[A-List] Global economy: impending oil crisis

["Michael Keaney" <michael.keaney@xxxxxx>]

We're scraping the bottom of the barrel: oil price puts global growth in
jeopardy
Demand for the black stuff is gushing but supply isn't and the surge in the
cost of crude to its highest level since 1990 shows no sign of running out
of fuel. Opec is powerless, writes Tim Webb, and the world economy will
suffer
The Independent on Sunday, 09 May 2004

Analysts from Lehman Brothers estimated at the end of last year that a
barrel of Brent crude oil would cost $24 (£13) on average in 2004. Taking
its cue from the terrorist attacks in Saudi Arabia, surging demand and low
oil stocks, the price of Brent went above $36 last week. In New York, the
price of the lighter West Texas Intermediate topped $40.

Prices are now at their highest since 1990, when Saddam Hussein invaded
Kuwait, and higher than they were in the run-up to the second Gulf war last
year. Compared to this time in 2003, Brent is more than $10 per barrel, or
40 per cent, higher - to the astonishment of economists and analysts who
have been predicting a crash in oil prices. Paul Horsnell, the head of
research at Barclays Capital, says: "That cry has been the oil analysts'
equivalent of walking around with a sandwich board proclaiming a very rapid
end for the world."

Clearly, they were wrong. The Bank of England said last week that it had
decided to increase interest rates partly in response to rising commodity
prices. Oil prices may drop a couple of dollars between now and the end of
the year, but no one is predicting they will drop below $30 any time soon.

So how high can they go? And is the global economy - and that includes us -
heading for the first oil crisis of the 21st century?

Global demand for oil is rising as the economy picks up, driven in large
part by China. Barclays Capital estimates that total worldwide consumption
for 2004 will be 80 million barrels of oil per day, up from 78.6 million in
2003. The growth in demand from China alone makes up almost a third of the
increase.

Seasonal demand is about to spike too with the approach of the "driving
season", mainly in May and June when petrol consumption increases as
Americans drive across the country in their gas-guzzling four-wheel drives
to go on holiday. Petrol stocks in the US are already low. But new
environmental regulations introduced by the government requiring refiners to
strip out the chemical MTBE, believed to cause cancer, have helped to
exacerbate the shortage this year, as there just aren't enough refiners
around which comply with the regulations.

Petrol stocks are estimated to be 13 per cent lower than needed to meet the
demand during the driving season. As a result, the US will import more
petrol from Europe, putting further pressure on crude supplies.

Dr Manouchehr Takin from the Centre for Global Energy Studies, a think-tank
set up by the former Saudi oil minister, Sheikh Yamani, says that
speculators have also played their part in pushing up the cost of oil.
"People are prepared to pay higher prices for gasoline because there is a
fear of shortage. But in the last six months, even pension funds have been
speculating, joining hedge funds. The expectation was that they would go
short on supply, but many are still holding long positions." This suggests
the market expects prices to go higher.

But there is little hope of a sudden glut of oil coming on to the market to
meet rising demand. The Organisation of the Petroleum Exporting Countries
(Opec), which pumps some 40 per cent of the world's oil, no longer seems
willing - or able - to manipulate prices by changing production levels. Its
quotas are rarely met and are becoming irrelevant.

This was underlined by comments last week from Indonesia, the holder of the
Opec presidency. An official explained the high prices were caused by
speculators and not a shortage of oil, as the cartel is already producing
more than two million barrels above its official quota. Ironically, its last
quota was meant to cut one million barrels last month because demand was
expected to fall after winter in the western hemisphere; the Centre for
Global Energy Studies estimates only 400,000 barrels were cut.

The admission that Opec is once again not meeting its own quotas is not news
to anyone. Officially, the cartel is still committed to keeping oil within a
price band of $22 to $28 a barrel. If prices are above this for more than 30
days, it is supposed to gear up production automatically. This mechanism is
now meaningless: Opec's own price has been above $28 since December and
there have been no moves to increase production, other than the unofficial
quota cheating. In March, Purnomo Yusgiantoro, the Indonesian oil minister
and Opec president, suggested a new range could be set at around $32 to $34
a barrel.

Opec is in a dilemma. Privately, the cartel members are happy to see such
high oil prices, even though they would not admit it publicly for fear of
angering consumers. Most of the members have huge budget deficits to service
and are largely dependent on oil revenues, both politically and
economically. In Saudi Arabia, for example, some estimates put unemployment
as high as 30 per cent. If prices fall, hitting government revenues,
criticism of the ruling Al-Saud family will increase.

But Fatih Birol, chief economist at the International Energy Agency (IEA),
says Opec's laissez-faire policy is "myopic". In the long run, it will lose
market share, he says, because higher prices will lead to lower consumption
as oil is used more efficiently and as more non-Opec producers are
encouraged to pump more oil. "It's better to have medium prices and higher
production than high prices and see their market share decline to non-Opec
producers."

