Sat, 15 May 2004

The oil price

Gwynne Dyer London

In Bob Woodward's new book, Plan of Attack, he claims that the Saudis promised President Bush to raise oil production in order to keep oil prices down in the run-up to the November election. On May 10, Saudi Oil Minister Ali al-Naimi declared that the Organization of Petroleum Exporting Countries should raise its production quotas by at least 1.5 million barrels a day, and the price promptly fell by a dollar from its recent high of US$40 per barrel. Maybe help is on the way.

Oil at $40 a barrel should not be such a big a deal, really. That's higher in dollar terms than it has been since 1990, but the U.S. dollar has lost a third of its value over the past two years, so for everybody else (including the oil producers), the real price hasn't gone up all that much. Even for American consumers, things aren't as bad as they were during the "oil shocks" of 1973 and 1981: The current U.S. pump price of around $1.75 a gallon compares favorably with the inflation-adjusted price of $2.97 a gallon in 1981.

But it is a big deal, for three reasons. One is the impact on President George W. Bush's re-election campaign of consumer outrage at the pumps. The second is the risk of a new world recession: It was soaring oil prices that triggered three of the past four global recessions, in the early 1970s, the early 1980s, and the early 1990s. The third is that a serious recession could have hugely destabilizing effects in China.

Americans pay far less to fill their cars than any other industrialized country, but they are hyper-sensitive to price rises: Bush could be punished at the polls in November if the price at the pump is still sky-high (by American standards). So will this happy coincidence of a Saudi call to raise OPEC production and bring the oil price down save him from that fate? Maybe not.

What has actually been happening since last September is that OPEC has figured out how to raise prices without cutting production. It has repeatedly announced that it will cut production because it fears that over-supply will make the price fall. The market responds by bidding the price of oil up -- and then OPEC doesn't really cut its production after all, so its members get to enjoy both high price and high production.

Nice trick, but how does it work? Partly it's just that the OPEC members are cheating on their quotas less than they used to. The steep fall of the U.S. dollar especially upset the big Middle Eastern producers who dominate OPEC, because while they are paid for their oil in dollars, they buy most of their imports from Europe, where the dollar doesn't go very far any more. They had to jack the dollar price of oil up just to balance their budgets, so they actually managed to cooperate.

But the trick also depends on China. The United States is still the world's biggest consumer of oil -- 20 million barrels a day (around 60 percent of it imported), out of global production of 65 million b/d -- but China is coming up fast. So long as China's economy continues to grow at seven or eight percent a year (and now India's is growing at a similar rate), oil imports by the Asian giants will grow fast enough to keep world demand permanently up against the limits of supply. In fact, demand may soon exceed potential supply, and OPEC is not a charity.

So the oil price will stay high no matter what the Saudi oil minister says. It may drift down a bit during the northern hemisphere summer, but it will soon bounce back up again. That doesn't just mean angry American voters; it also means that we are sitting on the brink of a global recession. It would probably take an even higher spike in price to push us over the brink, but that is distinctly possible. It could be caused by violence that interrupts Saudi oil exports, for example -- the terrorist attacks at Yanbo on foreign oil-industry employees on May 1 have already started an exodus from the kingdom -- or by a decision by OPEC to demand payment in euros rather dollars.

The recession would start in the United States, where a massive budget deficit (over $500 billion and rising), an equally big balance of payments deficit, and the soaring cost of the war in Iraq make a collapse of confidence quite likely. Recession in America would quickly spread to China, whose growth is heavily dependent on U.S. ability to take its exports. And the U.S. and China together accounted for two-thirds of global economic growth last year: If they go, everybody goes.

So the next world recession arrives much sooner than expected -- and what would make this one different is China, where political stability depends critically on maintaining employment. In a raw capitalist economy with close to a hundred million casual laborers, almost no protection for the unemployed, and a closed political system that lacks legitimacy, large-scale unemployment could easily lead to mass political protests.

China managed to sail through the start-of-the-century recession almost unscathed, but it would not escape an oil-fired recession in late 2004-early 2005. If political upheaval stalls growth in China for a few years, it could be a very long and deep recession. We really do not need another oil shock, but we are closer to it than most people think.

The writer is a London-based independent journalist.