases, that production increase turned into a glut and oil prices plunged by more than $30 a barrel.  Now that crude is down significantly from its record peak, OPEC is getting ready to take some of the excess supply off the market.

In its August Monthly Oil Market Report, the cartel lowered its global demand forecast to an average of 32.05 million bpd. In July, OPEC said demand for 2008 would average 32.64 million bpd.

“The softening economic situation has led to a further slowdown in oil demand growth,” the cartel said. “Oil demand growth will be on the decline in 2009 which will make the world demand growth the lowest since 2002.”

This bleak outlook could foreshadow a series of production cuts, not just for this year, but in 2009, as well. Here’s a key reason why: Falling oil prices are expected to cost OPEC about $176 billion in lost export revenue over the next two years, the International Energy Agency reports.

Net oil exports from the 13-member OPEC nations are projected to hit a record $1.172 trillion this year, the IEA said. While the total dwarfs the $671 billion the cartel raked in last year, it’s still $79 billion less than the EIA forecast in July. The IEA said OPEC would bring in $1.225 trillion in 2009, $97 billion less than last month’s prediction.

Emerging Markets Keep the Oil Bull Alive

While the IEA also lowered its demand forecast for members of the Organization of Economic Coordination and Development (OECD), the group said that demand in emerging-market countries – many of which subsidize the cost of gasoline for their inhabitants – remains strong.

"Demand is coming from emerging markets. As long as the [United States] doesn’t collapse, it doesn’t really matter if the mature economies are slowing," IEA analyst Eduardo Lopez, recently told The Independent

Chinese consumption rose above 8 million bpd for the first time in June, hitting 8.3 million bpd. Chinese demand is expected to grow by 5.6% this year and 5.7% in 2009. The IEA sees demand more than doubling to 16.5 million barrels a day by 2030.

Also in the short-term, the Chinese government has closed hundreds of factories and kept more than 1 million cars off Beijing roads as part of a massive effort to clean up the city for the ongoing Summer Olympic Games. There’s also a growing suspicion among many analysts that, after the games, the factors that are suppressing demand will be removed, meaning energy consumption will climb back to prior levels.

Meanwhile, India is expected to overtake the United States, Japan, and China as the world’s leading net oil importer by 2025. Still on track for robust economic growth, India’s demand for oil is expected to grow by 8% to 10% this year alone. That’s good news for OPEC, as India imports about 76% of its crude oil.

Despite the challenges posed by slowing economic growth, the IEA still expects world energy consumption to rise by 0.9%, or 86.9 million bpd, from 2007.

Given the relative strength of demand in emerging markets, the IEA was less eager to pronounce the oil bull dead than was OPEC.

“While OECD demand could still surprise us on the downside, non-OECD prospects, particularly for China and the Middle East Gulf, could be subject to upside adjustment,” the IEA said. “Add in customarily ever-changing sentiment over Iran, and it looks too early to cite definitively a sea change in the market.”

Political instability remains a global problem. Uncertainty and unrest remains a given in the Middle East and Africa. But with its Aug. 7 attack on neighboring Georgia, Russia has essentially positioned itself as a geopolitical wild card among oil producers, as well.

“We continue to stress the supply uncertainty that’s out there. The events over the past week in Georgia and Turkey have only reconfirmed that,” IEA analyst David Fyfe told The Wall Street Journal, referring to Russia’s incursion into the Georgian province of South Ossetia. [For a Money Morning investment research report on Profit Opportunities From the New Cold War, please click here. The report is free of charge.]

Oil and the Market Rally

Whether OPEC intends to stand back and watch as oil prices continue their decline – costing the cartel hundreds of billions of dollars in foregone export revenue – will become clear at the group’s next meeting, set for Sept. 9. That meeting, at OPEC’s Vienna headquarters, is where the group will have its first opportunity to combat oil’s ravenous price decline.

If OPEC does cut production, it will be bad news for investors. Oil’s long slide has been part of an overall decline in commodities prices that has been cheered by investors who are hoping the falling prices will provide a boost to a sputtering U.S. economy that’s been afflicted by the one-two punch of soaring inflation and sagging consumer sentiment. [For more detail on U.S. consumer sentiment, please click here to see a related story in today’s edition of Money Morning.]

Since oil began its decline in mid July, the Dow Jones Industrial Average is up more than 5%. The Standard & Poor’s 500 Index is up 6.5%.

"Commodities continue to fall off a cliff and the market likes it," Greg Church, chief investment officer of Church Capital Management, told The Associated Press.

