The fundamentals of the oil market are easing thanks to a combination of slower demand growth and record production from Opec, the Western countries’ energy watchdog said on Tuesday.

The International Energy Agency’s view came as oil prices dropped in early London trading to $113.50 a barrel, the lowest level since late April, and almost $35 a barrel below an intraday record high of $147.27 a barrel set in July.

The agency warned, however, that even if “any fall from recent peaks is welcome,” current prices close to “$115-$120 a barrel remains high by any measure, sustaining inflationary concerns, not least in developing importer countries.”

It also said that it was “too early to cite definitively a sea change in the market”, signalling that crude and product inventories in rich countries rose in the second quarter of the year at their lowest rate in more than 25 years.

In its monthly market report, the IEA pointed to a “potential easing in fundamentals for the second half of 2008 and into 2009, before a renewed tightening thereafter.”

Amid the economic slowdown in the US, it cut its global oil demand growth to 790,000 barrels a day, down from July’s estimate of 890,000 b/d.

“High prices are beginning to play a central role in determining demand, at least for the OECD countries,” the IEA said, noting that consumption is contracting in the US and Europe – with sharp falls in Italy and Spain – but is still growing in Japan.

The watchdog said that some of the demand in rich countries will be lost for ever, particularly in the US. “Even if retail prices ease, it seems unlikely that motorists who have purchased smaller cars will revert to gas-guzzling vehicles,” it said.

But demand growth in emerging countries remained strong, with Chinese consumption rising above 8m b/d for the first time in June, hitting 8.3m b/d.

The slowdown in global demand growth has come as production, particularly from Opec, jumped. The cartel pumped in July about 32.8m b/d, a record high, thanks to increases in supply from Saudi Arabia and Iran.

Opec’s output in July was about 1m b/d higher than in April and significantly higher than the 31.1m b/d in the same month of last year. The IEA estimated Saudi Arabia’s production in July at 9.55m b/d, below the kingdom’s official figures of 9.7m b/d, which represented the highest level in more than 25 years.

“Moreover, there are encouraging signs for crude capacity, with summer field start-ups in Nigeria and Angola, and a reportedly imminent capacity boost in Saudi Arabia, which could raise Opec spare capacity from July’s very low level of 1.5 mb/d,” the IEA said.

The cartel will review its production policy at a meeting in Vienna on September 9 and in Oran, Algeria, on December 17.

The IEA maintained its forecast for non-Opec production growth both this year and in 2009. But it warned that Russia’s production was falling more than expected, pointing out that “during July there were signs of a deepening rift between TNK-BP shareholders.”

The market is split about the direction in crude oil prices and about Opec’s response to falling prices, but the previous general bullish sentiment is cracking.

Ed Morse, chief energy economist at Lehman Brothers in New York, said: “Oil prices have peaked for the next few years.”

Crude oil rose for a second day after a U.S. Energy Department report yesterday showed a bigger- than-forecast decline in inventories of gasoline as refiners shut units and imports fell.
gasoline supplies dropped 6.39 million barrels to 202.8 million barrels last week, the biggest decline since October 2002, when tropical storms disrupted Gulf of Mexico output.

"The drop in gasoline inventories has boosted prices somewhat," said Eliane Tanner, an analyst at Credit Suisse Group in Zurich. "Prices are at more sustainable levels so we shouldn't see much more of a correction lower."

Crude oil for September delivery rose as much as $1.25, or 1.1 percent, to $117.25 a barrel, and was at $117.21 at 9:10 a.m. London time on the New York Mercantile Exchange.

Yesterday, futures increased $2.99, or 2.6 percent, to settle at $116 a barrel, the biggest one-day gain since July 30. Prices are up 61 percent from a year ago.

U.S. gasoline stockpiles were forecast to drop 2.15 million barrels, according to a Bloomberg News survey. Oil prices fell 5.8 percent in the previous three days to yesterday's session.

SPIEGEL INTERVIEW WITH IAE HEAD NOBUO TANAKA

After rising for months, oil prices are now on the decline. SPIEGEL spoke with the head of the International Energy Agency about the future of oil prices, the growing importance of nuclear power and the quantity of oil left in the world.

SPIEGEL: Mr. Tanaka, do you know what your organization predicted the price of oil would be in 2010 in a study conducted three years ago?

Tanaka: No, I wasn't in office at the time. Tell me.

SPIEGEL: It was $35 a barrel.

Tanaka: Then we must have been very wrong.

SPIEGEL: Why are all observers of the oil market, not just the International Energy Agency (IEA), so far off with their estimate of price developments?

Tanaka: The demand for crude oil has grown much more quickly than expected, especially in emerging markets like China and India. At the same time, on the demand side the producing countries have not expanded their production capacities sufficiently. The market has become extraordinarily tight as a result.

SPIEGEL: You're making it a little too easy for yourself. The incorrect estimates are also based on the fact that there is little reliable data in this market, especially on oil production.

Tanaka: The market clearly lacks the necessary transparency; otherwise it would work better. That's why we are currently working intensively on a major study on the productiveness of more than 700 of the world's most important oil fields, which will be published in November. We want to find out how large the potential is, but also the extent to which production is declining in individual fields. I too am very curious to see the results.

SPIEGEL: Do you really believe that you will get reliable information from the oil producers?

Tanaka: That's a fair question. It's easiest for us to get data from producing countries that are not part of OPEC, like the United States, for example, or Norway. Many other countries make a state secret out of their oil production. They don't allow us to review their books, and they certainly don't give us access to their reserves. In those cases we have to make do with information we receive from oil industry advisors and from service companies that assist in the production and processing of crude oil.

SPIEGEL: But even these experts often get their information from secondary sources. You can at best speculate over how much, for example, the big oilfields in Saudi Arabia are still producing -- whether pressure is declining and more water has to be injected to drive the oil to the surface, which increases production costs and suggests dwindling reserves.

Tanaka: Of course we would like to take a look on-site, but what should we do? This is a sovereign decision made by the producing countries. We can only make intelligent estimates.

SPIEGEL: This means that the answer to the key question must remain an approximation: How much oil still exists in the world?

Tanaka: Despite all inadequacies, I think that the IEA can still provide relatively precise information in this regard. We believe that, in principle, there are sufficient resources left to allow production until 2030. The problem lies above the ground: Countries are not investing enough in the exploration of new reserves and the expansion of old facilities. This gives us reason for concern.

SPIEGEL: What are the consequences?

Tanaka: We have noticed that production volume is declining sharply. According to our projections, the volume in existing oilfields worldwide decreases by an average of 5 percent a year. This means that each year we need an additional 3.5 million barrels of oil a day just to offset these losses. At the same time, however, demand is growing by about a million barrels a day. This imbalance makes it clear how incredibly tight the market is. A gap is developing here.

SPIEGEL: Is there a risk of supply bottlenecks developing?

