Issue 51

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Oil Shock

    The roller coaster
    Oil politics in the new world order
    Is there really a shortage?
    Another 'oil shock'

The phantom of the oil price shock has once again been raised before the capitalist powers by a three-fold increase of crude oil prices over 18 months, from around $10 to over $35 a barrel. The scale of the shock cannot be measured in advance. But economically, higher oil prices will accentuate the trends pushing the US and the world economy towards a downturn. Politically, the oil tax protests which have swept across Europe are the precursor of approaching upheavals. OPEC's agreement on 11 September to increase output is unlikely to stabilise the situation. LYNN WALSH writes.

PETROL PRICES HAVE surged, triggering a wave of protests in Europe and arousing deep discontent in the US. A gallon of petrol in Europe now costs between $4 and $5, while in the US gas (regular unleaded) has risen from about $1 at the end of last year to over $1.50 currently. The biggest share of the pump price is accounted for by tax (duty and VAT), but the current price increase has been caused by a rise in the world price of crude oil.

European leaders like Blair and Schröder have turned their fire on the OPEC oil producers, and more recently on the big oil companies, accusing them of profiteering. But they offer no explanation for the gyrations of the world oil market. What lies behind the price increase? How do trends in the oil price relate to the wider world economy?

    The roller coaster

THE WORLD OIL market has operated like a roller coaster over the last year and a half. The balance between supply and demand is extremely unstable. Supply is determined by such factors as the policies of the oil producers, the willingness of oil companies to invest in development and refinery capacity, etc. Demand is conditioned by growth of the world economy, especially of the gas-guzzling US economy which consumes a quarter of world output. The 'market', however, cannot be understood in isolation from international political and strategic factors. This is especially true as the crisis-torn Middle East is still the decisive oil-producing region. The intervention of the imperialist powers, especially of the dominant US superpower, is also a major factor. The recent return of oil price volatility clearly reflects the sharpening contradictions in the world capitalist economy and imperialism's growing strategic problems.

From the late 1980s to the late 1990s there was an exceptional period of relative stability. Towards the end of the 1980s growth cycle, crude oil rose to around $30, reflecting increased demand. In 1986-87 Saudi Arabia increased its output, under pressure from the Western powers. As in the past, the Saudi regime was able to compensate for lower prices by increasing its market share. Crude fell to around $12 to $15 a barrel.

After a sharp but short-lived hike during the 1990-91 Gulf war, the price hovered in the $18 to $22 range. The accelerated growth of the world economy, especially the US, pushed prices up again during 1995-97, to around $25 a barrel. After 1997, however, there was a sharp decline in crude prices. This resulted from two main factors. On the one side, Iraq resumed its oil exports under the oil-for-food programme (accepted by the US in an attempt to deflect criticisms of the horrendous effects of sanctions on Iraq's civilian population). Competition between Saudi Arabia and Venezuela for increased market shares, particularly in the US, also increased oil supply. On the other side, the slump in the Asian economies following the regional currency crisis sharply cut demand for oil from that region. In February 1999 the base crude oil price fell to around $10 to $12 a barrel, but some oil was being traded for as little as $8 a barrel.

This had contradictory effects on different sectors of the world economy. Cheap petrol was good news for consumers in the US, Europe and Japan (though most EU governments massively increased petrol taxes). At the same time, low crude prices squeezed the profits of the giant oil companies, whose percentage cut is determined by the crude price. In reaction, the oil companies cut back even more on expenditure on prospecting and developing new oil fields, investment in transport and refinery capacity, etc. Infrastructure investment fell to the lowest level in the post-war period, despite the approaching depletion of some of the existing oil fields.

Lower oil prices relieved some of the pressure on many semi-developed and poor countries. At the same time, however, it intensified the pressure on most of the major oil producers, who face mounting economic problems and rely on oil revenues to pay-off their massive international debts. Low oil prices also intensified the economic and political turmoil in Russia, not an OPEC member but the world's second-biggest oil producer.

