John Rapley, Contributor
EARLIER THIS week, the price of a barrel of oil on the New York Mercantile Exchange rose above $40. It now stands just a dollar shy of its all-time record, set in 1990.
Just a few months ago, industry analysts were predicting that by now, world oil prices would be retreating from the highs they reached when the Iraq war started, and would be drifting back towards $20. Instead, we are now hearing that the world may be headed towards its next energy crisis, as bad as or even worse than that of the 1970s.
What is going on? As with anything else, the price of oil is determined by supply and demand on the world market. Both factors have encountered some unexpected shocks, resulting in an uncertain outlook.
When it comes to demand, the recovery of the world economy has led to bigger increases in consumption than originally forecast. However, of greater significance is the booming demand coming from China. If China's economic growth is maintained at current rates, we may be seeing only the beginning of its impact on world oil prices. If one adds to this the possibility that Indian growth will also continue to accelerate at present rates, the world is facing a demand-side shock of possibly unprecedented proportions.
Ordinarily, when oil prices rise, new oil fields that are unprofitable at lower prices come on stream. Supply thus catches up to demand, and oil prices go back down. In large measure this is what happened in the 1970s. However, some industry analysts are now saying that this time may be different.
Some albeit not all oil experts argue that the world is confronting major new problems in supply. They point out that many of the world's major oil fields are maturing; future returns from them are thus likely to decline. There have been no major new oil finds in a long time. Thus, of the largest oil exporters, only Saudi Arabia has slack capacity. With prices higher, therefore, most producers are simply unable to meet the roaring demand. Still, Saudi Arabia is doing what it can. This week, it announced it would raise its output. Yet while the world oil price initially fell after the announcement, by the next day it resumed its upward course. This may be ominous.
TERRORIST ATTACK
Oil traders are increasingly saying what Western political leaders know but do not want to admit: that relying so heavily on this one country for energy supplies is dangerous. Saudi Arabia is a dubious and unstable ally. Islamists have begun targeting both the Saudi Government and its oil installations. This has added a security premium to the price of oil. Usually, something like a Middle Eastern terrorist attack causes a temporary spike in the oil price, after which it settles back down. Now, however, many observers are judging that the instability in the Middle East has moved into a structural phase.
By now, no doubt, the American soldiers who smiled for the camera while abusing Iraqi prisoners will have received their thank-you cards from Osama bin Laden. President Bush's chief political advisor, Karl Rove, is reported to have said it will take the U.S. a generation to undo the damage caused by those photographs. He may well be right: to the extent that they will feed opposition to the Americans and attract recruits to militant Islam, they will have helped to make attacks on Western interests in the region a more or less permanent feature. The horrific reply of terrorists who beheaded an American on an Internet video indicates that instability in the Middle East is becoming a staple of life. Uncertain that supplies will be secure, oil traders are raising the prices on future deliveries, even those for the long term.
One should not exaggerate the dangers. In real terms, the price of oil is still half what it was in the 1970s, and the industrial economies are more efficient than they were then. Consequently, an oil shock will probably not cause a global recession as it did back then. But if oil prices remain high, world growth will almost certainly slow. And given the fragility of this global recovery, that may bode ill for the future.
John Rapley is a Senior Lecturer in the Department of Government, UWI Mona.
