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Crude prices rose above $40 a barrel Monday as Israel and Palestinian militants exchanged rocket fire and the death toll mounted in the oil-rich region.

Light trading contributed to market volatility in the final days of 2008, with price swings of close to $5 a barrel.

Light, sweet crude for February delivery rose $2.31 cents to settle at $40.02 a barrel on the New York Mercantile Exchange, the first time crude has ended the day above $40 in a week. Nymex will be closed Thursday for the New Year's Day holiday.

Retail gasoline prices in the U.S. continued to fall and neared $1.60 per gallon nationally Monday.

In the Middle East, Israel destroyed symbols of Hamas power on the third day of what the defense minister described Monday as a "war to the bitter end." The three-day death toll rose to at least 364 on Monday, with some 1,400 reported wounded. Israel launched its campaign, the deadliest against Palestinians in decades, on Saturday in retaliation for rocket fire aimed at civilians in southern Israeli towns.

Israel obliterated symbols of Hamas power, with missiles striking next to the Hamas premier's home, and devastating a security compound and a university building.

Phil Flynn, an analyst at Alaron Trading Corp. in Chicago, called oil's initial run-up "an emotional reaction to what was going on in Israel," and said similar, short-lived spikes have occurred during other clashes in the region.

"In reality, the likelihood the conflict is going to interrupt oil supply in any way, shape or form is highly unlikely," Flynn said. "Obviously, if the conflict widens, and other countries get involved directly, you might have a different situation."

There were also hints from China the government could go on a crude-buying spree to take advantage of prices below $40 a barrel. A senior government official writing in the People's Daily said China wants to increase its oil reserves to cushion supply shocks that it believes are inevitable.

China is encouraging companies to use all spare petroleum storage capacity to take advantage of the current low prices, the official said.

Asia's biggest refiner, the state-owned China Petroleum & Chemical Corp., recently completed construction of its largest storage project, a 38-tank facility with a total capacity of 32.4 million barrels.

The Organization of Petroleum Exporting Countries, which accounts for about 40 percent of global supply, has announced crude production cuts totaling more than 4 million barrels per day as it tries to stop the decline in prices. OPEC members, however, have a history of ignoring announced quotas and crude traders are looking for evidence the 13-nation group is tightening the spigot.

In Vienna, JBC Energy, in its daily newsletter, said "the UAE has decided to reduce crude supplies in January and February in line with the OPEC production cuts." The United Arab Emirates are the fourth-largest producers in the 13-nation cartel.

Analysts at the U.S. firm Cameron Hanover noted Monday the UAE, unlike a number of other OPEC members, typically abides by planned cuts. "If OPEC countries actually cut all of the output they have agreed to cut, global supplies of crude will be tighter come spring," Cameron Hanover said.

Oil prices have fallen 73 percent since peaking at $147.27 a barrel on July 11 as a credit crisis in the U.S. sparked a steep drop-off in consumer demand and corporate earnings. Analysts expect more dismal economic news from the fourth quarter over the next few weeks.

"More bad profit reports, jobs reports, housing results will put pressure on prices," said Gerard Rigby, energy analyst with Fuel First Consulting in Sydney. "Once Obama comes in, that might start changing sentiment and generate more optimism." Barack Obama is scheduled to be sworn in as U.S. president Jan. 20.

Tumbling crude prices have led to enormous declines in the price of retail gasoline.

At the pump, retail gas prices fell eight-tenths of a penny overnight to a new national average of $1.619 a gallon Monday, well below the year-ago average of $3.039 a gallon, according to AAA and the Oil Price Information Service.

A Shell station in suburban Houston was selling regular unleaded for $1.19 a gallon on Monday.

In other Nymex trading, gasoline futures rose 3 cents to settle at 87.45 cents a gallon. Heating oil rose 4 cents to settle at $1.2853 a gallon, while natural gas for January delivery jumped 31 cents to settled at $6.136 per 1,000 cubic feet, well above the technically important $6 level.

In London, February Brent crude rose $2.18 to settle at $40.55 a barrel on the ICE Futures exchange.

Associated Press writers George Jahn in Vienna, Austria, and Alex Kennedy in Singapore contributed to this article.

Copyright 2008 Associated Press. All rights reserved. This material may not be published broadcast, rewritten, or redistributed

Oil prices rose sharply toward $50 a barrel Monday as investors anticipated OPEC will announce a large production cut at its meeting this week.

Light, sweet crude for January delivery was up $3.24 to $49.52 a barrel in electronic trading on the New York Mercantile Exchange by mid-afternoon in Europe. The contract briefly reached $50.05 before falling back. On Friday, it fell $1.70 to settle at $46.28.