Tanaka: As we have seen, in the current situation even a minor interruption in production can cause instability and trigger a jump in prices. All it takes is the news of a strike by oil workers in Nigeria. That's why it's so important that we work closely with the producers. I often communicate with OPEC Secretary General Abdalla Salem el-Badri (more...), and OPEC President Chakib Khalil, as well as with Saudi Oil Minister Ali al-Naimi. In an emergency, we have to be able to work together smoothly and react flexibly within 24 hours.

SPIEGEL: The oil price has declined somewhat in the past few weeks. Could the most recent crisis truly be over?

Tanaka: We remain cautious in our assessment. Naturally, we have seen that demand for fuel in the United States is declining and that Saudi Arabia wants to expand daily production by 2.5 million barrels of oil. Such signals are reflected in the price. We expect that the market will settle down in the coming one or two years. After that, however, the situation could become tense once again. A price level of less than $20, as we had 10 years ago, is something we'll probably never experience again.

SPIEGEL: You would rule out drastic price reductions?

Tanaka: We live in an era of high energy prices, and there is no turning back. If we want to avoid crises in the future, the producing countries will have to do their homework, and they'll have to expand their capacity considerably.

SPIEGEL: The OPEC members are essentially the only ones that can deliver these additional barrels. After all, they have by far the largest reserves.

Tanaka: Yes, and that's where we are pinning all of our hopes. Only the OPEC countries can still significantly expand their capacities.

SPIEGEL: Persian Gulf countries also have ambitious plans to develop refineries. The region would then not just be the leader in oil production, but also a leading manufacturer of oil products, like gasoline and heating oil. This would only increase dependency on OPEC and government-owned oil companies.

Tanaka: That's right, and yet these investments are absolutely reasonable. Unfortunately, the Western consumer nations have failed to modernize their refinery sectors, a fact which is extremely problematic because it creates the need to process more and more sulfurous, heavy oil, which is costly. If the producers want to do this themselves in the future, why not? We already depend on them, so it doesn't matter whether they supply only the crude oil or the products, as well.

SPIEGEL: Most, though, are countries that are not exactly democratic and tend to be politically unstable.

Tanaka: That's exactly why I think it's a good idea that they not just produce oil, but also process it. In this way, these countries will modernize their economies, with the development of a petrochemical industry being the obvious consequence. Some are even getting involved in alternative energy, like Saudi Arabia, which is investing heavily in solar technology.

 Part 2: 'We Should Commit Ourselves More Heavily to Nuclear Power'

SPIEGEL: You paint a very friendly picture of these countries. But it's precisely the hotheaded rulers, like Iranian President Mahmoud Ahmadinejad and Venezuelan President Hugo Chavez, who are driving up the oil price with their threats.

Tanaka: The price of oil is always a political price to some degree. When these politicians say something, it moves the markets -- but only for a day. When our agency makes a statement, the effect is more lasting.

SPIEGEL: Such regimes can only stay in power thanks to the high oil price. They're doing a booming business based on the scarcity of fossil fuels, while citizens and business owners worldwide are groaning under the cost burden. To what extent, in your view, does the global economy suffer from high oil prices?

Tanaka: There is a reliable indicator for this, which economists call the "oil burden." It describes the relationship between a country's expenditures for crude oil and its gross domestic product. This value increased dramatically this year. It is higher than it was in the days of the first oil price shock, in 1973, and it's approaching the level of the second shock, in 1979. Emerging nations that do not produce any significant amounts themselves are especially hard-hit, like Thailand or Vietnam. Some of these countries have subsidized fuel in the past, but now they're cutting back on this financial assistance, because it's getting too expensive for them and, by doing so, they hope to force their citizens to conserve energy.

SPIEGEL: Does this ease the situation in the oil markets?

Tanaka: It could in fact have a restraining effect on demand. This year China is spending roughly $40 billion on such subsidies, which isn't exactly a small amount. We are not in favor of this subsidy policy. We believe that the right thing to do is to pass price changes on to the consumer in as unadulterated a fashion as possible.

SPIEGEL: How does the current price shock differ from its precursors in the 1970s?

Tanaka: In 1973, OPEC curtailed the oil supply for political reasons, and prices shot up as a result. Today, however, the strong global demand has triggered the crisis. It is a structural phenomenon that will only increase and will impose an ever-growing burden on the economy. We are not properly prepared for this. It is critical that we search for solutions.

SPIEGEL: What could they look like?

Tanaka: Basically, all we have to do is consistently pursue the CO2 reduction goals that the industrialized nations have agreed to. This doesn't just help the climate, but it is also good for energy security. In the IEA, we have developed a scenario on how CO2 emissions could be cut in half by the year 2050. This would reduce demand for oil by 27 percent. The most important instrument in this scenario is energy conservation. We must drastically improve efficiency. Add to this the increased use of alternative sources of energy, like solar, wind and hydroelectric. And we should also commit ourselves more heavily to nuclear power.

SPIEGEL: What, specifically, are you proposing?

Tanaka: Based on our calculations, to achieve the goal of cutting CO2 emissions in half by 2050, each year about 17,500 wind turbines would have to be erected worldwide, 55 coal and gas power plants would have to be outfitted with CO2 filtration and sequestration equipment and about 32 new nuclear power plants would have to be built. Currently one or two nuclear plants are being built each year. But there was a time when 30 reactors were placed into service every year. Why shouldn't we be able to do this today?

SPIEGEL: Perhaps because the operators would run out of fuel?

Tanaka: Our colleagues at the International Atomic Energy Agency in Vienna have assured us that this is not a problem, that we have enough uranium. In fact, where we have a shortage is with experts: engineers with knowledge in the field are in short supply.

SPIEGEL: In Germany, many view nuclear energy with skepticism, partly for reasons of safety.

Tanaka: I know that there is a debate on this issue in Germany. Our role is to provide data and analyses on opportunities and risks. Using this information, every country can make its own decisions.

SPIEGEL: But your position in the discussion is obvious.

Tanaka: Without nuclear energy, it will be impossible to cut CO2 emissions in half by 2050. The Germans should also understand this.

SPIEGEL: Mr. Tanaka, thank you for taking the time to speak with us.

Interview conducted by Dieter Bednarz and Alexander Jung

Translated from the German by Christopher Sultan

Oil company BP has shut down indefinitely an oil pipeline running through Georgia as a precautionary measure following Russian bombing raids in the region.

However, the UK company said that it was not aware of any pipelines being hit, despite reports in Georgia that Russian jets had targeted the oil and gas supply routes.

BP said yesterday that the 90,000-barrel-a-day pipeline to Supsa on Georgia's Black Sea coast from Baku in Azerbaijan will remain closed until further notice. The pipeline runs through the centre of Georgia.

A second pipeline in Georgia operated by BP, the larger Baku-Tbilisi-Ceyhan (BTC) pipeline, is already closed following a fire last week on part of the link running through Turkey. Kurdish rebels claimed they had sabotaged the pipeline.

Georgian ports on the Black Sea are a main shipping point of Caspian Sea crude from Azerbaijan, Turkmenistan and Kazakhstan. More than 500,000 barrels leave these ports daily, and there are plans to raise capacity by an additional 200,000 barrels a day.

