Despite broad swings, oil prices are expected to follow an upward trend until the middle of the current decade, with lower spare capacity resulting in greater sensitivity to geopolitical trends.

The recent disturbances in the Middle East have helped lift crude prices. At present, I do not expect a significant hit to oil supply, but such a scenario, if it were to materialize, would clearly be even more supportive for prices.

The main reason for being bullish on the long-term oil price is that field decline and constrained access to new exploration acreage mean new supply will struggle to keep pace with demand growth.

Spare production capacity continues to fall from the 2009 peak as demand growth heads inexorably upwards. 2010 was a near record year in this respect, with global growth at 3.3 percent.

The level of global spare capacity fell in 2010 to below 5 million barrels per day, and is expected to finish 2011 at lower than 4 million barrels per day. Lower spare capacity in the face of surging demand, coupled with a sharp reduction in surplus inventories, imply a period of enhanced volatility.

The supply/demand balance remains very constructive in 2011, with demand expected to increase by 2 percent, led by further strong growth in China and other emerging markets.

After the relative calm of 2010, with its long periods of listless range-bound trading, the oil market is now set on a potentially far wilder course, with a narrowing of spare upstream capacity in a more uncertain and volatile world becoming the main driver of price dynamics.

There are three central and largely interrelated factors for the oil market in 2011.

The first key determinant of price outcomes in 2011 will be the extent of the follow-through of the 2010 demand surge.

We currently estimate demand growth at 2 percent, led by a further surge from China and Latin America, with Organization for Economic Cooperation demand stabilizing after 2010's rebound.

With non-OPEC (Organization of the Petroleum Exporting Countries) supply expected to have a flatter profile after last year's US, Chinese and Russian supply outperformance, the call on OPEC crude is set to rise again with a further diminution of the overall level of spare capacity and consequent increase in volatility and in the sensitivity to external events.

The second key determinant will be the evolution of a wide series of geopolitical issues, some of which are likely to remain central for a matter of years.

These range from developments in Nigeria and Iraq, to Iran's external relationships in the light of its stance on nuclear development, through to the economic and demographic pressure on, and in the some cases the political transition in, a series of Middle East and North African countries.

A period of considerably greater geopolitical uncertainty is likely to be accompanied by both higher average price levels and greater volatility in prices.

The broad sweep of global geopolitical issues appear to be negative in terms of their immediate implications for external investment, while also introducing a wider range of medium-term possibilities given the potential unfreezing of some deeply entrenched elements of the economic and political status quo in some key regions.

The final central strand of events driving market outcome is producer-country responses to higher prices, and, in the case of more dramatic geopolitical events, consumer-country policies towards potential price-dampening measures.

OPEC is normally expected to act to reduce the possibility of any explosive upside in prices developing, keeping prices from moving too far and too long above the $100 to $110 per barrel range for the value of the OPEC basket.

However, the fog created by both geopolitical uncertainty and market dislocations is likely to draw out the process leading up to an overt reaction, and to open up the possibility of a somewhat more sustained upside. For the more extreme price spikes, I would expect relatively swift use of strategic reserves to smooth out the peaks of prices.

However, more expansive oil market intervention policies are expected, and in particular consumer government attempts to reduce volatility artificially - in a world that is inherently less certain and has less cover - is at best misguided and at worst will create a major distortion to investment flows.

The stage is then set for a year in which the oil market becomes fixated on factors at very different points at the scale.

The author is a commodity analyst at Barclays Capital. The opinions expressed here are entirely his own.

(HK Edition 02/25/2011 page2)