Analysis: Amid talk of war, only one thing is certain: fuel prices will rise

Any interruption in oil supply because of war in Iraq could send prices into the stratosphere and end all hopes of economic recovery

Oil can never be separated from politics in the Middle East, still more so when the region is dominated by the threat of war.

Barely had the US Vice-President, Dick Cheney, made it clear on Monday night that he favoured an invasion of Iraq than the price of crude oil on the open markets went up a dollar a barrel. Twenty-four hours later, calming voices from the Organisation of Petroleum Exporting Countries (Opec) suggesting that the producers' cartel would increase production had prices back down again by 30 cents.

Mind you, that still leaves the price of oil some 36 per cent higher than it was at the beginning of the year and two and a half times the price three years ago. An interruption of supply because of war in Iraq, or even the threat of war, could send prices into the stratosphere, and petrol back up to the 82p or 83p a litre that had the oil tanker drivers blockading the terminals two years ago. It could also end abruptly any hope of economic recovery in Britain, America, or anywhere else. Remove the threat of war completely, and prices could be down a third within a couple of weeks.

Nearly 30 years after the oil crisis of 1973-4 helped to cause a world recession, it wasn't supposed to be like this. And indeed the market was able to bring about an adjustment in the intervening years, dragging down prices to around $12 a barrel through the Eighties and most of the Nineties and encouraging alternative supplies to the Middle East. A generation ago the 11 members of Opec accounted for nearly 60 per cent of all oil supplies going into world trade. Today their share is little more than a third. During the Gulf War, it was Russia which came in with more supply, not the Arab world.

What hasn't changed, unfortunately, is the world's dependence on oil for nearly all its transport fuel and the major part of its heating fuel. The years of record economic growth in America, and Britain, have taken demand levels back to the peaks that caused the original energy crises of the Seventies. At the same time the sources of new supply – the North Sea, the former Soviet Union, the Gulf of Mexico – have all been pushed to the maximum. Add to that the restriction on Iraq's ability to export, low stocks and a shortage of refining capacity and you had the soaring prices that brought the oil tanker drivers out in the dispute of July 2000.

Two new factors have brought about this year's rise in prices. One has been the decision of Opec deliberately to reduce supply nearer to match demand. Sensing that their rivals in Russia and the North Sea had run out of puff, Opec has introduced a series of cutbacks in official production ceilings through the early part of the year. It takes around 50 to 60 days to ship oil to the market, so these cutbacks are only just beginning to bite.

The cutbacks have not been universally complied with. But the simple fact is that most of the oil exporters are running budget deficits. Despite their absurd wealth, princes have spent too much on palaces, ministries have spent too much on defence equipment urged on them by greedy – and grubby – governments in Washington, London and Paris. After two decades of falling prices, their rulers have seen the sense in curbing output in order to nearer match demand.

The other factor, however, has been stockpiling on the part of the consumers. America in particular has been busily following a policy of building up its strategic reserve in preparation for potential problems in the Middle East.

The fear of the market pessimists has been that, in this situation, any disruption of supply because of an invasion of Iraq could only push up prices further. Hence the rise in "spot" prices of crude oil when the US Vice-President intervened to beat the drums of war once more. The hope is that there is plenty enough potential supply to cope with trouble if only the exporters are willing to help. Hence the fall in prices again when various officials of Opec suggested that their next meeting in September would see a rise in limits.

That Opec has the means to make up for any shortfall is not in doubt. In hard production/demand terms there is no reason why war in Iraq should cause even a ripple across the waters of the lake. Where Iraq is exporting perhaps 1.1 to 1.2 million barrels a day, Saudi Arabia is exporting 7.6 million barrels a day and could produce towards 3 million more than that a day. Iran has the capacity for an extra 0.5 million barrels a day, the United Arab Emirates 600,000 barrels.

That does not mean there could not be short-term problems, particularly if hostilities interrupted shipping throughout the Gulf. But precisely because the US has been building up stocks, a major crisis should actually be more manageable than a gradually escalating one. After the experience of 1973, all the major countries have well-established plans for coping with emergencies. Overall stocks among members of the Organisation for Economic Co-operation and Development (the major industrialised nations) stand at the equivalent of some 84 days of demand, adequate to meet most eventualities.

Longer term, there are several potentially sizeable sources of supply. One is the Caspian, where several giant oilfields have been discovered. The problem is transport. Russia, supported by the US, wants the pipelines to go to Europe via their territory. The quicker route – opposed by the US but supported by the Europeans – is through Iran.

But that is for the next decade. In the medium-term the most likely candidate for new supply is intriguingly Iraq, which is not the least reason why it looms so large in American thinking. So far exploitation of Iraqi oil has been held back by nationalisation and sanctions, as well as internal unrest. But studies suggest that its reserves could amount to 200 billion barrels, capable of producing 6 to 8 million barrels a day. In other words it could replace Saudi Arabia entirely, which is what some of President George Bush's advisers are saying to him as they press the view that Saudi Arabia is no longer trustworthy as an ally for the future.

Which is what Mr Bush may well believe himself, except that for the moment there is only Saudi Arabia to whom he can turn to ease supplies and to cope with any disruptions in Iraqi exports. The US doesn't directly take that much oil from the country, but in a global market it is the total pool, and the Saudi part in it, that matters.

That is why, after a month of a growing chorus of anti-Saudi sentiments voiced from the administration's right wing, the US President fell over backwards to offer hospitality to Prince Bandar bin Sultan, Saudi Arabia's Washington ambassador, at his ranch in Texas this week. And it is why his guest may have preferred to treat his host with the greatest caution.

The Saudi royal regime, dependent as it is on US support and military aid, may well want to be helpful. On the other hand, given the state of Arab public opinion over a western invasion of Baghdad, the last thing it would want is to be seen helping America to carry out its warlike plans against an Arab brother.

On past performance, the Arab oil producers will want it both ways – to have a rhetoric of anti-Americanism backed by a behind-the-scenes oil accommodation. But Iraq is forcing the issue in ways that none of them wants. No one is certain what the real US intentions are, or the likely consequences. Until that is clear the oil market will remain in suspense, and prices will continue to rise.