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Oil Prices to Hold Up Despite Weak Economy: Strategist

The price of oil will continue to be supported at a relatively high level by reduced inventories, demand from China and the potential for political unrest in the Middle East, a strategist told CNBC Tuesday ahead of the Organization of the Petroleum Exporting Countries' (OPEC) quarterly market report.

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Sabine Schels, senior director and global commodity strategist, BofA Merrill Lynch Global Research, doesn't expect any big surprises from the report, which is expected at 8:30 a.m. New York time (2:30 Central European Time) on Tuesday.

The price of oil has stayed above $100 a barrel for most of 2011, despite economic difficulties around the developed world.

"It remains a bit of a conundrum," Schels said. "You have to remember that the crude inventories are extremely low, with OPEC at the bottom of its five-year range, and European inventories low."

"Liquidity provisions from central banks are also helping to keep prices high," she added.

"As the economy worsens (and we expect a full-blown recession in Europe next year), it will have a negative impact on the prices." However, she said, "They will still stay relatively high given how limited spare capacity is in the market."

Concerns have grown about the future of euro zone economies in recent weeks, with European leaders admitting that Greece may have to exit the single currency.

The health of the Chinese economy is also increasingly important for oil prices.

In July, OPEC forecast that oil demand will be suppressed by a fragile global economy in 2012.

Schels believes that the Chinese economy probably won't have a hard landing, but added that the consequences for the oil price would be "serious" if it did.

"I still think Saudi (Arabia) and the core OPEC countries won't mind if oil prices come down because they understand that it's a tax on the consumer," Schels said. "The price that they need to break even is around $88, according to our estimates."

There has been trouble within OPEC itself, with countries such as Iran and Venezuela disagreeing with the traditional OPEC leaders, such as Saudi Arabia.

At the June OPEC meeting, "cohesion cracked up," according to Schels.

The countries failed to reach agreement on a Saudi-led proposal to increase output, and Saudi Arabia and the International Energy Agency then decided to release more oil without OPEC's agreement.

There is also continuing uncertainty over stability in the Middle East, in the light of the Arab Spring, which has seen the overthrow of governments in the region, including Tunisia, Egypt and Libya. Further controversy around Iran could erupt later this week if a much-anticipated report from the International Atomic Energy Agency (IAEA) says that that nation is planning to develop nuclear weapons.

"Political unrest is certainly part of why the oil price is getting so supported despite the decline in the macro environment," said Schels. "Iran is flexing its muscles in the region and we have all seen how strongly Saudi Arabia reacted."

Less traditional energy sources such as shale oil are also becoming more popular

"The supply increase in unconventional shale oil in the U.S. is truly phenomenal. However, most of that is in the Midwest of the United States, where there isn't the infrastructure capacity to export it," said Schels.

She believes that production will increase in the long term, but that it is "hard to see" a big increase in supply in the next five years.