Meanwhile, BP's troubled Russian joint venture, TNK-BP, said yesterday that it had bought 25pc of a Siberian power plant from electricity group OGK-1 for $345.6m (£170m).

Dubai World, the sovereign wealth fund of the Dubai government, is conducting due diligence for the potential acquisition of OGK-1 through a Russian partner, energy trader Roskommunenergo.

TNK-BP's shareholders are locked in a power struggle, which led to its chief executive, Robert Dudley, leaving Russia last month.

CALGARY -- Hard evidence is mounting that record oil prices are eating into global energy demand as consumers balk at absorbing the higher costs, two leading energy agencies say.

The U.S. Department of Energy said yesterday that oil demand in that country recorded the biggest drop in 26 years in the first half of 2008, falling by an average of 800,000 barrels a day from the same period a year ago. For the world's biggest energy user, it was the steepest decline since consumption tumbled during a recession in the early 1980s.

The International Energy Agency (IEA), meanwhile, confirmed that the U.S. consumer is starting to shun travel in an effort to cut costs. The IEA now expects a combination of high crude prices and a slowing economy will lead to a 3.1-per-cent decline in U.S. oil demand this year followed by a 2-per-cent drop in 2009.

In Canada, there was a statistical counterpoint to reports of ebbing U.S. oil demand when Statistics Canada reported yesterday that energy exports helped boost the country's trade surplus with the rest of the world by 11.5 per cent in June.

As oil prices soared over the past year to a record $147.27 (U.S.) a barrel in July, economists have searched for signs that high costs are starting to curb demand. Now, anecdotal evidence that consumers are reining in spending is being supported by economic data that show energy usage is indeed waning.

"When all is said and done we wouldn't be surprised to see very little global oil demand growth over this year and next," said Vince Lauerman of Geopolitics Central, an energy consultancy in Calgary.

With the U.S. consuming more than a fifth of the world's oil output, the driving habits of American motorists are being studied for clues to pending global oil demand. On the back of a continuing drop in U.S. vehicle sales, which fell 19 per cent to a 16-year-low in July, the IEA estimates that U.S. gasoline demand may well have peaked in 2007.

"Even if retail prices ease, it seems unlikely that motorists who have purchased smaller cars will revert to gas-guzzling vehicles," IEA economists wrote in a monthly report on oil markets. "Nevertheless, the transition to a more fuel-efficient U.S. fleet will take some time."

The Canadian trade surplus rang in at $5.8-billion (Canadian) in June, up from $5.2-billion a month earlier.

Buoyed by boom-time commodity prices, Canadian companies exported merchandise worth $43.2-billion in June, up 3.1 per cent from a month earlier, Statscan said.

Since then, however, commodity prices have pulled back as expectations for a softening global economy have taken hold.

Oil prices, for example, closed at $113 (U.S.) a barrel yesterday, off 23 per cent from the peak.

Indeed, the June trade report was likely the high-water mark for Canadian exporters, said Michael Gregory, a senior economist at BMO Nesbitt Burns.

"This probably was the best of all possible worlds," he said. "In a couple of years time when things settle down we'll point back and say that was the peak and we'll all be trying to analyze when we get back to that peak again - which I think we will."

In June, energy exports to the U.S. rose to $12.8-billion from $11.5-billion in May. The increase, however, was based more on high crude prices than increased sales.

Over all, prices for Canadian merchandise rose 4.5 per cent, while total sales volumes declined 1.4 per cent.

WASHINGTON, Aug. 11 (UPI) -- Oil prices may be dropping like a stone, but it won't last, according to one of the West's top experts on the industry, who is forecasting "an oil supply crunch" in or around the year 2013 when the price could soar as high as $200 a barrel.

The problem will come "not because of below-ground resource constraints but because of inadequate investment by international oil companies and national oil companies," argues Professor Paul Stevens, senior research fellow for energy at Chatham House, Britain's top think tank on international affairs.

He blames both the IOCs, such as ExxonMobil and Shell, and the far more powerful (because they control the bulk of known oil reserves) state-owned NOCs, such as Saudi Arabia's Aramco, Mexico's Pemex, Venezuela's PDVSA and so on.

"The willingness of the IOCs to invest is constrained by the adoption of 'value-based management' as a financial strategy. Thus they are returning investment funds to shareholders rather than investing in the industry. For the NOCs, willingness is driven by depletion policy. Increasingly, this is motivated by a view that oil in the ground is worth more than money in the bank," Stevens maintains.

"Many producer countries are also experiencing a resurgence of resource nationalism, which excludes IOCs from helping to develop capacity," Stevens writes. "In some cases, the structure of the oil sector militates against its ability to develop the country's reserves. Finally, in many cases, rising domestic oil consumption is eating into the ability to export."

Domestic oil consumption by the main oil producers has been rising fast, at close to 4 percent a year in the Middle East, while developed countries were increasing their consumption by one-tenth as much. Saudi Arabia's consumption grew at 4.6 percent a year in that period.

Stevens suggests the IOCs became, in a way, victims of market forces. At times of low prices, they saw little benefit in investing in exploration, and in boom times, the logic of the market pressured them to give money back to their shareholders.

He points out that in 2005 the six largest IOCs invested $54 billion in exploring, drilling, improving their skills and technology and so on, but returned far more -- $71 billion -- to their shareholders. This was done in line with the prevailing fashion in management theory that the performance of a company (and its share price) is measured by the returns to shareholders.

The IOCs, like ExxonMobil, Shell, BP and Total, were behaving rationally. They have been increasingly squeezed out of access to most of the world's low-cost oil-producing areas by the NOCs, and the low oil price of the 1990s was a disincentive to invest heavily in exploring for new supplies. At the same time, the industry slashed costs; more than a million employees were let go over the past two decades. Universities then cut back on the production of oil engineering graduates, and the shortages of skilled labor are now biting hard.

Stevens argues that the constraints on skilled manpower and engineering capacity are so strong, he sees little prospect of the Organization of Petroleum Exporting Countries reaching its announced goal of investing $160 billion between now and 2012.

"Even Saudi Arabia, whose record on capacity expansion plans has been superb, is facing questions over its ability to deliver," he notes. "The Khursaniyah expansion, which was due on-stream at the end of 2007, is now expected in mid-2009. Furthermore, there have been 'widespread reports of delays on start-up targets for the majority of its upstream program.'"

Stevens, author of the Chatham House report "The Coming Oil Supply Crunch," has just retired after 15 years as professor of petroleum policy and economics at the Center for Energy, Petroleum and Mineral Law and Policy, based at the University of Dundee in Scotland. (The professorship was created by BP.)

Other factors were important in forcing up prices, including political uncertainties and diminished production in Nigeria, Iraq and Venezuela, and, above all, the surging demand from emergent economies like China and India. But, Stevens notes, the role of China can be overstated. Between 1996 and 2004, when China's consumption of oil grew 3.4 million barrels a day and India's consumption grew by 1 million barrels a day, consumption in the United States grew by 3 million barrels a day.

Whereas in the 1970s the limits placed on OPEC production were more than compensated by the development of new energy resources in non-OPEC areas like the North Sea, Russia and Alaska, non-OPEC production these days is either stagnant or in decline, and not delivering the expected level of supplies.

