Oil price set to double if production is cut off

As Libyan output slumps, chances rise of a global supply shock that could push the UK back into recession. David Strahan reports

Oil prices could hit $200 a barrel if the unrest in the Middle East spreads to countries such as Algeria and Saudi Arabia, according to analysts at Nomura. They predicted a doubling in the price if production were to be cut off by the world's biggest producers.

Oil hit a 30-month high last week as the turmoil in Libya cut supplies by over a million barrels a day, raising the chances of a global supply shock that could push the UK economy back into recession. UK retailers forecast the recent rise in crude could push fuel prices up by 5p per litre.

Brent crude reached almost $120 per barrel, its highest level since August 2008, as international oil companies pulled out of Libya and foreign workers fled the country. Crude prices eased, closing at $111.36 per barrel on Friday, after the Organization of Petroleum Exporting Countries (Opec) promised to make good any lost production. But some experts fear the cartel will struggle to mobilise extra supplies quickly enough, or that vital producers such as Saudi Arabia may also be engulfed by revolution.

The oil price has been climbing since regional upheaval started last December, but jumped over 10 per cent this week as production was affected for the first time. Libyan output slumped as companies, including Total, Eni, Repsol and BP, withdrew, rebels seized some fields, and a Chinese installation was attacked. Analysts at Barclays Capital estimate two-thirds of the country's usual 1.6 million barrels per day is now shut down. The Italian oil company Eni estimates three-quarters has been lost.

Italy is the country most exposed to the shortfall – buying almost a quarter of its oil imports from Libya – followed by France and Spain. They will now have to bid for replacement supplies on the open market. Britain relies on Libya for less than 10 per cent of its oil imports, and produces around 1.4 million barrels per day (mb/d) from the North Sea, while consuming 1.6 million.

Libya produces less than 2 per cent of global consumption with 88.5 mb/d, and there should be no immediate shortage of oil because of high oil stocks and spare capacity.

In the countries of the Organization for Economic Cooperation and Development (OECD), the oil industry holds working stocks of about 2.7 billion barrels. Governments hold another 1.6 billion barrels of emergency supplies coordinated by the International Energy Agency (IEA), equivalent to 145 days' imports. But none of this has calmed the market, which is much more sensitive to the level of spare capacity – wells and pipelines that have already been built and can be quickly brought on stream. Saudi Arabia, the largest exporter, currently produces 8.6 mb/d but is thought capable of raising that to around 12 mb/d.

Few doubt that Saudi can raise output in the short term, but there are pervasive concerns about its ability to continue to fill the gap, particularly if the crisis spreads further. The world's spare capacity could also evaporate – and worse – if Saudi Arabia itself succumbed to a popular revolt.

The spark for that could be a "day of rage" planned for 13 March, or a flare-up of the conflict in its tiny neighbour, Bahrain. King Abdullah is evidently alive to the risk; this week he dispensed $36bn (£22bn) of largesse in higher wages, unemployment and other benefits, and promised to spend $400bn by 2014. Analysts say a Saudi collapse is unlikely, but if it happened the impact would be dire. "If Libya was Saudi, there would be no producer of last resort," says Chris Skrebowski of Peak Oil Consulting. "It would be like 1974 all over again and the price would go off the charts."

Even if Western economies manage to avoid a double dip, the relief may be short-lived. According to a US diplomatic cable written in 2007 and recently released by WikiLeaks, Saudi's claimed reserves may have been hugely inflated by "speculative resources", and its production may struggle to exceed 12 mb/d. If so, global oil production could peak and start to fall much sooner than most governments expect.

David Strahan is author of The Last Oil Shock: A Survival Guide to the Imminent Extinction of Petroleum Man