There could be trouble ahead As Opec flexes
its muscles and the price of oil rises,
recession becomes a frightening reality
Source: The Observer
Publication date: Mar 05, 2000
A MAN ALMOST no Observer readers have heard of has
spent the
last few days in urgent discussions trying to save
your job and, if
you've bought a house recently, from you collapsing
into negative
equity because you've almost certainly borrowed too
much. We won't
know until a key international meeting at the end of
the month
whether he's succeeded or not, but some very good
economists say
it's already too late. We know from past experience
that a recession
is now under way.
Bill Richardson is the US Energy Secretary and his
visit to Kuwait
and Saudi Arabia last week was prompted by the new
$30 a barrel oil
price. Opec, which was thought by the world to have
lost its teeth,
has struck again by limiting production rather as it
did in the autumn
of 1973. The oil price has now trebled in 12 months.
The consequences are already beginning to ripple
round the world. In
the United States, petrol at 85 cents a gallon has
passed into
history; petrol prices have soared to $1.50 and by
the summer they
promise to move up to $2. Poorer families are already
complaining
they can't afford to use their cars, while even the
rich are discovering
that their gas-guzzling automobiles are becoming
insupportably
expensive. In Britain, petrol taxes are so high that
only a small
fraction of petrol prices reflects the underlying oil
price, but even so
prices are rising here as well.
In Congress, the recriminations are beginning;
Democrats blame
Republicans for obstructing any initiative to develop
alternative energy
use or check the over-reliance on cheap gasoline
while Republicans
blame Democrats for allowing the US to become
overdependent on
foreign oil. And President Clinton has said he would
consider
releasing some of the US' s strategic oil reserve to
lower prices. It's
the first time any US President has suggested using
the reserve for
any purpose other than guaranteeing security of
supply; to suggest
the reserve should be use for price manipulation when
supplies are
secure is a signal of desperation.
But Richardson's and Clinton's concerns are
well-founded. In the post
Second World-war era, the oil price has traded at or
below $15.27 ( in
constant prices) for half of the last 55 years ; it
has only ever gone
above $22 in response to war or conflict in the
Middle East after the
Yom Kippur War in 1973, during the Iran/Iraq war in
1979 and again
in 1990, after the Iraqi invasion of Kuwait.
And after each of those price hikes, the world has
been plunged into
each of its three postwar recessions. The current
price rise is now as
rapid and as continued as the rise after the Iranian
revolution in 1979;
worse still, the price has been above the key $22
level for eight
months.
Opec, after nearly 20 years of futile squabbling, has
reasserted itself
with a vengeance. Two years ago, the Mexicans were
midwives to a
deal between the Venezuelans and the Saudis, in which
they agreed
to cut production substantially if Opec followed
suit,which it did. It
has taken three attempts to get there, but by last
March, despite lots
of cheating, Opec's production was down some 15 per
cent while
world oil demand had risen, driven mainly by the US
boom. In the first
three months of this year, world demand averaged 77
million barrels
of oil a day; supply stood at some 74.6 million
barrels, with the gap
being made up by running down world stocks. The
result an oil price
rising 7 per cent a month.
Alarm bells have been ringing since the autumn, but
Opec is
reluctant to unscramble its deal so quickly; it wants
its share of first
world riches and unlike other third world commodity
producers it has
power and is glorying in the reaction. Above all, it
needs the extra
revenue. But the Americans are putting on intense
diplomatic
pressure for Opec to agree to relax its production
cuts at their next
meeting in Vienna on 27 March.
Last Thursday, Richardson won a statement from the
Saudis,
Venezuelans and Mexicans that Opec finally would
increase
production to ease prices. But the amount was not
specified; indeed
the statement was so vague that oil prices climbed to
new highs on
Friday night.
As Leo Drollas of the Centre for Global Energy
Studies remarks,
Opec will have to agree in Vienna to lift production
by more than two
million barrels a day to secure any downturn in
price, and that scale
of increase will be opposed by the cartel's hawks
(who don't like
Israel's stance in the Lebanon and anyway need the
revenue); any
increase is thus sure to be too little too late.
In any case, whatever relaxation is agreed, it takes
40 days for
shipments to cross the Atlantic to the US the key oil
market which is
just increasing petrol production for the annual
summer holiday
season.
Drollas thinks prices are certain to carry on rising
before any possible
fall in the autumn; the only issue is by how much.
And even any
subsequent fall promises to be small; the futures
markets are trading
oil in12 months' time at $23 a barrel lower than
today but still above
the $22 benchmark.
On past evidence, what has already happened is
sufficient to trigger
an economic slowdown the open question is whether it
will turn into
recession. Andrew Oswald, professor of economics at
Warwick
University, argues forcibly that the short-run impact
of a rise in the oil
price is an inescapable rise in real business costs
that necessarily
lowers the share of profits in GDP and precipitates
cutbacks in
business activity and thus recession. What generated
the new
economic paradigm in the US was not the genius of
Bill Gates and
the Internet, he insists, but the lowest oil price
for 50 years, which
prompted a profits boom.
In the UK, profits reached a peak of 16 per cent of
GDP in 1998, but
are now falling back to 13 per cent and heading
towards the 11.5 per
cent of GDP that characterised the last three
recessions. Already,
there are portents of a slow down rising joblessness
in the US and
falling manufacturing production in Britain. Each
slowdown has its
own special factors that cause recession; this time
round it is the
fantastic bubble in stock market and house prices on
both sides of
the Atlantic. Once the markets get wind that the
economy is slowing
down, the downward reaction in share prices will be
self- feeding and
possibly hysterical, interacting with the effects
prompted by the oil
price hike.
Oswald and Drollas may be overstating their case, but
the numbers
and history are persuasive. Time, I suspect, to be
careful about
buying a house or shares at current prices, for
Gordon Brown to err
on the side of generosity in his Budget this month,
and for pondering
whether the current structure and management of the
world economy
is sustainable. In today's world, national economic
sovereignty is a
myth. Will Hutton is chief executive of the
Industrial Society
Publication date: Mar 05, 2000
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