Crude oil hits record $93, fuelling fears of a recession

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The Independent Online

The world is less dependent on oil than it used to be, as industries have become more efficient and nations have diversified their sources of energy supply, but the looming possibility of the oil price reaching $100 a barrel and an immediate spike in prices for fuel in America is concentrating minds.

Yesterday, crude oil climbed above $93 a barrel in New York for the first time, as Mexico shut one fifth of its production and the dollar fell to a record low. Mexico is the second-biggest source of US imports of refined products, so such an interruption in supply will have a significant effect on America.

Some economists see the surge in the oil price as simply a symptom of the global demand for the black stuff, fuelled by runaway economic growth in China and other emerging markets. Some add that the relative strength of the euro and sterling will insulate Europeans from the brunt of the dollar-denominated increases. Others fret about the effects a heightened oil price will have on the West's stumbling economic performance. Either way, few take the oil shortage as being unalloyed good news.

The oil market "may be only one or two events away from" $100-plus barrel, Daniel Yergin, chairman of Cambridge Energy Research Associates and a leading oil analyst said yesterday: "What we're seeing in the oil market today is rooted more in the cauldrons of geopolitics and the impact of financial markets, expectations and psychology than in supply and demand."

As with the spike in prices in May, the immediate problem is not so much the price of crude as the price of refined products – petrol, diesel, heating oil, plastic feedstocks and the rest – going into the US. With a background of a housing slump and sluggish consumer demand, another squeeze from higher gasoline prices on the pocket books of Americans heightens the possibility of a recession.

Four months ago, it was the shutdown of refineries in the US itself; now it is the Mexican refineries, affected by bad weather, that are the problem. Capacity is tight in any case, with a mis-match between the world's refining capacity (geared towards treating "light" oils) and its production (growing most at the heavy end of the crude spectrum). No new refineries have been built in America since the 1970s. US stocks of oil and gasoline are low by recent standards.

Medium-term factors are also at work. The difficulties in getting the Iraqi industry back to something approaching normality are being exacerbated by political problems in the Kurdish region next to the Turkish border. The prospect of further US action against Iran has also disquieted the markets. Iran and Iraq hold the world's second- and third-biggest crude-oil reserves, after Saudi Arabia. Longer term, the much-awaited "peak" in world oil production, after which it will be downhill all the way, is fast approaching. The International Energy Agency has said that world production overall will peak between 2010 and 2020.

The one constant factor unavoidable in the oil equation, on any time scale, is the voracious appetite from China and India for raw materials. China accounts for by far the largest portion of the recent increase in demand for oil. In 2004, China passed Japan as the world's second-largest consumer of oil; her demand for oil is expected to continue to increase by five to seven per cent a year. If that happens, China will surpass the US as the world's largest consumer by 2025. Similarly, India's oil needs are expected to grow by four to seven per cent a year. In 2004, it consumed two million barrels a day.

Every variety of oil has seen rises. Crude oil for December delivery reached $92.38 a barrel on the New York Mercantile Exchange while futures climbed to $93.20, the highest since trading began in 1983, and up 52 percent from a year ago. Brent crude oil for December settlement rose 70 cents, to $89.39 a barrel on the London ICE Futures Europe exchange. Brent crude reached $90, the highest since trading began in 1988.

In real terms, oil has probably already exceeded its previous speak in 1979/80, again a time of intense geopolitical tensions, especially between America and Iran. Taking into account the change in real per capita incomes, oil prices would need to hit around $120 a barrel before it could be said to be close to approaching the level of pain inflicted on the world economy almost three decades ago. The chances of that happening soon depend less on fixing up the Mexican refineries as on Opec's ability to pump more oil (it's reserves are looking a little healthier), the prospects for peace in the Middle East and on the severity of America's winter. It's a very uncertain outlook.