War fears push price of oil to two-year highs

The price of oil soared to fresh two-year highs yesterday as the United States and Britain continued to pile on the pressure for war with Iraq, while data showed that US oil inventories have dwindled to 27-year lows.

Commercial crude oil stocks in the world's biggest consumer nation are now at their lowest level since 1975, when the West built reserves to avert future price shocks after the Arab oil embargo.

International benchmark Brent crude oil rose 66 cents to hit $33.11 a barrel, its highest level since November 2000. US crude futures peaked at $36.35, their highest since October 2000, gaining 58 cents yesterday. Analysts said the persistent diplomatic divisions in the West had unnerved markets further.

Lawrence Eagles, of the brokerage GNI, said: "At the moment the world oil market is on a knife-edge. Stocks are very low and supply is tight. With a cold winter in the US, demand is strong. That all creates a very bullish environment."

The Economist Intelligence Unit (EIU) said uncertainty about the shape of any conflict has already pushed oil up by about $6 a barrel. Some analysts said oil was yet to peak and, given the low stocks, it was possible that a price spike could last longer than the short hike that preceded the last Gulf War, more than a decade ago.

Stephen Lewis, the chief economist at Monument Derivatives, said: "Oil could easily go above $40. We have not yet reached the highest level of anxiety. Most believe that war is still weeks away.... A sustained high price would be enough to push the global economy back into recession, deeper than the one seen in 2001."

The mainstream scenario adopted by the market is that of a short and decisive war, like the last conflict with Saddam Hussein's Iraq. That would entail a brief oil price peak – the last war saw oil touch $40 but that came well before the allies' military assault began. A high oil price for more than three months would start to present serious risks to global economic growth, economists said.

Iraq supplies less than 2 million barrels a day of the Middle East's daily production of more than 20 million barrels, so it is expected that Iraqi output will be replaced during the war by other exporters cranking up production. However, if the supply from one of these other countries, such as Kuwait or Saudi Arabia, gets disrupted as a result of the war, analysts warn that oil could shoot a lot higher than $40.

To match the 1973 or 1979 oil shocks, which had a dramatic impact on the world economy, the price of crude would have to go to $70 or $95 a barrel respectively, after adjusting for inflation, Morgan Stanley said. That is considered unlikely but possible if, for instance, the war in Iraq precipitates serious civil unrest in Saudi Arabia, the biggest producer.

A more likely scenario sees a fraught next couple of weeks before the increased output from Saudi Arabia, which began pumping more oil in early January, starts reaching the US. And, as winter lifts, demand will lessen anyway. In any oil price crisis, the international community could release supplies held in strategic reserves.

The EIU estimated that a short-lived war in Iraq would slow OECD growth by just 0.2 per cent. It sees oil dropping to $20 a barrel after a quick conflict. It said that the main damage to the world economy is coming from the build-up to an attack, which puts a risk premium on oil.