"Part of the reason for this poor performance is that the natural decline rates in the OECD (Organization for Economic Cooperation and Development) fields have taken analysts by surprise," Stevens notes. "Furthermore, in many of the deepwater fields, where much of the new non-OPEC capacity is coming on-stream, maintaining production is difficult because operations such as in-fill drilling are much more complicated and far more expensive than in traditional oil fields."

Stevens, whose advice is taken very seriously by the British government and by several major oil corporations for whom he is a consultant, recommends that to avoid the threatened oil supply crunch, "energy policy needs to reduce the demand growth of liquid fuels, to increase the supply of conventional liquids or to increase the supply of unconventional liquids."

He proposes the Western governments and enterprises should be prepared to improve the investment climate for sovereign wealth funds and also seek to bring OPEC into the International Energy Agency's emergency sharing scheme.

But he concludes that "only extreme policy measures could achieve a speedy response -- and these are usually politically unpopular. Any major price spike would carry a macro-economic impact which would of itself provoke a policy reaction." At the same time, an oil price spike "might break down opposition to a much greater interventionist approach by governments in their energy sectors. Thus it might do for energy policy what 9/11 did for U.S. military and security policy."

That sounds like a very double-edged sword.

With the oil price apparently in full retreat, it is tempting to breathe a sigh of relief. After soaring to an all-time high of more than $147 a barrel in mid-July, the cost of crude has dropped by nearly $30 in the last four weeks. Although the price is still more than 10 times higher than a decade ago, some analysts are now talking of a "tipping point", predicting a continued slide to $90 a barrel.

So why has a commodity that until recently seemed like a one-way bet suddenly gone into reverse? And having helped push the economy to the brink of recession, is the oil shock over, or merely in remission?

One thing is almost universally agreed upon: the recent slump is not due to the bursting of a speculative bubble. Opec, the 13-member cartel that produces 40 per cent of the world's oil, has long claimed that the steep rise in price was not justified by "fundamentals", blaming it squarely on speculators. But few others believed that. Yes, hedge funds have poured billions of dollars into oil futures contracts, but a recent report by the International Energy Agency concluded that this was largely a result of the price rise, rather than a cause.

Instead, the driving factors are to be found not in the financial markets, but in the real world. It is endlessly reported that the demand for oil in Asian countries has soared since the turn of the century, and that China's thirst has been especially prodigious. What is less realised is that global oil production has been essentially stagnant, at around 86?million barrels a day, since early 2005. Despite soaring demand, production outside of Opec has been persistently disappointing, as international oil companies struggle to maintain production from ageing fields. Opec itself has been unwilling - or unable - to raise its output.

So, for the last three years, global oil supply has been a zero-sum game. With supply fixed, and the East consuming ever more, the price had to rise high enough to force the West to consume less. And that is exactly what happened: overall oil consumption in developed countries has fallen for two years in a row.

The price rise was further fuelled by the fact that consumers in many Asian countries are protected by hefty subsidies. China is estimated to have spent $40?billion on fuel subsidies in the last year, and Indonesia $20?billion, so their people could afford to consume more fuel even as the oil price rocketed. The same is true in Opec countries such as Saudi Arabia, Kuwait and Venezuela, where subsidies keep fuel costs at mere pennies a litre.

But two things have now changed. Saudi Arabia, the only country in Opec with spare production capacity, has finally yielded to international pleas and raised its output, announcing increases of 300,000 barrels per day in June, and a further 200,000 in July. At the same time, the industrialised world is no longer simply economising on oil, but plunging into outright recession as a result of the credit crunch and the oil price spike - signalling further future cuts in demand.

In the US, the world's biggest oil consumer, motorists are driving fewer miles and deserting gas-guzzling SUVs in droves, leading to a collapse in sales at car-makers such as Ford - which recently announced stunning losses of $9?billion for the three months to the end of June. In May this year, US demand for fuel dropped to 19.7?million barrels a day - almost a million barrels less than last year.

In Britain, where the price of unleaded has jumped from around 85p a litre 18 months ago to 112p now, drivers are also cutting back. Yesterday, it was reported that dealers were refusing to accept petrol-thirsty 4x4s in the second-hand market: they cost so much to refuel that they are worth more as scrap.

A recent survey by National Express showed that more than 60 per cent of motorists had cut their annual mileage and were considering greater use of public transport. In Spain, the government has announced a plan to cut oil imports by 10 per cent a year and impose a 50mph speed limit on dual carriageways.

In Asia, too, there are signs of a slowdown. A survey released last week showed that in July, China's manufacturing sector contracted for the first time since 2005.

"China's economic growth has shown a drastic deterioration lately, which is much faster and worse than many people's expectations," said Lan Xue, an analyst at Citibank Asia. South Korean oil consumption has been falling for eight months, while Japanese imports have recently fallen for the first time in nine months.

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TEHRAN (Reuters) - Rising OPEC output has cut the group's spare capacity and left the oil market vulnerable to any surprise supply disruptions, Iran's OPEC governor said on Sunday.

The Organization of the Petroleum Exporting Countries (OPEC) pumped more oil for the third consecutive month in July, helping to bring prices down $30 from a peak above $147 a barrel to a three-month low on Friday.

Rising OPEC output has coincided with a fall in demand from top energy consumer the United States, hit by an ailing economy and soaring pump prices.

"The drop in oil price has come at the expense of supply security," Iran's OPEC Governor Muhammad Ali Khatibi told Reuters by telephone.

Consuming countries benefiting from the price fall should be aware that it could easily be reversed by any surprise supply outages, he said.

"The drop in prices works in favor of consumers," Khatibi said. "But on the other hand, any drop in market security in the form of spare capacity is highly detrimental to consumers. We need excess capacity to guarantee supply security."

OPEC, source of over a third of the world's oil, had around 1.5 million barrels per day (bpd) of spare capacity to meet any disruptions, he said.

The dispute between Iran and the West over Tehran's nuclear programme has been the main focus of supply concern in oil markets as investors fear any conflict could threaten Iran's around 2.5 million bpd of exports. Iran is the world's fourth-largest exporter.

OPEC's Secretary General Abdullah al-Badri said in July it would be impossible to replace Iran's oil output in the case of disruption due to an attack.

Top oil exporter Saudi Arabia is the holder of most of the world's spare capacity. The kingdom pumped at the fastest rate for 27 years in July, boosting production without making any formal agreement with other OPEC members to boost the group's supply target.

Saudi output hit 9.7 million barrels per day (bpd), while its capacity stood at 11.3 million bpd.

Saudi Arabia has a long-held policy of keeping between 1.5 million bpd and 2 million bpd as a supply cushion.

Record fuel prices sparked protests worldwide this year and led to pressure from consuming countries on producers to boost output.

Khatibi said last week that the oil market was oversupplied by around 1.3 million bpd, but that a seasonal increase in global demand during the northern hemisphere winter should absorb the extra barrels.