Of course, if oil prices resume their upward trend, the rally of the past month will have been short-lived, indeed. Crude prices fell $1.30 to settle at $113.71 a barrel Friday.

“It looks like crude oil prices will find support at $110 per barrel,” Xu Jiashun, an analyst from Yong’an Futures, told Interfax.

News and Related Story Links:

• OPEC:
  August Monthly Oil Market Report

• Money Morning Investigative Research Series
  :
  Cashing in on Commodities: What’s Driving the Oil Bull, How Much Further It Will Go, and How Investors Can Profit.

• Money Morning Investment Research:
  Profit Opportunities From the New Cold War.

• Money Morning Economic Analysis:
  
  Soaring Consumer Prices and Mounting Foreclosures Threaten 2008 Economic Growth.

• The Wall Street Journal:
  Tight Crude-Oil Supplies Seen Easing in Near Term

• Associated Press:
  Stocks rise modestly as oil continues slide

• IEA:
  International Energy Agency – Oil Market Report

• Interfax:
  SHFE gold may rebound as crude oil nears bottom.

• WhiteHouse.gov:
  President George W. Bush.

• Reuters:
  
  EU, U.S. back Georgian call for truce in S.Ossetia.

Crude oil prices slipped below $119 a barrel on the New York Mercantile Exchange yesterday (Monday) for the first time in three months as tropical storm Edouard veered away from energy facilities in the Gulf of Mexico, and a government survey that revealed U.S. consumer spending flagged in June.

Light, sweet crude for September delivery tumbled $3.69 to settle at $121.41 a barrel yesterday, after earlier dropping below $119 a barrel for the first time since May.

Part of the reason for the decline was that tropical storm Edouard lost strength and turned westward to miss vital oil facilities in the Gulf of Mexico, but declining demand is probably the biggest figure in oil’s slump. Crude fell 11% in July after more than doubling in price over the 12 months prior.

"The fact that we’re lower seems to speak volumes about how (falling) demand has moved into the top place in this market," Peter Beutel, oil analyst with Cameron Hanover, told CNNMoney.

A report from the Commerce Department yesterday showed consumer spending, adjusted for inflation, actually declined 0.2% in June, an indication that demand may further slacken. The Commerce Department said nominal spending grew 0.6% on the month, but the increase was all due to higher prices, which spiked 0.8%, the most for a month since 1981.

Overall, "the market remains bearish, both fundamentally and from [speculative] traders exiting positions," Darin Newsom, a senior analyst at DTN, told MarketWatch. "Support is at about every $20, with initial support at last week’s low of $120.40 (roughly) and then between $102 and $98."

The next stop is probably $100 "but will take some time to get there," he said.

News and Related Story Links:

• MarketWatch:
  Crude falls as U.S. data weigh on demand prospects

• CNNMoney:
  Oil takes a big dip

• Money Morning:
  Exxon Mobil and Shell Post Record Income but Demand and Production Weigh on Shares

• Money Morning:
  Chevron Says Hurricane Dolly Evacuation Won’t Affect Company’s Gulf Oil Production

• Money Morning:
  Buy, Sell or Hold: Chevron Corp.

By Jason Simpkins
Associate Editor

The benchmark crude oil rose 57 cents to settle at a record-high $140.21 a barrel on the New York Mercantile Exchange Friday, after a sell-off on Wall Street left the Dow Jones Industrial Average in bear territory.

After plummeting 358 points on Thursday, the Dow dropped another 107 points to end the week at 11,346.51. After sliding 4.2% last week, the Dow is now down 20% from its Oct. 9 high of 14,165. And that means the benchmark U.S. index has officially entered into a bear market. 

“With oil prices bursting through the $140 threshold and seemingly unstoppable, economists are busily debating whether it’s all going to end in fire (inflation) or ice (deep recession),” said Doug Porter, senior economist at BMO Capital Markets.

“Equity markets aren’t so concerned about the fineries of the debate, but are instead much more focused on the ‘it’s all going to end’ portion of the discussion,” he wrote in a note, seen by MarketWatch.com.

Story continues below…

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Whether inflation or growth should remain the No. 1 concern of the U.S. economy is a question that was thoroughly discussed last week by the policymaking Federal Open Market Committee (FOMC) at its meeting Tuesday and Wednesday.

The U.S. Federal Reserve voted to hold the Federal Funds rate steady at 2.0% last Wednesday despite mounting inflationary pressures.