In London, January Brent crude gained $3.40 to $49.81 on the ICE Futures exchange.

The Organization of Petroleum Exporting Countries, which accounts for 40 percent of global supply, has signaled it plans to announce a substantial reduction of output quotas at its meeting Wednesday in Algeria.

"The extent of such cuts is still unclear and this uncertainty has been a source of continuing volatility in futures markets," said a report by analysts at KBC Market Services in Great Britain.

Kuwaiti oil minister Mohammed al-Eleim said Monday that OPEC was "undoubtedly inclined" to cut production. But he added that any decision would balance the need for a cut with its impact on the ailing world economy and producer nations' need for revenue to fund development projects.

Iranian Oil Minister Gholam Hossein Nozari was quoted Sunday on his ministry's Web site saying that Iran would push for a production cut of 1.5 to 2 million barrels per day.

Saudi Oil Minister Ali al-Naimi said oil prices needed to return to $75 to keep the more expensive new projects at the margins of world supply on track. His comments may come as a relief to consumer nations fearful of a return to $100-plus oil. U.S. crude <CLc1> was valued at $55 at the close of trade on Friday.

"There is a good logic for $75 a barrel," Saudi Oil Minister Ali al-Naimi, OPEC's most influential voice, told reporters in Cairo, where the producer cartel was meeting. [ID:nLT557953]

"You know why? Because I believe $75 is the price for the marginal producer. If the world needs supply from all sources, we need to protect the price for them. I think $75 is a fair price," he said.

Saudi King Abdullah announced $75 as a fair price in an interview with Kuwaiti newspaper Al-Seyassah.

Naimi's comments stopped far short of suggesting OPEC adopt a new formal price target to guide policy. But the unexpected break from his customary refusal to cite any sort of preferred price will give markets a new reference point when world oil demand recovers from the current recessionary slump.

In June, a couple of Dutch energy researchers released a fascinating, long-gestating report on high oil prices. At the time, oil was selling for about $130 a barrel, and the authors, neatly dissecting the market, argued that prices were only going to get worse. Just the next month, they did rise — to $147 a barrel.

But, as O and G readers know, there was good reason to argue the other way at least in the short term – Ed Morse, now shifted from defunct Lehman over to LCM Commodities, asserted correctly that we were in for a considerable price correction.

So, with prices having gone strongly down, as Morse forecast, I made a phone call to the report’s lead author – Jan-Hein Jesse, whom I met last year at an OPEC meeting in Vienna – and asked whether he thinks his thesis still holds. I.E., is another price spike coming down the road?

The answer, Jesse replied, is probably yes. The ‘probably’ covers the event that we are headed into a long, deep depression, in which case all such previously composed economic analyses are off the table, and one must reassess the facts afresh.

But if in the next two or three years we come out of recession in fair economic shape, look for another steep rise in oil and gasoline prices.

Fatih Birol, chief economist at the International Energy Agency, has been arguing the same point while making the rounds last week and this week in Washington and elsewhere. He’s been explaining the IEA’s latest World Energy Outlook, which is just as bleak as Jesse’s paper. Jesse wrote the paper with Coby van der Linde.

In short, demand in China, India and elsewhere in the developing world is probably going to roar back and outstrip supply in 2011 or beyond.

That alone will push prices back up. But oil companies also are now responding to $50 oil by shelving oilfield development projects. So, as Jesse told me, “In 2010 or 2011, we will be in the same situation as [the high prices of] last year. Then we will start all over again [in an energy crisis], but it will be much more difficult.”

One interesting observation of Jesse’s is that price no longer works as a stimulant in the other direction – high prices don’t necessarily motivate oil producers to flood the market with supply, and thus tamp down the upward motion of prices. That’s because almost all the available new oilfields are controlled by national oil companies like Saudi Aramco, Russia’s Gazprom and Venezuela’s PDVSA. Unlike oil companies such as Exxon and BP, which if they can are driven to maximize profit by producing more oil when prices are high, these national companies earn what they need from the higher prices, and let the rest of the oil sit in the ground.

In order to meet rising demand starting in 2011 and beyond, Jesse wrote, these producers – the companies and countries – will have to bring twice as much newly found oil onto the market in the next 22 years than what they did in the last 22 years. Meaning they will have to find and deliver 70 million barrels a day of new supply to the market. Almost no one thinks that is possible.