The burgeoning wave energy sector, which has endured ups and downs in recent years through initial testing of devices and uncertain government support, has recently set sail with new projects that have brought the industry to the brink of commercial development.   Portugal has established its role as a pioneer in wave energy development.  Through the Aguçadoura project off the coast of northern Portugal , for instance, Enersis and its technology partner Scottish company Pelamis Wave Power (PWP) completed initial deployment of a 750-kW PWP wave-power unit, in August 2008, that generated electricity for the Portuguese grid, a source familiar with the initiative told Platts.  The unit initially encountered difficulties with buoyancy, but these problems were solved, the source noted.  Though the system did not reach peak generation, it produced "hundreds of kilowatts," he said, adding that it has since been disconnected to prove it can be returned to harbor for inspection of the component parts. "Everything is in very good order," the source added.

The Aguçadoura project partners are looking to have three 750-kW machines ready by September 2008.  The goal is to have 30 machines deployed within a few years exceeding 20 MW - a venture that could expand "up to 500 MW," the source said.  The Portuguese government is supporting the project by a feed-in tariff provided specifically for marine energy of about €0.23/kWh (US36¢/kWh), according to PWP's Web site.

Portugal has established its role as a pioneer in wave energy development, with national institute Instituto Superior Técnico studying the technology since 1977.  It boasts a 250-350-kilometer (150-220 mile) stretch of coast deemed suitable for wave-energy exploitation.  Other companies are looking to join the rush in Portugal for wave power, as developers Tecdragon, EDP and Eneólica take major steps in experimental development.  Additionally, Portuguese steel construction giant Martifer has created a joint marine-energy venture with Scottish Briggs, while Generg conducts research and planning for a wave energy plant.

EDP, Portugal 's largest power utility, is in the final stages of talks to install wave energy demonstration projects in Portugal .  This deployment would follow the company's participation in a review of more than 50 offshore wave energy technologies.  Final site selection has begun on one EDP project known as the Breakwave, a system financed with €2 million ($3.1 million) of European Union funds that uses oscillating water column technology.

More advanced is Tecdragon, which aims to install in Portugal 's São Pedro de Moel pilot zone the first world's 7-MW wave-energy plant.  "Until now the start of installation was not possible due to adverse meteorological conditions," explained Tecdragon Manager Borges da Cunha.  The system would be based on Wave Dragon technology, which the company describes as a "floating, slack-moored energy converter" that meshes current offshore and hydropower turbine technology. Wave Dragon, the company said, is the only wave energy converter being developed that can be freely scaled up.

António Sarmento, director of Portugal 's Wave Energy Center , said that over the next 30 years Portugal could invest €5 billion ($7.8 billion) to install up to 5 GW of wave energy capacity along its western coast and along the coasts of its Madeira and Azores islands.  Another EU member is jockeying with Portugal to become the world leader in wave energy deployment - and to reap the anticipated benefits in new jobs and export earnings that the emerging marine energy industry is expected to generate.

The UK wave power sector moved ahead on July 30 when Jim Mather, minister of enterprise and energy for the Scottish regional government, commissioned a 100-kw Wavegen turbine.   Scotland offers developers some of the world's best wave-power levels.  The 100-kW turbine is "a major step forward," the Scottish government said, for the Siadar Wave Energy Project, which is being developed by Npower Renewables, RWE Innogy's UK operating company, on the Scottish isle of Lewis.  Npower Renewables submitted planning applications in April for SWEP, which would generate up to 4 MW using 40 Wavegen 100-kW turbines.  If the Scottish government approves the plans, construction could start as early as 2009 and would take an estimated 18 months to complete.

When the main pipeline that carries oil through Georgia was completed in 2005, it was hailed as a major success in the United States policy to diversify its energy supply. Not only did the pipeline transport oil produced in Central Asia, helping move the West away from its dependence on the Middle East, but it also accomplished another American goal: it bypassed Russia.

American policy makers hoped that diverting oil around Russia would keep the country from reasserting control over Central Asia and its enormous oil and gas wealth and would provide a safer alternative to Moscow’s control over export routes that it had inherited from Soviet days. The tug-of-war with Moscow was the latest version of the Great Game, the 19th-century contest for dominance in the region.

A bumper sticker that American diplomats distributed around Central Asia in the 1990s as the United States was working hard to make friends there summed up Washington’s strategic thinking: “Happiness is multiple pipelines.”

Now energy experts say that the hostilities between Russia and Georgia could threaten American plans to gain access to more of Central Asia’s energy resources at a time when booming demand in Asia and tight supplies helped push the price of oil to record highs.

“It is hard to see through the fog of this war another pipeline through Georgia,” said Cliff Kupchan, a political risk analyst at Eurasia Group and a State Department official during the Clinton administration. “Moving forward, multinationals and Central Asian and Caspian governments may think twice about building new lines through this corridor. It may even call into question the reliability of moving existing volumes through that corridor.”

At the very least, the analysts warn, a newly emboldened Russia may figure even more prominently in shaping the region’s energy future.

The latest struggle over Caspian oil started in earnest in the 1990s under Bill Clinton, after the breakup of the Soviet Union. The building of the pipeline that passes through Georgia, the Baku-Tbilisi-Ceyhan line, or BTC, remains one of the signature successes of the American strategy to put a wedge between Russia and the Central Asian countries that had been Soviet republics.

Attempts to get oil out of Kazakhstan through a non-Russia route failed. Most of the oil production from the giant field of Tengiz, for example, in which Chevron is the largest investor, now travels through a pipeline known as the Caspian Pipeline Consortium, which runs along the northern Caspian coastline to the Russian Black Sea port of Novorossiysk. And proposals for new oil and natural gas pipelines in the region have stalled, in part, because of Moscow’s opposition.

Some analysts believe the armed conflict between Russia and Georgia not only is rooted in historical enmity, but it is an outgrowth of Russia’s fears that Georgia, with its pro-Western bent, could prove to be a lasting competitor for energy exports.

“Russians treasured the fact they had a monopoly on oil and gas pipelines from Central Asia, as it gave them considerable clout,” said Marshall I. Goldman, a senior scholar for Russian studies at Harvard and the recent author of “Petrostate: Putin, Power, and the New Russia.” “By agreeing to having an oil pipeline, Georgia made itself more vulnerable.”

A big concern for the future is what will happen to oil from Kashagan, the giant oil field in the Caspian Sea that holds over 10 billion barrels of reserves. Located off Kazakhstan, Kashagan is the most ambitious attempt to date by Western companies to develop new supplies in the Caspian. It will be at least five years before oil starts flowing from there, but the operating consortium, which includes Exxon Mobil and ConocoPhillips, plans to transport some of Kashagan’s oil through the BTC pipeline.

That would involve building a new pipeline under the Caspian to connect to BTC. Russia has opposed similar plans in the past.

The Baku-Tbilisi-Ceyhan pipeline, 1,100 miles long, transports 850,000 barrels a day of oil, or one percent of global supplies, from Azerbaijan through Georgia and Turkey, ending at the port of Ceyhan on the Mediterranean. Much of the oil is bound for Europe and the United States.

