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Saudi and China Make Biggest Impact On Oil

WITH FRIENDS LIKE THESE....

Saudi Arabia
AP
Saudi Arabia

Washington has been talking tough on oil prices on several fronts, calling for new trading regulations on speculators and reopening offshore oil drilling. But it's successful jawboning two of our major allies that seems to have had the biggest impact on prices this week. When it comes to oil, we may be the biggest consumers but our friends may have bigger pull on the market.

First, Saudi Arabia does its part. President Bush's entreaties to King Abdullah last month apparently did not fall on deaf ears. At this weekend's unprecedented Oil Summit hosted by the Saudis in Jeddah, the kingdom is expected to confirm that they're boosting production by 500-thousand barrels a day. (Saudi officials first told our Melissa Francis as much a couple of weeks ago following oil's spike to $139. Watch for Melissa's report on that conference, live on Monday.)

Then, our friends in China set the stage for a real pullback, sending Nymex crude down nearly $5 after a surprise cut in domestic gasoline subsidies. Treasury Secretary Hank Paulson's recent meetings on the issue apparently resonated with Beijing.

Yet, just when it seems we're getting a reprieve on oil prices "With a Little Help From Our Friends," as the Beatles put it, the market changes its tune on reports Israel conducted what amounts to a dress rehearsal of an attack on Iran.

POINTS OF A COMPASS

Remember, two weeks ago it was an Israeli minister's comment that an attack on Iran's nuclear facilities seemed "unavoidable," which helped propel Nymex crude $11 to $139 a barrel. Today, the U.S. confirmed Israel conducted massive war games in the region on the heels of those comments early in June.

As one military official described it to NBC News' Jim Miklaszewski: "If you put one point of a compass on Israel, the other on Iran and swing it around to the Med, (Mediterranean), it's clear the exercise covered the same distance it would take to attack Iran."

How serious a threat is it? If history is any guide, Israel is more likely to conduct a small surprise tactical air raid. U.S. officials tell NBC the scope of the mission and the U.S. confirmation of the exercise should be seen as warning shot to push Iran on the nuclear issue, rather than a sign that an attack is imminent.

How do you price an Israeli attack on oil? With a quarter of the world's oil reserves, traders say an attack on Iran would have wide-reaching implications and could easily push prices well over $200 a barrel. As MF Global's Mike Fitzpatrick wrote clients, "Buyers clearly are worried that a resultant conflagration could engulf the entire region and threaten the world's oil supply, particularly the Strait of Hormuz."

LIKE KISSING YOUR SISTER

For all of the sturm und drang and volatility during the week, at the end of the day, the July crude contract settled at $134.62... that's 24 cents below where we closed last week.

This weekend, all eyes will be on Jeddah and the Saudi oil summit. Expect lots of rhetoric. The Saudis will likely boost production by 500-thousand barrels a day. The rest of Opec will stand pat. The petulant Venezuelans have decided they will attend after all. And in a big switch, Venezuela will probably rail against the EU rather than the US for a change, over a new immigration proposals in Europe.

But whatever production boosts the Saudis make next month, will only offset losses elsewhere. Mexico's production for May was down by 300-thousand barrels. Shell has declared force majeure after Nigerian rebels hit its 225-thousand barrel per day Bonga Oil field.

Reports say Chevron was also hit, and that a strike at its Pengassan facilities now looms on Monday, with the collapse of union negotiations this week.

Oh yeah, if that doesn't deflate your expectations enough -- that helping hand from our friends in China may come back to bite prices, too. While cutting subsidies may cut consumption, analysts at Goldman Sachs and others say it could actually boost demand. The prospect of higher prices is likely to push Chinese refiners to process more oil.

Questions? Comments? energysource@cnbc.com