Fears over Middle East unrest send oil to pre-recession highs

The oil price shot through the $121 per barrel mark yesterday, returning to heady levels not seen since August 2008.

In London, Brent crude prices rose nearly $2 to a two-and-a-half year high, while in the US, West Texas Intermediate rose to nearly $109.

Oil has been climbing consistently since last autumn, as growing confidence in the global economic recovery boosted demand. But the pace accelerated sharply in mid-February as the unrest that toppled regimes in Tunisia and Egypt spread to Libya, which is Africa's third-largest producer.

The spike is a function of fear rather than fundamentals, according to Manouchehr Takin, a senior analyst at the Centre for Global Energy Studies (CGES). "In terms of supply and demand, the price should probably be at around $100," Mr Takin said. "But both the physical and the paper markets are being driven by fear of disruption spreading."

Libya's daily production rate of around 1.8 million barrels per day (bpd) is too small a proportion of global demand to have a major impact on price. Not only is Saudi Arabia estimated to have raised production by around a million bpd in recent weeks in an attempt to take the sting out of the Libyan shortfall, but the desert kingdom still has another 3 million bpd-worth of available capacity.

But it is Saudi's overwhelming dominance of global oil supplies that itself is a key factor in soaring prices. Oil buyers are growing increasingly concerned that even highly repressive – and wealthy – Saudi may not be immune to the upheavals sweeping the Middle East.

Such unease is not unjustified. Last month the Saudi king launched a package of wage rises and job creation schemes worth hundred of billions of dollars, in an attempt to douse the sparks of civil unrest blown over from Egypt and Libya.

"Fundamentally there shouldn't be this rise in price just because of Libya," Mr Takin said. "The fear is that the contagion could extend to other Persian Gulf producers and even to Saudi Arabia itself."

In the short term, the Opec oil producers' cartel shows little sign of instigating a formal production increase to help bring down the oil price. Massoud Mirkazemi, the oil minister of Iran, which holds the rotating Opec presidency, said again at the weekend that there is "no need" for an emergency meeting of the 12-country group. The Iranian President, Mahmoud Ahmadinejad, yesterday added the warning that oil prices are "not real" and will spiral as high as $150 a barrel.

If prices continue to rise, there will be an appreciable drag on global economic recovery, affecting both fast-growing emerging economies and the leviathans of Europe and the US. It is in Opec's long-term interest to keep prices down, to avoid a slump in demand and a faster switch to alternative fuels.

The chief executive of the state-owned Kuwait Petroleum Company, Farouk al-Zanki, yesterday said a "fair price" for oil is between $90 and $100 per barrel. But he confirmed that Kuwait has not been asked to boost production to neutralise fears over Libya. And in the short term, Saudi Arabia may decide it needs all the revenues it can raise, in case it needs to spray more cash at a restive populace.