The oil comes from several fields in Azerbaijan, offshore in the Caspian. The line, which cost $4 billion to build, also carries some oil from Tengiz that is barged across the Caspian.

Before the BTC pipeline was built, the West struggled to find routes that would avoid what Western leaders considered to be potential trouble spots, but it was difficult. The United States did not want the line to pass through Iran, for instance. In the end, the United States government, BP, which operates the pipeline, and other private investors decided the line should proceed on its current route. That gave a boost to newly independent counties and to Turkey, an ally, but it also sent the line through three nations struggling with separatists.

Even before the outbreak of hostilities between Russia and Georgia, analysts were reminded of how precarious even the favored route could be.

Last Wednesday, the pipeline was shut down after it was hit by an explosion in Eastern Turkey. Kurdish separatists claimed responsibility, although it remains unclear what caused the blast.

There have also been unconfirmed reports in recent days that Russian planes had targeted the pipeline, although BP has said the line was not hit.

BP said on Wednesday that it would take a week to determine how long the pipeline will remain shut. Other investors in the pipeline are Socar, the state-owned oil company of Azerbaijan; Chevron; ConocoPhillips; StatoilHydro, from Norway; ENI, from Italy; and Total, from France.

Russia, which is flush with petrodollars because of the rise in the price of oil, has not been afraid to flex its muscle in recent years to bring its neighbors in line. Two years ago, Gazprom, the national oil company then run by Dmitri A. Medvedev, now the Russian president, cut off natural gas supplies to Ukraine in the winter because of a price dispute.

That had a knock-on effect in Europe, where many policy makers began questioning their reliance on Russian natural gas, although there was no consensus on what to do. One proposal, favored by the United States, has been to build a natural gas pipeline parallel to the BTC line.

“For the Europeans, the Ukraine gas crisis was like a snooze alarm,” said Frank A. Verrastro, the director of the energy and national security program at the Center for International and Strategic Studies in Washington.

But Mr. Verrastro, a former senior executive with Pennzoil, said it would be very hard now to build a new Western pipeline.

“We got BTC because there was a confluence of commercial and diplomatic interests,” he said. “But the United States didn’t learn the right lessons. They thought that all you had to do was lean on these countries and a new pipeline would happen. But that was an abject failure.”

He added: “There is a shift happening in the marketplace. We need a Plan B. But we don’t have a Plan B.”

It was controversial from the start. Now President Saakashvili claims that Georgia's BTC oil pipeline was a key reason for the Russian offensive.

When it was conceived in the 1990s, the pipeline was backed by the US and Britain as a way to reduce Western dependence on Russian and Middle-Eastern oil. UK taxpayers even underwrote some of the $3billion construction costs. But Russia always opposed it, wanting to maintain its grip on the vast resources of the former Soviet Caspian region. Its strategic value is clear. At current prices it carries more than $1billion worth of crude oil every ten days.

Strangely, when the current war broke out, the pipeline, which is 30 per cent owned by BP, was closed. Just 48 hours before Georgian troops made their ill-fated incursion into South Ossetia, a mysterious fire broke out several hundred kilometres away in the Turkish section. Kurdish rebels later claimed responsibility, though there is still some uncertainty about the cause.

So far, oil markets have not reacted strongly to the war despite reports that the Russians have tried to bomb the pipeline. The market has preferred to focus on signs that global oil consumption is slowing as the world economy has weakened. But a sustained war in the Caucasus or efforts by Russia to seize control of the pipeline would create the threat of higher prices - and hence more expensive petrol on UK forecourts.

Many people have another stake in the future of the pipeline through their ownership of shares in BP, Britain's largest company, although as pension-holders they may well not know that the funds they depend on hold such shares.

With the depletion of reserves from the North Sea, oil from the Caspian region is of growing importance to Europe. As North Sea oil declines, high-quality crude from Azerbaijan is helping to take up the slack - and the BTC is likely to become even more important as the taps are opened on the vast new oilfields of Central Asia.

When it was discovered in 2000, Kazakhstan's Kashagan oilfield was the largest found since the 1960s. It has not yet entered commercial production - but when it does, the BTC will be its route to market. Understandably, Russia wants control over these reserves, which are of growing strategic importance to global energy supplies.

While oil prices tend to be influenced by shorter-term factors, the prospect of direct Russian control of the BTC pipeline would be unwelcome in the West, bolstering the Kremlin's dominance over our energy future. This is one key reason why the current conflict is raising hackles in the West.

A US Coast Guard cutter will depart for the Arctic this week as part of a race against Russia to claim the vast spoils of oil and natural gas below the sea floor that both nations are scrambling to exploit.

The cutter Healy will leave Barrow, Alaska, tomorrow on a three-week journey to map the Arctic Ocean floor in a relatively unexplored area at the northern edge of the Beaufort Sea, in an attempt to bolster US claims to the area by proving that it is part of its extended outer continental shelf.

The rush to stake out territory across the Arctic has intensified since last August, when a Russian submarine planted the nation's flag on the sea floor beneath the North Pole, which was viewed as a provocative land grab.

That triggered an immediate response from the Canadian Government, which within a week announced that it was going to build two new military bases in the Arctic wilderness, a warning shot in the new Cold War over the far North's energy resources. The Healy will be joined by a Canadian icebreaker on September 6.

On board the Healy will be scientists from the US National Oceanic and Atmospheric Administration. They will use an echo sounder to make a three-dimensional map of the sea floor in an area known as the Chukchi borderland.

The US Geological Survey believes that the Arctic region contains 90 billion barrels of oil waiting to be explored, about 15 per cent of the world's undiscovered reserves, and a third of the world's undiscovered natural gas.

Under international law each of five Arctic countries — Canada, Russia, the United States, Norway and Denmark — controls an economic zone within 200 miles of its continental shelf. The limits of that shelf are in dispute, and as Russia seeks to expand its gas and oil reserves, the region is at the centre of a battle for energy rights and ownership.

Last summer's Russian expedition, when two mini-submarines reached the seabed 13,980ft (4,260m) beneath the North Pole, was part of a push by Moscow to find evidence for its claim that the Arctic seabed and Siberia are linked by a single continental shelf, thus making the polar region a geological extension of Russia.

The vessels recovered samples from the seabed in an attempt to demonstrate that the Lomonosov Ridge, an underwater shelf that runs through the Arctic, is an extension of Russian territory.

The United Nations rejected that claim in 2002, citing lack of proof but Moscow is expected to make its case again next year.

Denmark and Canada also argue that the Lomonosov Ridge is connected to their territories. Norway too is conducting a survey to strengthen its case. All five Arctic nations are competing to secure subsurface rights to the seabed.

The Healy mission comes amid growing concerns in the US over Russia's strategic advantages in the Arctic. Russia has seven icebreakers to America's three and the Russian vessels are bigger and more powerful.

In recent testimony to Congress Admiral Thad Allen, the head of the US Coast Guard, said: “We are losing ground in the global competition. I'm concerned we are watching our nation's icebreaking capabilities decline.”