In the short term, however, the scope for outside producers to meet the
shortfall is limited. The US and Europe are all pumping less oil than two
years ago, according to Barclays Capital, and the performance of non-Opec
countries this year is even weaker than expected. In other words, with
demand expected to remain strong, and no gush of new oil predicted in the
foreseeable future, the current high prices are unlikely to be a short-term
phenomenon.

The IEA released a report last week analysing the effect of this on the
global economy. It makes for sober reading. If the oil price sustains the
$10 per barrel increase from $25 to $35 for a year, in the developed world,
inflation will increase on average by 0.5 per cent, GDP will fall by 0.4 per
cent and unemployment will increase, the report predicts. The impact will be
bigger the more oil a country imports. The IEA adds that the current high
prices are hurting the global economic recovery, noting that sustained oil
price inflation from 1999 contributed to the downturn in 2001.

The UK is still a net exporter of oil and gas, but will become a net
importer by the end of the decade as the North Sea fields age. Oil
consultancy Wood McKenzie estimates the industry paid £9.5bn in total in tax
to the Treasury last year. Because production is falling (in 2005 the UK
will become a net importer of gas), the tax take is unlikely to be equalled,
even with high oil prices.

Businesses will also be affected. John Butler, an economist at HSBC, says
companies are more sensitive to higher oil prices because margins are
already low: "In the past, they have tended to be a cost that companies have
been able to pass on. Now, perhaps because of greater competition, this is
not always possible. The impact may not be in terms of rising RPI [retail
price inflation] but more in dampening profits, hurting employment and a
negative impact on GDP growth."

The developing world will be still worse off, the IEA warns, as the poorest
economies use more oil and less efficiently. It estimates that a sustained
$10 a barrel increase would cut the GDP of countries in sub-Saharan Africa
by more than 3 per cent. And their currencies would also become devalued as
the dollar-denominated bill for imports increased, also raising the cost of
servicing Third World debt. Mr Birol at the IEA says: "Developing countries
like India can't afford these rises. They suffer more than OECD [developed]
countries."

Prices are not as high as during the 1970s oil crisis, when crude hit over
$70 a barrel in today's money after Opec turned off the taps. But in many
ways, the current outlook for oil is more serious. Today's high prices are
not the result of manipulation by a cartel. They are instead the product of
a longer-term trend: the world is consuming oil at a faster rate than it can
find it. In the 1970s, Opec backed down and prices returned to more
acceptable levels. If only the solution were that simple now.

ALL HANDS TO THE PUMPS: WINNERS AND LOSERS FROM THE FUEL FALLOUT

The recent surge in oil prices has raised the spectre of a repeat of the
fuel strikes in September 2000, which almost ground the country to a halt.

Ray Holloway, the director of the Petroleum Retailers' Association, who
helped co-ordinate the protests, has warned Gordon Brown, against raising
petrol duty. The Chancellor announced a 1.9p per litre extra duty in his
latest Budget, but deferred its introduction until 1 September.

"We are already paying a high price at the pump," says Mr Holloway. "Gordon
Brown will come under pressure not to introduce the duty. His option is to
consider whether British businesses can cope with the type of strikes we had
before."

Farmers and road hauliers are particularly opposed to the planned hike, he
adds.

The average price for a litre of unleaded petrol in the UK last month was
78.6p, according to the Automobile Association. Prices have since increased
to 80p per litre in some areas. The highest monthly average in the last
three and half years was in June 2000, when prices hit 85p.

But Mr Holloway says there is room for negotiation: "Our first thought is
not to protest."

A spokesman for the Treasury says it is in regular contact with road user
groups about issues such as fuel duty but adds that it has no plans at the
moment to defer the September increase. "We always keep the position under
review. No decision would be taken about it until nearer the time."

Among the other losers in the great oil game are the airlines. Analysts at
Dresdner Kleinwort Wasserstein have downgraded their earnings forecasts for
British Airways. In March, the airline said it had only hedged 30 per cent
of its fuel needs for the first half of the year, and 12 per cent in the
second half, which could lead to a hit of £50m or more in the financial year
ending March 2005, according to the DKW analysts. Other airlines hedge more
of their fuel needs.

Times are tough, as shown by last week's easyJet warning that the cheap
fares it is charging are unsustainable. With many American airlines only
just recovering from the after-effects of 11 September, and Italy's Alitalia
flirting with bankruptcy last week, a fuel shock is the last thing the
sector needs.

The undisputed winner from the surging oil price is, not surprisingly, the
oil and gas sector. Shell and BP have both announced share buyback
programmes over the year to return surplus cash to shareholders generated by
high oil prices.

British oil and gas exploration and production has raced ahead in the past
six months. Cairn Energy is typical of the smaller oil companies: its share
price has more than doubled since January after major finds were made in
India. The fact that it bought the Rajasthan field from Shell, which is now
desperate to boost its production after its reserves scandal, makes it all
the sweeter.