Jesse’s ultimate forecast is that the West – the U.S. and Europe – are going to have to use a lot less oil in order to make way for rising demand in China, India and elsewhere. If they don’t, he says, look for geopolitical tension, and another possible deep and prolonged recession. The coming energy shortages are bound to produce “sometimes confrontational relationships” between the world’s main oil consumers and the petro-states, the authors write.

Jesse and the IEA come to the same conclusion – the current global energy model isn’t sustainable. In order to avoid “the nasty side of oil scarcity,” Jesse and his co-author write, OPEC and other petro-states need to produce more oil, and the West needs to purse efficiency and the development of alternative energy.

OPEC oil ministers on Friday downplayed expectations of, but didn't dismiss outright, an immediate output cut as they faced a third test in as many months of their ability to engineer a rebound in oil prices.

The outcome of the hastily convened Cairo meeting Saturday, billed as a consultative gathering to assess the impact of earlier production cuts, likely hinges on a key issue with which the cartel has had a checkered past: unity.

Kuwaiti oil minister Mohammed Al-Aleem told reporters in Cairo that while the market was oversupplied, he believed there was "no need" for the Organization of Petroleum Exporting Countries to decide on cuts ahead of its regularly scheduled Dec. 17 meeting in Algeria.

But Rafael Ramirez, oil minister for price hawk Venezuela, later said the option remained to cut production by "at least 1 million barrels" at the weekend gathering. "Maybe it's necessary, a new cut," Ramirez said. He quickly added, thought, that such a decision could be taken now or next month.

The diverging takes highlighted the difficulty of the task facing producers of almost 40 percent of the world's oil.

"There is total confusion" among OPEC's 13 members, said Fadel Gheit, managing director of oil and gas research at Oppenheimer & Co. in New York. "These people ... really have no business model. They basically thrive when oil prices go up, and now they are crying uncle when prices go down."

And, down they have gone, in a financial avalanche triggered by demand destruction, itself sped along by a world financial meltdown that also threatens to cut deeply into OPEC member states' government budgets.

Whereas crude stood at about $147 a barrel in mid-July, it now hovers about $90 lower. On Friday, the U.S. benchmark West Texas Intermediate crude for January delivery was trading at down about $3 per barrel at about $51.

"They (OPEC) simply don't react quick enough, and prices keep going down," said Vincent Lauerman, OPEC expert and president of Calgary, Canada-based consultancy Geopolitics Central.

This meeting will come down to what kingpin and traditional price dove Saudi Arabia wants, he said.

Saudi oil minister Ali al-Naimi told reporters answers would come on Saturday.

The cartel has already held one emergency meeting - on Oct. 24 in Vienna - to try to halt the slide in prices with an announcement of a 1.5 million barrel per day drop.

It failed to support prices, and the cartel cobbled together the Cairo gathering on the sidelines of the Organization of Arab Petroleum Exporting Countries' meeting.

But members have been circumspect about expectations, leading some to speculate OPEC is staying quiet to maintain the element of surprise.

"As long as they do a substantive cut, they may be getting ahead of the curve, and should be cutting enough to get ahead of demand destruction," said Lauerman, citing about 1 to 1.2 million as the magic number.

That has been the figure most readily cited by those nations proposing cuts, including Venezuela which, like fellow price hawk Iran, need crude of about $90 per barrel to meet current spending needs aimed in part at propping up its domestically unpopular regime.

The two have found support from non-OPEC oil giant, Russia. Its president, Dmitry Medvedev, said Thursday his country would cooperate with the group to support prices.

Other OPEC members, such as Nigeria and Ecuador, face budget problems too, making them reluctant to implement more cuts that might shrink revenues further.

Nigerian envoy, Odein Ajumogobia, said the ministers were "just going to exchange ideas and views" at the gathering.

Kuwait's al-Aleem said current low prices benefit neither consumers nor producers and could undercut investments in future projects - a scenario that could lead to another spike down the road.

"We think a decision could be taken, but I think it will happen in Algeria," he said.

OPEC's last round of cuts would put its total production at about 30.5 million barrels per day, according to the IEA.

Unlike many of their fellow members, the Saudis are better positioned to cope with the drop in prices. The International Monetary Fund estimates Riyadh needs crude in the range of about $50 per barrel for 2008 fiscal accounts to break even.

While al-Naimi refused to tip his hand, an indication of the Saudi thinking may have emerged earlier this month when, during the Group of 20 meeting in Washington, King Abdullah pledged the kingdom would do everything in its power to help the global economy recover.

Higher oil prices would undermine that promise.

