Holding the world's fortune over a barrel: It doesn't take a war or political coup to make oil prices volatile. Robert Cole examines why

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IT is not only world-shaking events like the Gulf war that influence the value of oil.

The price of this commodity is highly volatile, even during relatively quiet political spells. Like house prices, it has been the subject of a series of spectacular booms and busts driven in equal measure by supply and demand as well as political events.

Most recently, Brent crude, the North Sea oil that is the most widely traded, has swung from a low of dollars 8 a barrel in 1986 to a high of dollars 41 in 1990. Adjusted for inflation, Brent crude fell 60 per cent between August 1984 and June 1986. It then soared by 120 per cent to October 1990 and slumped 65 per cent in the period to January 1994.

The Gulf war drove the most dramatic of all oil price movements. While the crisis of 1973 had a greater impact on the world economy, events from August 1990 to February 1991 present a more graphic illustration of oil price instability.

When Saddam Hussein's Iraqi armies invaded Kuwait in August 1990, the price of oil nearly tripled as the world fretted that hostilities might threaten all Middle Eastern production. As a result, a barrel of Brent crude rose from dollars 15 in June 1990 to a peak of more than dollars 41 four months later.

But the build-up of the Desert Shield anti-Iraqi militia in Saudi Arabia rapidly calmed the market and the price of oil swiftly declined from dollars 41 a barrel to dollars 30 on the eve of the Allied campaign to reclaim Kuwait. The launch in January 1991 of operation Desert Storm saw the price of oil drop a further dollars 13 to dollars 18 as the markets grew confident of success.

So far this year the trend has been the opposite, as the price has risen from dollars 13 to dollars 18 a barrel, 25 per cent ahead of the UK retail price index. This time, however, the movement is more directly related to supply and demand criteria.

'Opec, the Arab oil-producing consortium, has stuck reasonably close to the 24 million-barrels-a-day quota agreed. That is unlikely to change before the start of next year,' explained Lawrence Eagles of GNI, the commodity broker.

'But at the the same time it has begun to sink in that demand is picking up. The US economy is growing strongly - which means the US will consume more oil - and by the back end of this year the greater demand from recovering European economies will begin to show.'

'It is not only clear that unused Opec capacity is limited, but also that it is concentrated in a few countries,' said Joe Stanislaw, of Cambridge Energy Research Associates.

Daniel Yergin, Cera president and author of the oil blockbuster, The Prize, added: 'With economic expansion firmly rooted in North America and recovery beginning in other major OCED economies, we see sustained growth in demand at 0.9 per cent for this year and 1.5 per cent for 1995.'

Analysts at merchant bank Salomon Brothers, concur. 'With the world economy beginning to take off there is enough of a potential increase in demand to absorb rises in production.'

Demand is also receiving a kick from the states that formed the Soviet Union. The collapse of the former Soviet economies reduced world demand for oil. Falling demand in the Eastern bloc even masked improving demand elsewhere, especially in the US.

Initially, reduced demand east of Poland was matched by lower production. But disruption in supplies from the Russian oilfields has continued while consumption is stabilising.

Short-term oil price inflation has also been affected by worries over the security of supplies from smaller producers.

Earlier in the year, armed conflict in the the Yemen put upward pressure on the oil price. More recently, a general strike in Nigeria has given traders cause to jack up prices.

Yet Iraq continues to cast its shadow over the oil price. The UN embargo remains in place, but at some stage Iraqi supplies are likely to swell world production again.

The increase will not be enormous - perhaps little more than 3 per cent, or 1-2 million barrels a day - but it is enough to worry the market. Like many commodities, oil is traded at a number of different prices, depending on the date a buyer wants delivery, but generally all move in roughly the same direction.

Iraq complicates things. The suggestion is that the United Nations will lift sanctions on Iraq some time next year which will see supplies of oil increase and the price fall.

As a result, a projected demand increase this year is pushing prices up in the short term while predicted supply increases next year are pushing prices down. So while the price of oil for delivery in the next few months is firm, the price for delivery next year is weak.

The phenomenon is more than an isolated freak of the futures market. As soon as Iraqi supplies return, minds will begin concentrating on potential additions from the Russian oil fields.

In 1988, Russia extracted about 20 per cent of the world's oil, or 12 million barrel per day. Political and economic chaos has nearly halved output since then. Nevertheless, Russian oil production will rise again in due course.

By then consumption in the former Soviet economies may also have picked up, but that is the gamble the markets will have to take. If it has not, and if the extra output is driven by Western companies who do not re-invest the resulting profits in the former Soviet states, the world may face a glut of oil and the price will fall.

Yet there is one other unquantifiable: consumption by China, India and the emerging markets of South-east Asia.

'By 1997 or 1998, total consumption by East Asian countries, including Japan, will overtake the US. When it does, the entire oil industry, which has focused on North America for the past 100 years, will shift eastwards,' Dr Stanislaw says.

(Photograph omitted)