High demand
World oil demand is growing at its fastest pace in 16 years. U.S., European and Japanese economies are finally growing again and China is sucking in oil -- imports are 20 percent higher than a year ago -- to power its manufacturing and to make gas for its booming car market. The world consumed 79 million barrels of oil a day in the second quarter. Forecasts call for that to rise to 82.5 million in the fourth quarter.


Low inventories
Stocks of oil are low by historic standards, removing a cushion between demand and supply. The unusually cold winter in the Northern Hemisphere caught oil companies shorthanded, forcing them to run down stocks. But oil companies are keeping less oil on hand than in the past to lower their cost of business. OPEC has kept its stocks low as a matter of policy.


Supply snags
Unrest has disrupted oil production in the Middle East, Nigeria and Venezuela. New production investment has been low in the Persian Gulf and Caspian Sea. Mature U.S. and North Sea oil fields are producing less and new finds have dropped to 6.8 billion barrels annually in 2001-2003 from 11.4 billion barrels per year in the previous five years. U.S refineries are running at near-full capacity, slowing gas deliveries to consumers. Summer driving will only make things worse.


Pump problems
U.S. gas prices rose more than 50 cents per gallon during the first five months of 2004, but higher crude accounted for only about half of that. Severe winter weather delayed U.S. refiners from making their annual switch to summer products. Even if they try to play catch-up, tankers from the Gulf take six weeks to reach the U.S. so new supplies wouldn't reach consumers until late summer. And because different U.S. regions require different gas formulations, a shortage in one can't be met with shipments from another.


Price pressure
Oil prices have jumped 30 percent this year thanks to the supply-and-demand problems, the weaker U.S. dollar and speculation. A 10 percent drop in the dollar against currencies of other oil-consuming countries means a 7.5 percent rise in the dollar price of oil. OPEC officials also blame hedge fund bets that prices will go higher for up to 20 percent of $40 oil. But even at $42, a barrel of oil is cheaper than it was in 1980, when it cost $81 in today's money. (In 1864, oil hit a giddy $8 per barrel -- $92 in 2004 dollars.)


Economic disruption
High oil prices push up inflation through higher energy and transportation costs; they can push up interest rates and trim economic growth too. A $1 gain in crude oil prices adds $280 million per year to U.S. airlines' fuel bills. If price rises are steep enough or last long enough, they can trigger recessions, as happened in 1973-1974, when OPEC tripled oil prices overnight, and in the 1980s, when oil prices stayed above today's prices in real terms for seven years.


Cartel crunch
OPEC's 11-member states pump 39 percent of the world's oil production and half of oil exports. The 44-year old cartel tries to manage prices by regulating output, though quotas rarely reflect true OPEC output. But while OPEC opted to raise output at its June 3 meeting in Beirut, most members are producing at full capacity already. OPEC also has internal policy divisions between pro-U.S. members such as Saudi Arabia and Kuwait and countries less favorably disposed to the Bush administration such as Iran and Venezuela.


The fear factor
Although the U.S. gets only 10 percent of its oil from the Persian Gulf, the Middle East remains the world's largest oil producing region. Recent violence in Saudi Arabia, including a deadly attack by Islamic militants in Khobar, and a fear that al Qaeda-linked forces are trying to provoke civil war in the kingdom have again raised fears about supply interruptions. Continuing unrest in Iraq will delay the return of its oil to world markets in any significant volume.


Vulnerable infrastructure
The world's oil infrastructure has many points open to terrorist attack, but it would take simultaneous strikes to cause a significant disruption. Oil wells, pipelines and tankers are the least of the worries. Ports are a bigger potential chokepoint because most oil producing nations have only one or two terminals. But with U.S. refineries already at full capacity -- no new ones have been built for years because of environmental concerns and NIMBYism -- taking out one would send U.S. fuel prices soaring.


The bottom line
Although oil -- and natural-gas -- prices have risen sharply, they will likely have only mild effects on overall economic activity, making real U.S.gross domestic product only about 0.9 percent lower than it would otherwise be. Not enough to derail the recovery. Businesses also have more experience with energy price shocks; they understand how the shocks affect them and how other segments of the economy will respond. But many of the factors behind the recent surge in prices are likely to persist.