The strategists of US imperialism, who for obvious reasons normally favour low oil prices, became alarmed at the potential repercussions of a prolonged oil price slump. They were particularly concerned about tensions in the Middle East, the growing crisis in Mexico, and the turmoil in Russia, where they were committed to supporting the Yeltsin regime. Russia exports over one billion barrels of oil a year, which provides 20% of its foreign exchange earnings (1996). Pushing for an increase in crude oil prices was virtually the only way that the US could bolster Yeltsin's position following the suspension of international aid to Russia in 1998 after its catastrophic internal financial crisis.

At that point, the Clinton administration actively intervened to restore the oil price to a higher level (aiming at around $18 a barrel). Clinton commented that oil prices were "way too low", and the US energy secretary, Bill Richardson, flew to Riyadh in February 1999 to persuade the Saudi regime to restrict output and push up the price.

"It is clear that Richardson's visit to Riyadh in February 1999 coincided with new decisiveness in Saudi thinking. At a joint news conference with the US energy secretary, [Saudi oil minister] Naimi said oil markets were oversupplied and promised to take steps to avoid harm to the world economy, suggesting that Saudi Arabia had decided to put price concerns [ie a higher price] ahead of [attempts to increase its] market share". (Washington Post National Weekly Edition, 8 May 2000)

On 16 March 1999, Saudi Arabia announced that it would cut its output from over 8 mb/d to 7.4 mb/d, while OPEC as a whole would cut output more than 2 mb/d, approximately matching the oil that Iraq was now supplying to the world market. Richardson told a US congressional committee that a further expansion of Iraqi oil exports "will not have any... significant price effect".

Following the agreement, the price of oil steadily recovered, reaching $18 in May. The enhanced price had a number of effects. In particular, it benefited the Yeltsin regime in Russia, which was also able to increase its exports to Iraq (which could now pay for them with renewed oil revenues). The oil price deal cemented Yeltsin's effective support for the US intervention in the Balkans: the bombing of Serbia began on 24 March.

The US, however, got more than it bargained for. The oil price shot up during 1999 and went above $30 per barrel in March 2000. One factor behind this was the role of the Iraqi regime. Recognising that world oil stocks were getting low, the Iraqi regime moved to push the world price up. In September-November 1999, Iraq reduced exports by 1.2 mb/d, and on 22 November shocked international oil markets by suspending its oil-for-food sales. When the price rose to around $30 a barrel, Iraq resumed official oil-for-food sales and also expanded its oil-smuggling operations.

The manoeuvres of the Iraqi regime, however, coincided with a turn by Venezuela, Iran, and even Saudi Arabia to a policy of higher oil prices in an attempt to recoup their serious losses during the 1997-99 'counter-shock' and to ameliorate their crippling economic problems.

By February-March 2000, the US administration had changed its tune, once again putting pressure on Saudi Arabia and OPEC to increase oil output to bring down the price. Clinton threatened to draw on the US strategic oil reserve (built up after the 1973 and 1979 'shocks') to flood the market if OPEC failed to comply with US demands.

OPEC has agreed to a modest increase in output. Facing mounting problems of their own, however, they are far from willing to flood the market and suffer a further massive reduction in the oil price. Even if the oil producers are willing to concede further output increases, moreover, it is far from certain that this will in itself bring a sustained reduction of the oil price. There are many complex, uncontrollable elements in the situation. Shortages of transportation and refinery capacity and especially financial speculation on the oil futures market are now big factors in the situation.

    Oil politics in the new world order

THE RADICAL POPULIST government of Hugo Chávez of Venezuela has played a key role in mobilising the oil producers behind moves to achieve a substantial price increase. This is a sharp change from the past, when Venezuela frequently sabotaged OPEC agreements by producing above its agreed quota, thus undermining the world oil price. Chávez's position reflects the deep economic and social crisis in Venezuela, intensified by the slump which hit developing countries following the 1997 Asian currency crisis. Oil accounts for 70% of Venezuela's exports, 60% of the government's tax revenues. For every dollar the price per barrel falls, the country loses $1bn (£700m) a year. "We don't want prices to drop below their present level", Chávez said in August: "Lower prices would be like passing a death sentence on ourselves and our people".

