The oil sector: Fears loom of Seventies gloom

Of all commodities, oil is the most volatile even at the best of times. A stray word from one of the majors, or a rumour concerning Opec outputs, and the price of crude will be sent through a violent series of peaks and troughs.

The New York attacks, with their double focus of the Middle East and the global economy, are creating yet another frenzied episode in the troubled market for crude. In the immediate aftermath of the events, oil soared, a knee-jerk reaction to fears that a war in the Middle East could squeeze supply.

In the following days, the decline was even more dramatic. As fears of a global recession took hold, traders adopted the view that demand for oil and its by-products would slump. High on the list was a massive downturn in the demand for commercial jet fuel. But with crude back down at $26 (£17.70) from its peak of around $29 per barrel, the big question is what happens next. The global oils team at Merrill Lynch believes that the situation throughout the world now closely resembles that of the oil shock-littered Seventies, with three major areas of similarity.

The first is that oil producers outside Opec are generating only a lacklustre supply. Many assumed that high oil prices would encourage non-Opec countries to boost output, but the evidence suggests otherwise.

The problem is, in large part, a fallout from the past 19 years of a down cycle. Despite the attraction of high prices, the oil industry has been left without the staff or investment opportunities to aggressively boost production.

The second is that Opec is now in the strongest position for decades to control the oil price by using its stranglehold on the supply/demand balance. Opec has an ideal price band, and even with a worldwide slump in demand, the producers are normally expected to keep crude prices within that.

The third feature is a return to Seventies levels of military and political volatility. The relative calm in the region before the attacks, has now given way to an era that will likely be marked with sudden and unpredictable supply shocks, say the analysts.

The overall conclusion, partly borne out by the actions of the futures market, is that oil will stay around its current highs in coming months and could be subject to more price spikes. For the rest of the world economy, desperately wondering when recovery will come, the growing spectre of an all-powerful Opec makes the prospect seem even more faint.