World oil prices continue to reach record levels. Crude oil over the last few days has risen to above $147 per barrel, with the latest surge driven by ongoing geopolitical concerns over Iran, an Opec member, and its recent missile tests.

Brent crude climbed to $147.02, before settling at $144.49. US light sweet crude rose to $147.27, before falling back to $145.08. However, it is more than political factors which are driving the price higher.

The world oil market remains very tight, as has been the case for some months. This is clearly seen through rising prices, low surplus production capacity, and the concern that global supply growth may not keep pace with demand growth over the near term. Preliminary estimates indicate that higher oil consumption in the second quarter of 2008 and a slight increase in production left OECD commercial inventories below the five-year average at the end of June 2008.

Following pressure from the US, Saudi Arabia is in the process of increasing production from 9.4 million barrels per day (bpd) in June to 9.7 million bpd in July, a 27-year high for the Kingdom. Despite this, oil prices have not eased. Supply losses in Nigeria, as well as tensions between Iran and Israel, raise new concerns about future supplies.

Moreover, while the Saudi action adds supplies to the market, remaining available surplus production capacity during the third quarter of 2008 is at the low level of about 1.2 million bpd, all concentrated in Saudi Arabia, according to the Energy Information Agency (EIA).

Global oil consumption continues to grow despite seven consecutive years of rising prices. Data indicates that world oil consumption during the first half of 2008 rose by roughly 520,000 bpd compared with a year-earlier. This increase reflects a 170,000-bpd gain in the first quarter, followed by an 870,000bpd increase in the second quarter. A 760,000 bpd decline in consumption in OECD countries during the first half of 2008, mainly concentrated in the US, was more than offset by a 1.3-million-bpd increase in consumption in non-OECD nations led by China and the Middle East, and in particular the GCC states.

The EIA projects world oil consumption to rise by almost 1.2 million bpd during the second half of 2008, despite seasonal pressure, reflecting the impact of higher expected prices, lower economic growth, and growing pressure in some countries (such as India, Malaysia, Indonesia, and China) to ease price subsidies, which could dampen consumption growth.

Global consumption in 2009 is expected to increase by 1.4 million bpd because of upward revisions in projected 2009 economic growth in some regions, such as Latin America.

If financial strains in the United States spread to other nations, depressing economic growth, consumption growth would slow, and thereby placing some downward pressure on the oil price.

Opec supply growth is another key determinant of future market conditions. Despite higher prices and recent past projections of substantial growth in non-Opec supplies that matched or exceeded consumption growth, actual non-Opec production fell far short of both expectations and consumption growth. More accelerated declines in older fields and delays in expansion projects have limited supply growth.

At the beginning of 2008, non-Opec supply growth was projected to rise by 860,000 bpd in 2008 and by over 1.5 million bpd in 2009. Production is now expected to rise by only 230,000 bpd in 2008 and by 830,000 bpd in 2009. Lower than expected production from Russia and the North Sea, along with lowered expectations for Brazil, are the main factors for lower non-Opec supply levels.

Second-half 2008 non-Opec supply is expected to increase by about 700,000 bpd, driven by growth in Brazil and Azerbaijan. Possible additional delays in key projects as well as accelerating production declines in some older fields cannot be ruled out.

As a result, net non-Opec production gains could be less than the current forecast, leading to both higher demand for Opec oil and higher prices than currently projected.

Opec crude production in the second quarter of 2008 averaged an estimated 32.3 million bpd, according to the EIA, slightly ahead from 32.2 million bpd in the first quarter of the year. Higher production in Iraq and Angola more than offset lower production in Nigeria caused by security problems and worker strikes.

Assuming that Saudi Arabia's announcement of increasing July output to 9.7 million bpd results in a higher sustained rate of production through to at least September, Opec crude production is projected to average 32.7 million bpd during the third quarter.

At these production levels, available surplus production capacity during the third quarter would be only 1.2 million bpd, marking the third consecutive quarter that surplus capacity stood at or below 1.5 million bpd. All of this capacity is held by Saudi Arabia. The EIA believes that any industry operating at close to 99 per cent of capacity will remain vulnerable to surprises that either boost consumption or disrupt production.

Such surprises would place additional upward pressure on prices and contribute to oil price volatility. In this tight global oil market, Opec countries have also faced delays in adding new production capacity, notably in Algeria and in Saudi Arabia.

OECD commercial inventories declined during the first quarter of 2008 by 39 million barrels.

During the second quarter, inventories increased by only 36 million barrels, well below the average build of 83 million barrels during this time of year. At the end of the second quarter, estimated OECD commercial inventories stood at 2.57 billion barrels, 26 million barrels below the 5-year average and equal to 53 days of forward consumption.

Although some observers speak of an oil price bubble at the moment, simple supply and demand economics suggest that the price is unlikely to fall back quickly or sharply.