Sunday, May 23, 2004
Over a barrel
Posted by David Smith at 08:59 AM
Category: David Smith's other articles

Late last month a small patrol boat off the coast of Iraq intercepted an Arab dhow sailing towards an oil terminal near Basra. As the patrol craft drew alongside, the dhow exploded, killing two coalition sailors. It had been a floating bomb targeted at the oil installation.

Not far away, two speedboats were racing towards the main Basra terminal where four huge tankers were moored. Security forces opened fire. One speedboat blew up some distance from the ships, but the other, packed with high explosive, was within seconds of striking one of the tankers before it, too, blew up in a fireball.

The attack was just one of an increasing number aimed at disrupting oil supplies that are sending jitters through the world economy.

A tight market and fears of a sudden and serious disruption of supplies have sent the price of crude oil racing up from $33 to more than $40 in little more than a month. The jump has already pushed petrol up by 6p a litre or 27p a gallon since May 1; retailers warn it could go much higher if crude prices do not fall.

The immediate threat is domestic protest at high pump prices, which are already beyond the 80p a litre that sparked the fuel blockades of four years ago, nearly paralysing the country. Now protesters such as Farmers for Action are warning of another showdown. “We have told the government that if the crisis of fuel prices is not addressed by the end of the month, we will have no alternative but to call people out again,” said David Handley, an organiser.

The rise in crude prices, however, threatens far wider problems than higher petrol prices. In New York last night Gordon Brown, the chancellor, was dining with the other G8 finance ministers and all were concerned that high oil prices could wreck their economic plans.

If crude stays at $40 a barrel or more, it threatens to push up inflation, which could precipitate higher interest rates. They in turn could hammer British consumers, who are already weighed down with almost £1,000 billion of debt. A vicious downward economic spiral, including a property crash, could ensue.

Yesterday Opec ministers attending an informal conference in Amsterdam indicated they would try to raise crude oil production to ease the pressure on prices; but many observers remain deeply concerned. Some forecasters have warned that crude prices could hit $50 a barrel or more. The government has been laying plans to use the army to break any new fuel blockade. Behind the gasoline smell there’s a whiff of panic in the air.

Might the current crisis even reach the same magnitude as the “oil shocks” that rocked the world in the 1970s, plunging it into recession?

IN 1973, the year of the first oil price crisis, the omens were never very auspicious. Donny Osmond was in the charts. The White House was mired in Watergate. Israel was fighting the Arabs. And Edward Heath was fretting in Downing Street as strikes beset the mines, railways and power stations.

Against that background, Opec flexed its muscles. Arab members, angry at western support for Israel in the Yom Kippur war, imposed an embargo on supplies then pushed up prices. That November the Tory government announced it was printing 16m petrol rationing books.

The crisis was so serious that senior figures in the US administration considered invading Saudi Arabia to secure the oilfields. British intelligence chiefs, according to government records released only last January, feared America would ask the UK to help.

Sound worryingly familiar? The White House currently relies on British help in Iraq and is mired in scandal over the abuse of Arab prisoners. Israel is fighting the Arabs. The railway workers are threatening to strike. And Donny Osmond has lined up comeback concerts this summer.

But there is one crucial difference (so far) between then and now. In 1973 the oil price quadrupled: in three months it rose from just over $3 a barrel to nearly $12. In today’s crisis prices have not even doubled.

It was the scale and speed of the fourfold increase in 1973 that tipped the world economy into recession. Barely had the economy recovered than a second oil shock, precipitated by the overthrow of the Shah of Iran in 1979, pushed prices up again, causing a second world recession. Again, the price rise was much greater than now: in today’s money, oil hit nearly $75 a barrel.

The world economy has also become less sensitive to price shifts since then. The decline of heavy manufacturing industries greedy for energy and the switch to more fuel-efficient vehicles have been key factors.