Commenting on the petrol tax protests in the advanced capitalist countries, Chávez also commented "We understand that they [consumers] start to feel uneasy when crude prices reach $30 a barrel, but they can imagine how it must have been for us when it fell to $8".

Venezuela currently holds the presidency of OPEC, and earlier this year Chávez toured Mexico and the ten other OPEC members, including (much to the annoyance of the US) Iraq. In countries like Algeria, Iran, Libya and Nigeria, Chávez found strong government support for higher prices. Like Venezuela, most of these producers are producing at full capacity and cannot compensate for low prices by increasing their output.

This time, even the reactionary regime of Saudi Arabia swung behind moves to push up the price of oil. Saudi Arabia is still the key OPEC country, producing about a third (7.4 mb/d) of OPEC's output. Its position is decisive because it is the only OPEC country with significant spare production capacity (around 2 mb/d out of OPEC's total estimated spare capacity of 3 mb/d).

A close ally of US imperialism, the Saudi regime has traditionally resisted measures to push up the oil price. The slump to below $10 a barrel, however, appears to have provoked panic amongst the Saudi ruling class. While the advanced capitalist countries were experiencing an upswing fuelled by cheap oil and gas, Saudi Arabia was facing mounting economic problems. In 1998 the budget deficit reached 10% of GDP, while unemployment rose to between 15% and 20% of the 20-29 age group. There is no cash for the grand infrastructure projects of the past, and the Saudis have even had to borrow from the rulers of Abu Dhabi to stave off crisis. A prolonged recession raised the spectre of social unrest on a massive scale. Every $1 decline in the oil price costs the Saudi regime around $2.5bn a year.

The Saudi regime agreed to enforce production quotas. When the price went up to $35 a barrel, however, the Saudis came under extreme pressure from the US to increase production to curb the price rise. At the 12 September OPEC meeting the Saudis agreed to increase their output (by a modest 800,000 b/d - in reality, probably less than 300,000 b/d of new output).

While partially acceding to Western demands for a price reduction, the Saudi regime certainly does not favour a massive fall. Like other oil producers, they want to recover some of the losses of the earlier period and reportedly favour stabilising the price around $22-$28.

The Saudi oil minister, Ali al-Naimi, rejected Western claims that the oil producers were responsible for the petrol protests in Europe. Referring to the fact that taxation accounts for between 60% and 80% of the pump prices, while the producers receive only about 12%, al-Naimi called on Western governments to cut consumer taxes: "We hope the consuming countries will do their part to lower the product price and lower the burden on consumers". (Financial Times, 9 September)

Behind the diplomatic exchanges an intense struggle is developing between the oil producers and the advanced capitalist consuming countries over the distribution of the proceeds from oil, an immensely valuable 'rent' derived from a natural resource. EU governments are demanding the producers cut the price of crude. Oil, they argue, costs Saudi Arabia only $2.50 and Dubai $6 a barrel to pump out of the ground: why should the greedy producers get $30? But, reply the producers, we take only 16% of the price charged to consumers, while greedy Western governments use petrol as a lucrative tax vehicle, collecting 70-80% of the pump price.

The Saudi regime is resisting pressure from the US to break the OPEC front. "Mr Naimi insisted his country would not take any unilateral action that might erode OPEC's hard-won consensus and possibly damage Saudi Arabia's recent political rapprochement with its Gulf rival Iran". (International Herald Tribune, 11 September) Iran is one of the leading 'price hawks' within OPEC, arguing that the producers deserve to reap profits now after enduring the serious hardships imposed when crude prices fell below $10 a barrel. Al-Naimi said: "We have spent the last two years developing a more co-operative spirit within OPEC. Do you now expect us to throw that away?"

