August 17 2000 ANALYSIS The oil spectre cycles round again

ANY economy that relies on a single commodity is wide open to trouble. History is littered with cautionary tales of the consequences, from British cotton and Irish potatoes to Zambian copper or pre-war Japan's lack of oil. Through folly or necessity, many countries are as vulnerable as ever. Oil is often the culprit. On the day when the market price of crude oil reached its highest since the Gulf War spike of 1990, Hugo Chavez, Venezuela's populist new President, described his own country's position in characteristically melodramatic terms. Any fall in the price of oil would, he said, be "a death sentence for our people".

Venezuela survived the 1990s when Brent crude generally traded at between $15 and $20 per barrel, and even in 1998-99, when it traded between $10 and $15. Open market supplies for next month top $32. Seqor Chavez's desire to keep it there tells you a lot about his country's need for economic reform.

Once, global commerce was affected by discoveries of gold or wheat harvests. Today, oil is probably the only commodity whose price variations can affect the world economy.

Twice before, in 1974 and 1979, oil prices lagged behind an inflationary international boom, only to catch up and overtake suddenly through the efforts of the Opec cartel. Each time, the rest of the world was quickly thrust into recession.

Having over-reached itself, Opec is no longer so powerful. Many other sources of oil have been developed and industrial economies have learnt a little from these disasters. Yet oil still matters. Shipping rates, for instance, have jumped to their highest for 30 years.

The amazing longevity of America's non-inflationary expansion owes much to the stable oil price and, particularly to the low prices prevailing before they trebled in the past 18 months. That 1998-99 trough, in turn, resulted from the Asian crash. Troubles in Korea, Nigeria and Venezuela directly helped healthy expansion in the West.

The boot is now on the other foot. Opec and its allies engineered the recovery in oil prices by cutting output. After crude bounced above $30 at the beginning of March, Saudi Arabia and key allies turned the taps a little higher in the hope of stabilising prices at about $25 per barrel. But the momentum is now upwards.

Asian tiger economies are recovering strongly from their lower base. Continental Europe has woken from slumber. Meanwhile, it turns out, America's stocks of oil were run down to avoid the high prices, and partly because air conditioning evens out seasonal demand in a hot summer.

Industrial economies are beginning to hurt. US and UK manufacturers are already reporting rises in material, power and transport costs that are big enough to hit profits unless prices are raised. That will present a stern test of permanent growth without inflation.

In the euro zone, the impact is potentially much worse. The new currency's decline has coincided closely with the rise in the dollar oil price, exaggerating the impact on costs and prices. Inflation has surged over the ceiling the European Central Bank imposed on itself. The hope is that high import prices will not last long enough to generate sustained domestic inflation in the zone.

Pressures on the ECB vary from different members of the zone. Inflation already tops 6 per cent in the Irish Republic. France generates most of its power from nuclear plant and has benefited from the competitive level of the euro.

German industry relies on falling costs of imported materials but now faces much higher costs of its oil-related power. Unless oil prices subside, the euro zone faces a stiff test too.

Seqor Chavez's language suggests that he fears Opec and the oil price will go soft after its meeting next month. They remain a threat to stability both now and in the future.

Energy sources have not been diversified as much as was hoped in the 1970s and planned in the 1980s. Nuclear energy plays the key role in France and Japan, but has been stymied elsewhere by high interest rates, the Chernobyl accident and the lack of a breakthrough on waste.

Renewable energy sources have so far made only a marginal impact. The lack of a cost breakthrough in solar energy has been a serious economic disappointment.

Disillusioned Internet investors are piling billions into all manner of fuel cell technologies and small-scale energy companies. Only a sustained and therefore damaging high oil price is likely to speed them to significant shares of the markets for electricity, transport fuel or industrial power.

In the UK, meanwhile, we have swapped dependence on coal for reliance on natural gas. Partly through contract and partly through the development of market-based energy trading, price trends are moving ever closer together.

On top of the markets in oil, we are developing traders' markets in gas, coal and electricity. Internet-based markets are growing rapidly and leading energy companies expect to make a lot of their future income from operating and trading on those markets.

In principle, large scale arbitrage trading in energy markets should dilute the peaks and troughs in any one of them. But then, in theory, large-scale speculation damps volatility. It does not always seem to work that way on the foreign exchanges.

The danger is that all energy prices will more closely follow the price of oil. The marginal oil price already gyrates much more wildly than it would if all contracts passed through the market. The oil tail could wag an even bigger dog in future. There will doubtless be conflicting attempts to push more business through the markets and to try to insulate contract prices from short-term market movements.

So long as economic development is energy-intensive and fuel comes out of the ground, it will remain an agent of instability. Even under the best financial policies, economic cycles will still be with us.

http://www.sunday-times.co.uk/news/pages/tim/2000/08/17/timbizana01002.html

-- Martin Thompson (mthom1927@aol.com), August 17, 2000

Answers

This is only the beginning of the end for non-renewable oil. If anyone has any doubts, they should read the excellent article that some posted here previously:

When Drill Holes Become Rat Holes

http://rense.com/general2/rat.htm

-- K (infosurf@yahoo.com), August 17, 2000.