Sterling plunged against the euro and the dollar on Wednesday as the Bank of England gave its bleakest economic assessment for more than a decade and financial markets priced in a series of interest rate cuts.

Mervyn King, the Bank of England governor, said the British economy required a “painful” adjustment to higher energy and food prices, predicting the economy would grind to a halt for a year before recovering, probably to a slower growth path than before. There was “bound to be a quarter or two” of economic contraction, he said. Official figures on Wednesday showed unemployment rose by 60,000 in the second quarter, a jump from the 13,000 recorded in the first quarter.

Mr King predicted inflation would peak at 5 per cent at least, restricting the room for easier monetary policy, but markets immediately interpreted the strong likelihood of recession and a prediction of a rapid decline in inflation next year as a strong signal of lower interest rates to come.

Sterling fell more than 1 per cent against the dollar, the euro and on a trade-weighted basis. At times it lost more than three cents against the dollar and finished the day in London at $1.8712, while the euro gained ground just falling short of 80 pence at £0.7969.

The latest downward lurch for the pound came as advanced economies around the world received a wake-up call that none were immune to the effects of the credit crisis.

In Japan, new data showed the world’s second-largest economy contracted by 0.6 per cent in the second quarter, its worst quarterly performance for seven years. While on Thursday the first estimate of eurozone second quarter growth is expected to show the first contraction since the single currency was launched in 1999.

With the US economy already having contracted at the end of last year, none of the world’s rich economies appears to be able to sustain continued expansion as the credit turmoil progresses.

This anaemic performance is not, however, matched in much of Asia’s emerging economies and oil producers, where expansion has barely dimmed.

Most economists shared the market’s view that the Bank was signalling a bias to start lowering interest rates, probably late this year or early next.

Simon Hayes of Barclays Capital said: “The surprise today was not so much that the next move in rates is likely to be down, but that the Monetary Policy Committee seems happy to nurture this expectation.”

But the Bank is unlikely to feel comfortable with the extreme reaction to its forecasts. Mr King repeatedly insisted the balance to inflation risks were tilted to the upside because it was still unclear if households and companies would begin to behave as if high inflation was normal.

The Bank also published similar inflation and more benign inflation forecasts three months ago, which the markets then interpreted incorrectly as a signal of higher rates to come.

The focus will shift to the eurozone on Thursday with the publication of growth figures for the second quarter. Little hope remains of a revival this year. This month, Jean-Claude Trichet, European Central Bank president, warned the second and third quarters would prove “particularly weak”.

Additional reporting by Ralph Atkins in Zurich

Europe's economy contracted in the second quarter - the first time it has shrunk since the launch of the euro almost a decade ago.

Gross domestic product fell by 0.2pc in the eurozone, which comprises the 15 nations that subscribe to the single currency, official statsistics showed today.

The fall compared with GDP growth of 0.7pc in the first quarter, and provides further evidence that the worst of the slowdown in the global economy may not yet be behind us.

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The decline was prompted by a second-quarter contraction of Europe's two biggest economies - Germany and France - as well as a fall in Italy.

"The question now is, are we close to the bottom?", said Kenneth Broux, European economist at Lloyds TSB. "We take the slightly more optimistic opinion that the economy will improve by the end of the year."

But the second quarter marked a low for the eurozone, following growth in the previous quarter.

The German economy contracted for the first time in almost four years, while the French economy shrank by for the first time in nearly six years.

Germany's fall was the sharpest, with gross domestic product down 0.5pc when seasonally adjusted, compared with a 1.3pc rise in the first quarter.

The French economy contracted by 0.3pc, contrary to the National Institute for Statistics and Economic Studies' (INSEE) expectation that it would grow by 0.2pc. Italy also fell by 0.3pc in the second quarter.

INSEE also revised down its previous estimate for French economic growth in the first quarter to 0.4pc from 0.5pc.

In Germany it was the first contraction of the economy - Europe's largest - since the third quarter of 2004 when GDP fell by 0.2pc, according to the country's Federal Statistical Office.

The struggle in the period was mainly the result of falls in construction activity, consumer spending, and capital investment.

The recent strength of the euro and a lack of business confidence also hit demand for German exports, which have helped power the country's growth in recent years.

"The decline reflects a backlash from the strong first quarter as well as a cyclical economic downturn," Matthias Rubisch, an analyst at Commerzbank told Bloomberg.

"High oil prices, the euro's strength, and the weakness in global demand are all clouding the outlook," he added.

After publication of the figures the euro was flat against the dollar at $1.4930 and little changed against sterling at 79.78p

The German Government forecasts growth will slow to 1.7pc this year from 2.5pc in 2007, slowing further to 1.2pc in 2009.

The data from Germany and France comes a week after Jean-Claude Trichet, the President of the European Central Bank warned that economic growth in the eurozone would be "particularly weak" in the third quarter, prompting investors to increase bets that the ECB will start cutting interest rates next year.

Yesterday the Bank of England gave its clearest indication yet that the UK is likely to enter a recession.

Speaking as the Bank published its quarterly Inflation Report, Governor Mervyn King said that because the central growth projection was for broadly flat output, "it's bound to be the case that there is the possibility of a quarter or two of negative growth." A technical recession occurs when there are two successive quarters of contraction.

Prices in Spain rose at their fastest annual rate for 15 years in July, driven by rising food and fuel costs.

The annual inflation rate climbed to 5.3% in July, up from 5% in June.

Transport costs were 10.6% higher than a year earlier, the National Institute of Statistics said, with food prices up 7% compared with July 2007.

Spanish inflation is above the eurozone average of 4.1%, but recent falls in the price of crude oil could bring the rate down.

Spain's Economy Minister Pedro Solbes said the rate of inflation could drop to about 4% by the end of the year as crude prices have declined.

Later on Wednesday Spain set out a number of economic reforms aimed at tackling the cooling economy, following an emergency meeting.

Prime Minister Jose Luis Rodriguez Zapatero had interrupted his holidays to attend the meeting with Mr Solbes and other cabinet members.

The plan, yet to be finalised, included a 20m-euro package ($30m; £15.9m) to help families access finance for mortgages and to help smaller firms among others.

The Japanese economy contracted by 0.6% between April and June, prompting fears that it is sliding towards recession.

Declining exports and consumer demand were behind the fall - the first for more than a year - which came after a rise of 0.8% in the previous quarter.

With consumer confidence at record lows, private consumption, which accounts for half of GDP, fell by 0.5%.

Some economists believe the economy will contract in the next three months, partly due to the slowdown in the US.

An economy is considered to be officially in recession after two consecutive quarters of negative growth.

"The data gives the impression that the economy has entered a recession and I think it is in recession," said Takahide Kiuchi, chief economist at Nomura Securities.

GDP, the total value of goods and services in the economy, shrank by 2.4% between April and June, compared with the same period in 2007.

That is a significant change from the first quarter between January and March, when the economy grew by 4% compared with a year earlier.

Figures released last month showed consumer confidence in Japan fell to its lowest level for 26 years in the quarter to June.

As in many economies around the world, rising costs for energy and food have damaged confidence and made consumers reluctant to spend, particularly on more expensive durable goods.