When the Saudi regime was attempting to increase its world market share it was prepared to abandon quotas and increase its output. Economic problems and strategic pressures, however, have brought about a change of policy. The Saudi regime now needs a higher crude price, which depends on enforcing quotas. To do this they need the co-operation of other OPEC producers. At the moment, it no longer suits their interests to appear as stooges of US imperialism.

    Is there really a shortage?

THERE IS NO certainty at all that the agreement reached at the OPEC annual meeting on 11 September will result in a sustained price fall. At the time of writing (22 September), the price is continuing to rise (above $35-$37 a barrel). OPEC agreed to increase production by 800,000 b/d, but this probably represents less than 300,000 b/d of 'new oil' above existing cheating on quotas by OPEC members. Many commentators argue that this is not enough to ensure a steady price reduction.

Some OPEC representatives and oil industry experts even dispute whether there has been a shortage of crude oil at all. They blame the price rise on the chaotic international oil market, the oil industry's inadequate infrastructure, and on escalating financial speculation in oil markets. Troubling trends, commented the Financial Times (28 July), are provoking turmoil in "a commodity market where knowledge of true supply/demand balances is sketchy if not deliberately obscured by participants".

One factor which has clearly pushed up prices in the advanced capitalist countries is the inadequate infrastructure. With low crude oil prices squeezing their profit margins, the big oil companies have been very reluctant to invest in new refinery capacity and transportation facilities. "There's no big shortage of crude oil", said a senior European trader yesterday. "There's a refinery capacity problem, especially in the US, and there's a logistical problem". (Financial Times, 11 September)

The world's tanker fleet has been operating at 97% of capacity for the first time since 1973. Oil refineries in the US have been running flat out, which does not suggest a shortage of crude. "The ability of the global petroleum industry to meet sudden shortages triggered by infrastructure problems [such as refinery or pipeline breakdowns] in big markets such as the US is decreasing". (Financial Times, 28 July) Refining "has been unprofitable as margins have been squeezed and construction has ground to a halt in the US and Europe. The US has run a structural deficit in petroleum for several years". (Financial Times, 1 September)

In other words, because the oil companies' profits have been squeezed during the period of low oil prices, they have not been willing to invest in increased capacity to keep up with surging demand during the last phase of the economic cycle. Moreover, the oil bosses view the recent price rises as a short-term trend, expecting that longer-term prices will decline. Why stock up now if it will be cheaper to buy later? As a result, stocks in the US have fallen to their lowest level for 24 years - creating shortages of petrol and especially heating oil, which will become an acute problem if there is a harsh winter.

This situation has given rise to increased financial speculation in the oil commodity markets, another major factor in the recent price increase. "The oil price has gone from $10 to $35 a barrel yet production has only altered by around 3%", says a London oil trader. "The market is not functioning properly..." (Daily Telegraph, 14 September)

"The paper markets have driven the price up", commented another trader. (Financial Times, 12 September). The 'paper market' refers to the trading of futures (contracts to buy yet-to-be-produced consignments), which can also form the basis of various 'derivatives'. Like other 'paper markets', the oil futures market is intended to 'hedge' against future rises/falls in oil prices, that is to spread the risk for producers, distributors, and consumers. But like other 'hedge' markets they have themselves become a vehicle for speculation, generating volatility and additional risks. Much of the trading on the oil markets, moreover, is on the basis of borrowed money, and through this debt the oil market becomes interlinked with other, highly speculative financial markets.

