Update: Oil Soars Above $35 a Barrel, Despite OPEC Output Hike

Updated from 2:08 p.m. EDT

While the recent production increase from the Organization of Petroleum Exporting Countries is likely to slow -- if not stop -- the sharp jump in oil prices, analysts say the added output is too little and comes too late to provide significant relief in the upcoming months.

Indeed, oil prices rose sharply Monday following the announcement. The benchmark October future contract for crude oil climbed $1.51, or about 4.5%, to settle at $35.14 Monday on the New York Mercantile Exchange.

The price surge came despite an agreement by OPEC at its meeting Sunday in Vienna to raise its oil production ceiling 3%, or 800,000 barrels a day, starting Oct. 1.

The organization also agreed to meet again on Nov. 12 to reassess oil supplies and prices. In the meantime, OPEC will maintain its price mechanism, which aims to keep oil in its "basket" (which includes blends from Algeria, Indonesia, Saudi Arabia and Venezuela) between $22 and $28 a barrel.

OPEC's production increase is more than the half-million barrels a day recommended under the organization's price band mechanism if the "basket" oil price remains above $28 for 20 consecutive days, as it had by Friday. But analysts said that the additional crude oil may not be enough to cut prices significantly from the current 10-year highs.

Though the latest increase raises OPEC's output target to 26.2 million barrels a day, there are questions about whether some of the cartel's members are even capable of meeting the new output level.

Industry analysts said that the actual increase is not likely to be anywhere near 800,000 barrels a day, since many OPEC members are already producing at or above capacity. Those with additional capacity are likely producing above their quotas already, so the new agreement may simply legitimize the current "cheating" among members.

GNI, a London-based financial services firm, said that oil output in August among OPEC members Algeria, Kuwait, Libya, Qatar, United Arab Emirates and kingpin Saudi Arabia, the world's largest oil exporter, was already higher than the newly approved production ceilings.

"How much extra oil this (agreement) will actually achieve is open to debate," wrote GNI analysts in a Monday research note.

Deutsche Banc Alex. Brown estimated that the increase could be just 300,000 more barrels a day -- not enough to roll oil prices back much below $30 a barrel on the NYMEX before next year.

Deutsche Banc predicted that oil inventories will not return to robust levels until the first quarter of 2001, at the earliest, and maintained that oil prices will roll back to the low $20s by the second half of the year.

Christopher Stavros, a PaineWebber analyst, said that the net production increase could be as little as 100,000 additional barrels a day. He also noted that the rise in oil supplies needed to match current demand had overwhelmed the capabilities of the tankers, pipelines and refineries that distill and deliver it.

PaineWebber does not foresee domestic oil prices falling below $26.50 a barrel until winter has ended.

"We maintain that the oil market is constrained as a result of tightness within the world's oil infrastructure," Stavros said in a research note. "This situation has been exacerbated as a result of low refined product inventories, particularly for middle distillates (such as diesel fuel and heating oil)."

In its communique issued Monday, OPEC attributed the high cost of oil in part to shortages caused by bottlenecks in the refining industry.

On Monday, the October contract for heating oil rose more than 5 cents to close at about $1.05 a gallon. The October contract for New York Harbor unleaded gasoline jumped 2 cents to settle at 97.35 cents, after climbing just short of $1 a gallon earlier in the day.

Meanwhile, prices at the pump have jumped back above $2 in California. And the national average for all grades of retail gasoline is nearly $1.60 a gallon -- the highest level since mid-July.

Consumers won't just be paying higher prices at the pump. By Saturday, all of the nation's top five airlines had announced they would be adding a $20 surcharge to every roundtrip fare to cover the rise in jet fuel costs.

"This could be the beginning of the end for the gas guzzling generation," said Phil Flynn, senior energy analyst and vice president at Chicago-based Alaron Trading, adding that the OPEC increase is unlikely to prevent a return to summer's soaring gas prices.