Oil at four-month high as Iraq turns off taps

Ahead of today's Opec meeting, Saudi Arabia hints at higher production to compensate for Saddam's action

The price of oil leapt to a four-month high yesterday before today's meeting of the Organisation of Petroleum Exporting Countries (Opec), as Iraq closed the taps on its exports.

The latest diplomatic dispute between Saddam Hussein and the United Nations sent the price of a barrel of crude on the world's markets up 52 cents to $29.59 ­ within a hair's breadth of the psychological $30 mark.

The only factor keeping it below that barrier was strong hints from Saudi Arabia and Kuwait, which are broadly supportive of the West, that they would increase production.

The 2 per cent price surge is reminiscent of last autumn, when the price of Brent crude rose as high as $35. Oil experts believe that these sharp movements in the price raise important issues for both short and long term.

As last year, tension in the Middle East tends to drive up the price, and at home fuel protests have recurred that almost brought Britain to a halt a year ago. But most economists doubt that the West is looking at another bout of spiralling prices. The world is simply a different place from last autumn, when the US, the world's largest consumer of oil, was growing at an unsustainable pace and the oil markets were looking ahead to a cold winter.

Fast-forward to June 2001 and the major concern is whether the US will suffer a slowdown or actually plunge into full-blown recession.

Lawrence Eagles, oil analyst at brokers GNI, said the global economic outlook was the prime driver of the price. He said figures from the International Energy Agency showed that demand for Opec oil expected in the fourth quarter of this year will be just a fraction above the cartel's supply a year ago.

"So as things stand, there is really is little reason for Opec to increase output now," he said. "They should be able to meet global demand, but if they have three months without Iraq pumping that could create a large deficit."

OPEC is constrained in what it can do to respond. Since last autumn, it has operated a price mechanism. Using a basket of eight oil blends, it has aimed for a band of $22 to $28. The Opec benchmark stood Thursday at $26.56. Prices have stayed inside the band since January, helped by Opec decisions earlier this year to remove 2.5 million barrels a day from the market.

Opec's dilemma is that if Iraq keeps the taps shut, by the time the price hits $28 ­ and stays there for 20 consecutive days, as it must do to trigger the mechanism ­ it might be too late to increase supply.

But if Opec was to boost production to stave off an Iraqi-driven shortage, but Saddam backed down, the cartel ­ and Saudi Arabia in particular ­ would be blamed by hard-line Arab countries for undermining the price. As Ali Rodriguez, Opec's secretary-general, put it yesterday: "We have to wait and see what's happening."

However, the last few days have reminded the West that oil shortages must be cause for long-term concern. The bigger question for both economists and business people is can the world afford to carry on buying oil over the long term?

According to Andrew Oswald, economics professor at Warwick University and a renowned oil hawk, the answer is 'no'. He pointed out that at 70 million barrels a day, the world is more dependent on petroleum than at any time in its history. "Without petroleum a modern society would grind to a halt," he said.

Last year, in the face of spiralling oil prices, many economists said technological bene- fits from the new economy meant that a high oil price no longer had the devastating power it had in the 1970s.

But with the US close to ­ or possibly in ­ recession, Japan stagnating and Europe slowing, that argument is harder to sustain, Professor Oswald said. There are two key issues, he said: geology and population. According to an economic formula known as the Hubbert curve, any given oil reserve hits a peak in output decades before it finally runs out.

"We have 30 years of proven reserves or possibly even more ­ that may be true," he said. "But the US passed its peak decades ago."

However for Professor Oswald the "wild card" is China, with five times more people than the US but a population that on average consumes per person just 4 per cent what their US counterpart uses.

"The arithmetic of China is incredible if you think about it," he said. "The US has 135 million vehicles and China only 4 million. Yet China is industrialising now."

These arguments cut little mustard in the oil industry, which has had record profits in recent years. One senior analyst for a UK oil giant, speaking on condition of anonymity, described those who forecast a world running out of oil as "Luddites".

"There is no evidence that will ever happen, and there are adequate supplies and reserves, and the costs of finding new sources are continuously falling," he said. "There are also a variety of economically viable alternatives."

He said the current price of $30 was "massively in excess" of what the industry structure should dictate and said it would be "difficult to maintain".

Last year Shell announced a £1.2bn investment into exploring and developing small-scale reserves in the North Sea. It said innovative technology had made it viable to exploit prospects that would not have been commercially possible even three years ago.

Rising oil prices are spurring investment in oil fields outside of Opec nations. Oil companies will increase spending on drilling and exploration by 20 per cent to $114 billion this year, according to Salomon Smith Barney.

But in the immediate outlook, the last word must go to Opec. "Opec will manage the market," said Iran's oil minister, Bijan Namdar Zanganeh. "I am not concerned about any shortage in the market."