Also unclear, after two earlier cuts failed to push prices higher, is what the group can do without prolonging the global economic downturn.

"I would play 'good cop' and not do anything," said Oppenheimer's Gheit. "If they are patient, they will be rewarded because you will see a precipitous drop in capital spending, and that will tighten the market, in itself."

But demand has shown little indication of rebounding soon, and global crude stockpiles are growing - as evidenced by a U.S. government report showing a surprisingly large 7 million barrel build in stocks last week.

Those factors argue against restraint if some in OPEC want crude back up to at least $70.

Even so, Algerian oil minister and OPEC president Chakib Khelil has urged a wait-and-see approach, saying that the group risks losing credibility if it enacts new cuts in Cairo only to find members were not complying with the Vienna decision.

Political considerations are also likely to factor prominently.

Saudi Arabia is a close U.S. ally in the Middle East, and is eager to see concerted Washington backing for peace efforts in the region.

One way of winning new support from the incoming administration of U.S. President-elect Barack Obama would be by tacitly working to undercut two of Washington's most strident foes, Venezuela and Iran. It would not be an onerous job for the Sunni Muslim Saudis, who have no great affection for Shiite Iran.

"Saudi Arabia is playing ball with the U.S.," said Gheit. "It is going to punish Venezuela. It is going to punish Russia. It is also going to curtail Iran."

AP Business Writer Adam Schreck contributed to this report.

Copyright 2008 Associated Press. All rights reserved. This material may not be published broadcast, rewritten, or redistributed

As Somali pirates hold captive the Sirius Star, a Saudi ship with almost $100 million in oil on board, and Indian, British, Russian, and German ships battle pirates up and down the Gulf of Aden, one might imagine that the battle against piracy (BusinessWeek.com, 11/18/08) is the largest crisis faced by the merchant navy industry.

After all, since January of this year, some 580 crew members have been held hostage, according to data collected by the International Maritime Bureau, and many millions of dollars have been paid in ransom. Insurance rates are up, ships are trying to avoid the Suez Canal (which ships get to via the Gulf of Aden, along the coastlines of Somalia and Yemen), and crews from India to Britain are refusing to board ships that pass through that zone. "This sort of thing can't be shut down immediately," says an aide to Indian President Pratibha Patil, who advises her on naval affairs. India's navy has fought at least three different pirate groups in the last week. "To some extent, the world's navies have to flex their muscles, and that takes time."

But what's missing in the news reports about the modern-day pirates and the political repercussions is a simpler fact: The world's shipping industry is already on its knees and has spent the past six months in a slow-motion collapse kicked off by the . And the pirates, it would seem, are the least of the problem. Just six months ago, despite the fact that the economy in the U.S. was already slowing down, the industry was steaming ahead. As ships of every flag, color, and size were crossing oceans, carrying in their often cavernous cargo bays the essentials of trade—oil, steel, cement, iron ore, and coal—shipping rates worldwide in June hit their highest peak ever. It cost nearly $234,000 a day to rent one of those large capesize vessels, the ones so big that they don't even fit through the Suez Canal.

Last week, you and your friends could have rented one of those ships for a weekend bachelor party and football game for less than $4,000, according to data collected by the London-based Baltic Exchange.

Low Shipping Costs

What happened? And what does it mean for the world economy? Not good news. Let's start with shipping rates. They are the lowest they have been in six years, as measured by a relatively obscure indicator called the Baltic Dry Index. The index, which measures the cost of shipping most commodities other than oil, has been in free fall since the middle of the year, down 93% from its peak of 11,793 in May 2008. As a result, daily rates for chartering a merchant ship are still down by as much as 98% from just six months ago.

With shipping rates so low, the first casualties, not surprisingly, are shippers. Stocks for companies that construct ships and operate container carriers have languished. For instance, Singapore-based Neptune Orient, the largest shipping carrier in Southeast Asia, on Nov. 19 announced it was cutting nearly 1,000 jobs, or 10% of its workforce. All of the lost jobs are in the U.S. and Canada.

Not too many people pay attention to the BDI other than shippers, but economists trying to read the tea leaves of global trade see it as a solid leading indicator of whether the world's economy is headed up or down. There's a good reason for that: A ship leaves from somewhere in the world with a cargo load of iron ore, cement, or coal, heading most likely for China, India, Western Europe, or the Americas; two months later, when the ship finally docks, that cargo gets used for roads, dams, cars, buildings, airplanes, anything that generates economic activity. As global trade hums along, the index gains, because the number of ships in the world is pretty steady at about 22,000, so increasing demand increases shipping costs.