Despite these differences, however, the jitters remain. “We’re nervous because the oil price rise goes alongside a lot of other things that we’re nervous about, including overheating in China and America’s economic imbalances,” said Michael Dicks, an economist with Lehman Brothers, the investment bank.

“We’re not predicting that the world economy is about to topple off the edge but the risks have increased. The chances of a world recession because of all this have risen to about a quarter.”

One of the key concerns is not simply price but security of supplies, especially as competition hots up. China is rapidly emerging as one vast petrol tank eager to be filled. Last year the Chinese bought 2m cars and forecasters predict that within 10 years the country could have 100m vehicles on its roads. It’s the great leap forward with the foot flat to the floor.

This year China overtook Japan to become the world’s second-largest oil importer and its emissaries are touring the world signing deals with oil producers. This is a challenge America and other nations cannot ignore, if only because their own supplies are dwindling. Though new oilfields are being found and developed, they are not always in regions that guarantee supply to the West.

Increasingly, too, terrorists recognise the power of oil as a weapon. In Colombia, rebel forces blew up a pipeline in February last year. In September disgruntled tribesmen in Yemen blew up the main export pipeline. Earlier this month five foreign contractors were killed in an attack on Yanbu in Saudi Arabia.

At least $6 of the current oil price reflects worries that a terrorist attack will cut off some of the 9m barrels pumped every day in Saudi Arabia or the 2m produced in Iraq where sabotage is now a pastime.

THANKS to increasing energy efficiency, oil demand per person is slightly lower than in 1979. Other sources of energy are also being more widely used. Despite these advances, however, we remain in thrall to the black gold. Hybrid electric cars and fuel-efficient engines are making only slow progress; gas-guzzling 4x4s are still conspicuous on the school run.

And there lies the root of the fear feeding into high prices. Despite the proliferation of countries supplying oil, the Middle East still has by far the largest reserves. It is a situation that threatens to leave America, the world’s biggest consumer of oil, uncomfortably reliant on a highly unstable region. Such uncertainty means a volatile oil price.

What does it all mean for Britain’s consumers? To Handley and his fuel protesters, geopolitical risks seem to mean whether he can afford the fuel to get his farm produce to market. His concern is not Iraq, but his local pump price. “None of us wants to take action,” he said. “We would much rather the situation was sorted out with dialogue, but at the moment we have no indication that that is going to happen.”

But even if a petrol blockade can be avoided, the wider impact may be less easy to manage. The Bank of England signalled last week that it will raise interest rates if the rise in oil prices pushes inflation above its 2% target.

The combination of rising mortgage rates and higher oil prices would put a squeeze on household budgets, possibly provoking a plunge in house prices.

For now, the hope remains that disaster won’t happen, that oil prices can be brought down. But an oil shock similar to the 1970s price hikes could be only one terrorist attack away.


1. Al-Qaeda terrorists attack and destroy main pipelines in Saudi Arabia. Crude oil supplies fall by 2m barrels a day. Prices leap by $10 a barrel and then creep even higher towards $60. In Britain, petrol prices top 90p a litre.

2. The Bank of England is alarmed by signs that higher oil prices are feeding through into bigger wage demands and price hikes across a range of goods. The Bank, which has already raised interest rates from 3.5% to 4.25% since November, announces an immediate hike to 5%.

3. Firms, worried by signs of a new downturn in the global economy and facing a severe squeeze on profits, announce large-scale layoffs. Unemployment starts rising by 50,000 a month, shooting back up through the 1m level.

4. Gordon Brown, hit by a sudden loss of tax revenues, is forced to slash government spending — cutting tens of thousands of public sector jobs — and to put up taxes.

5. Households, sitting on a record £1,000 billion of debt, are faced with the twin nightmare of sharply rising mortgage rates and the threat of redundancy. House prices start to slide, slowly at first, but then much faster as panic selling of investment property sets in. Tens of thousands lose their homes and are forced to declare themselves bankrupt.

From The Sunday Times, May 23 2004