Several recent economic reports showed the U.S. economy remains sluggish at best. Consumer sentiment is at a record low, unemployment climbed 0.5% in May to 5.5%, housing values seem to be in perennial decline.

“Tight credit conditions, the ongoing housing contraction, and the rise in energy prices are likely to weigh on economic growth over the next few quarters,” the FOMC statement read.

“The Committee expects inflation to moderate later this year and next year,” the statement read. ”However, in light of the continued increases in the prices of energy and some other commodities and the elevated state of some indicators of inflation expectations, uncertainty about the inflation outlook remains high.”

News and Related Story Links:

• Money Morning:
  Fed Holds Rates Steady in Face of Upside Inflation Risk

• MarketWatch:
  U.S. stocks post sharp weekly losses; bear-market nears

Oil and gold each experienced a fresh resurgence yesterday (Thursday) – with crude achieving a new trading record – after the dollar weakened in response to the policy decisions by central banks around the world, and the Organization of Petroleum Exporting Countries’ president said oil may reach $170 by the summer.

Gold jumped 3.7%, trading at a level of $915 an ounce for most of the day, while oil settled at all-time high of $139.64 a barrel, up $5.09, after setting record intraday high of $140.39 – its highest level since reaching a record $139.89 on June 16.

"I foresee prices probably between US$150 and US$170 this summer," OPEC President Chakib Khelil was quoted as telling a French television station. "That will probably decline a bit toward the end of the year."

Also, the head of Libya’s national oil company said the country could cut crude production because the oil market is well supplied, Bloomberg News reported.

Another driving force behind the gains made by oil and gold was the depleted greenback, which tumbled after the U.S. Federal Reserve’s decision to hold its key lending rate steady at 2.0%.

"The Fed said that inflation is a major concern, but they’re not going to do anything about it, which made gold go ballistic," Leonard Kaplan, the president of Prospector Asset Management, told Bloomberg News. "The dollar is going to get slammed again."

After meeting Wednesday, the policymaking Federal Open Market Committee (FOMC) acknowledged that inflation as a growing problem, but also expressed its belief that an economic downturn would eventually blunt demand for goods and drive down prices.

"The committee expects inflation to moderate later this year and next year," the FOMC said in a statement.

While the Fed is content to sit back and measure the stimulative effect of its previously mandated rate cuts, Jean-Claude Trichet, chairman of the European Central Bank, is telegraphing a rate hike that will do even more damage to the U.S. dollar.

The greenback, which fell to $1.5758 against the euro in afternoon trading, will likely sink further after the central bank’s Governing Council meets July 3, as the body is largely expected to raise its interest rate a quarter of a point to 4.25%.

"The Governing Council remains particularly concerned that current elevated inflation rates, which have proved higher than and more persistent than previously foreseen, may become entrenched in private inflation expectations and lead to second-round effects," Trichet told an economic committee of the European Parliament.

Even a minute ECB rate increase will significantly widen the gap between the euro and the dollar, and will further elevate commodity prices.  Oil, was up more than $4, or 3%, by midday, trading at $138 a barrel.

One of the many investors to voice concern over mounting inflationary pressures is Warren Buffett chairman of Omaha-based Berhshire Hathaway Inc. (BRK.A, BRK.B). 

"I think inflation is really picking up," Buffett told CNBC earlier this week. "We see it everyplace.  It’s exploding."

Of course, many analysts believe the situation is out of Fed Chairman Ben S. Bernanke’s hands at this point, contending that if he does raise rates to combat inflation, he will forfeit what little economic growth remains to be seen in the U.S. economy.

"In an environment of dislocated funding markets, a rate cut would not produce a recovery buy a rate hike could trigger recession," wrote Tullett Prebon economist Lena Komileva.

Indeed, Money Morning Investment Director Keith Fitz-Gerald said that institutional traders are at the flight controls of market prices right now – not the Fed.

"Every time the Fed goes up against institutional traders, the Fed loses," Fitz-Gerald said.

News and Related Story Links:

• Bloomberg:
  Gold Futures Climb as Fed Keeps Rates Steady; Silver Advances

• Fortune:
  Buffett vs. Bernanke: The inflation showdown

• Money Morning:
  Fed Holds Rates Steady in Face of Upside Inflation Risk

• Bloomberg:
  Libya May Cut Oil Output on U.S. Threat to its Assets

• International Herald Tribune:
  OPEC president: Oil prices could hit $170 a barrel this summer