The creaking state of Britain’s nuclear power stations was laid bare yesterday when British Energy revealed a sharp drop in first-quarter profit as a year-long outage at two of its biggest reactors reduced its power output.

The nuclear generator, which is looking for a buyer, was unable to take advantage of soaring power prices because of the shutdown of its Hartlepool and Heysham 1 reactors. The group, which has eight reactors and provides 15 per cent of Britain’s electricity, said that profits in the three months to June fell by 65 per cent to £62 million, compared with £179 million in the same period last year. The group produced 9.5 terawatt hours (tWh) of power in the period, down from 13 tWh a year earlier.

The nuclear group has been plagued by a string of technical faults at its ageing reactors in recent years. Problems were first discovered at the Hartlepool and Heysham sites in October and the generators will not be back on line until the end of the year. The full cost of the outage has now reached at least £115 million, according to British Energy, and could get higher.

The sharp fall in profits will also affect the amount of cash the Government, which has a 35 per cent stake in the company, takes at the end of the year. It is entitled to 35 per cent of the free cash flow from the generator after its bailout of the company in 2002, and received £102 million for the last financial year. That figure is expected to fall by as much as 60 per cent this year.

British Energy is looking for a buyer and major shareholders rejected a £12 billion takeover bid from EDF, the French energy giant, at the beginning of the month. The Government had pushed for a sale to EDF.

Bill Coley, chief executive of British Energy, denied that the operational difficulties at the group had made it more difficult to secure a sale to EDF. “I am completely comfortable with our plants and our people, who are a huge asset and make us a very attractive company to buy,” Mr Coley said.

Talks with the French company are continuing but there are few signs of a breakthrough. EDF had offered 765p a share in cash for the company, or 700p plus a further payment based on performance. Analysts believe that a deal will be done but doubt that the stalemate between shareholders and the Government will be broken quickly.

If no deal is achieved, British Energy will pursue joint ventures to develop new nuclear generators with other interested energy companies.

However, it admitted yesterday that those discussions were still taking a back seat to potential takeover talks.

Mr Coley said that he intended to maximise British Energy’s involvement in the development of new nuclear capacity in the UK.

“Anyone can have sites but if you look at our people they are a unique asset – it takes many years to build up that sort of experience,” he said of the 6,000-strong workforce which work in nuclear generation.

Mr Coley, a veteran of the US nuclear industry, praised the Government’s commitment to nuclear development and denied that the delays to the sale were holding up the replacement of the country’s nuclear fleet.

He said: “There are many complicated steps that need to be taken – for example on planning, on education and on approving new designs before a spade can be put in the ground. I look around the world and this Government is not taking much longer than anyone else.”

British Energy’s poor output and profits were partially offset by higher selling prices – up 12 per cent at £45.7 per megawatt hour – for the power it produced. However, operating costs soared by 47 per cent.

The rising cost of coal made up just less than half the increase in operating costs at the nuclear group, which has doubled its output from its single coal-fired power station at Eggborough.

Rising uranium prices are also a factor. At the beginning of August, the long-term price of uranium was $80 per pound, down from a high of $95 per pound in March this year but still higher than this time last year. British Energy has struck purchase contracts for uranium at much lower prices and has a fuel cost advantage of approximately £115 million per year at these prices. But it gave warning that this benefit will reduce over the next nine years.

Government figures published this month showed the share of electricity generated by Britain’s nuclear power stations has fallen to 15 per cent of total demand, its lowest level in 21 years.

Turning down the wick

British Energy outages

Heysham 1 Boiler closure, unit problems
Hartlepool Boiler closure, unit problems
Dungeness B Unit 1 closed for refuelling
Unit 2 statutory outage
Hinkley Point B 70% capacity
Hunterston Statutory unit outage
Unaffected
Heysham 2
Torness
Sizewell

The Scottish government is in talks with two Middle Eastern sovereign wealth funds to provide the cash for a £4.8bn offshore energy grid, to be built off the east coast of the UK.

Scottish Development International (SDI), the government's inward investment agency, has been in discussions with the funds for two months. One is known to be from the United Arab Emirates, and SDI is opening an office in Dubai to tap into the region's vast funding potential.

Paul O'Brien, SDI's senior executive for renewable energy development, said that the grid would "accelerate offshore wind, wave and tidal energy projects in Scotland".

The move would help meet the European Union's strict sustainable energy targets, although a deal is unlikely to be agreed until next year, according to Mr O'Brien.

"The point we have to address," he said, "is finding a way of sparking their interest. They could be joint venture partners or at least part of a wider consortium."

The transmission grid would stretch from Shetland and the Orkneys on the east coast of Scotland down to Norfolk. Mr O'Brien said that there was 60GW of "untapped potential" from offshore energy that could be accessed only through establishing the grid.

A spokeswoman for the Crown Estate, which owns the seabed, said that SDI and any Middle Eastern partner would have to apply for a licence to undertake the development.

However, the Crown Estate is likely to approve the idea, having published a feasibility study in January, looking at a power grid on the east coast seabed. The cost of the core part of the project was estimated at around £1.7bn, but was expected to rise to £4.8bn as more phases were added up to 2020.

The Crown Estate has awarded a number of offshore wind farm contracts, including a £900m agreement in May with the US engineering and construction conglomerate Fluor to build a farm off the coast of Suffolk. The grid would provide links between these wind farms.

SDI has launched a feasibility study into a similar project on the west coast. This is being run in conjunction with the governments of the Irish Republic and Northern Ireland, and is funded by the European Union.

The governments hope that the west coast scheme could ultimately be joined up with the proposed grid to the east.

Small businesses are more vulnerable to exploitation and sharp practice on the part of energy suppliers than are residential customers, according to the British Chambers of Commerce.

The BCC is urging Ofgem not to overlook business customers as the regulator carries out an investigation into the energy industry.

Last month, a wave of steep price rises from energy suppliers sparked widespread concern about the numbers of residential customers likely to sink into fuel poverty this winter. Some campaigners have called for a windfall tax on energy company profits to help the worst-affected households, a measure that has been under consideration by ministers.

British Gas imposed a 35% rise in gas prices and a 9% increase in electricity for its 15.9 million customers last month. EDF raised its gas prices by 22%.

In February, Ofgem's chief executive, Alistair Buchanan, announced an investigation into the impact of wholesale gas and oil prices in Europe on energy bills in the UK. He said the inquiry was in response to public concern that the market was not working as it should.

The BCC said data from the consumer group Energywatch showed commercial customers were finding it particularly hard to manage their energy supply. Unlike residential customers, firms are unable to access transparent tariff data for easy comparison.

Moreover, many energy firms demand contract commitments for periods up to five years from business users, whereas domestic customers are able to switch suppliers every 28 days.

"With the economy slowing and energy bills on the rise, it is totally unacceptable that hard-pressed businesses are left so open to exploitation by energy suppliers," said David Frost, director general of the BCC. "Ofgem's investigation into the industry must hold the suppliers to account over the very apparent lack of transparency and fairness in their dealings with business."