"Sentiment among traders at the New York Mercantile Exchange (Nimex) and International Petroleum Exchange has swung wildly. 'The expectation factor at the Nimex is dominating the fundamentals in a very unhealthy way', says Robert Mabro, the director of the Oxford Centre for Energy Studies. 'Thirty-dollar oil makes as much sense as ten-dollar oil, and that's no sense at all'." (Financial Times, 28 July)

"There are all kinds of oil plays going on and it's not just the oil market", says one London trader. "A whole bunch of financial markets are uniformly bullish on oil". (Financial Times, 7 September)

A glimpse of the kind of speculation taking place was provided by the legal action recently initiated by the giant US refiner and distributor, Tosco Corporation, against the London-based oil trading company, Arcadia Petroleum. Tosco alleges that Arcadia, in collusion with 'other unnamed conspirators', used futures contracts to buy up in advance the whole September 2000 output for UK Brent crude (from the North Sea field), pushing up the price of Brent crude by $2.33 a barrel between 21 August and 5 September (the equivalent of around 2p a litre). As Brent crude serves as the price benchmark for the entire Atlantic basin, Arcadia's action pushed up the price of crude oil supplies for the whole of Europe, Africa and the US East Coast.

Arcadia, however, denies that it has done anything wrong. "Industry sources", commented the Daily Telegraph (14 September), "said there was only a very fine line between creating an illegal monopoly and using experience to create a clever trading position to legitimately enhance profits".

    Another 'oil shock'

WHEN THE OIL price began to rise earlier this year, most commentators dismissed it as a factor of little importance. Oil, they said, is nothing like so important to the advanced capitalist economies as it was in the 1970s. Even a significant hike would not interrupt the growth of the new economy, especially in the US. In any case, they said, in this period of neo-liberalism the oil producers would not be able to effectively combine their forces to impose another oil shock on the West.

Events have shattered this complacent view. Oil is still a strategic raw material, and will remain so for the foreseeable future. Unpredictable levels of supply and volatility in the price for crude and refined oil will intensify systemic volatility in the world economy. At this stage of the business cycle, even a stabilisation of crude oil prices around $30 a barrel will, in combination with other emerging economic trends, help push the US and world economy towards a new downturn.

The price of crude oil could be driven up above $35 (some commentators predict $40) for a period, which would constitute a serious 'oil shock'. Most capitalist leaders and commentators are desperately trying to minimise the impact of higher oil prices. "Real oil prices are still quite low", writes Martin Woolf. "Even today, the real price is less than a third of the 1979 peak and only some 50% higher than during most of the last decade". (Financial Times, 20 September) In the present conjuncture, however, even a 50% rise will have a serious negative effect.

The president of the World Bank, James Wolfensohn, warns that "a $10 shift in oil prices can make a difference and result in one-half percentage point lower growth at the world level. For developing countries as a group, the higher price suggests three-quarters of a percentage point lower growth". (International Herald Tribune, 15 September) This is a minimum estimate of the effects. There is no doubt that higher prices will undermine the recovering growth in South-East Asia and provide a further barrier to a recovery in Japan, the world's second-largest economy. Another commentator writing in the Washington Post, refers to a conversation with "one of Europe's leading central bankers", who "predicted that the oil shock may slice up to a full percentage point off expected growth in gross domestic product around the world over the next year".

Why is an oil price rise so damaging? In the first place, because it cancels out one of the key conditions of the 1990s economic cycle - cheap oil (combined with cheap raw materials generally). Early in 1999, when the crude price dropped below $10, oil was in real terms only half the price of the 1950s, a fifth of the price of the early 1980s. Cheap input prices for the big corporations meant super-profits. In dismissing the role of oil in the 1990s, many commentators ignored this crucial factor.

Andrew Oswald of Warwick University, however, has long argued that the 'favourable supply shock' (cheap energy) was much more important that the 'new economic paradigm' in explaining the 1990s economy. "Historically", he argues, "sharp rises in the price of energy have always been the best predictor of a slump to come". (Observer, 3 September)

Compared with 1980, the advanced capitalist countries get 25% more output for each unit of energy, and some economists claim more. When the world economy depends on 70 mb/d of oil "that [saving] is useful", says Oswald, "but it is a relatively small gain in the face of a trebling of the price of petroleum".

Higher oil prices will raise input costs and squeeze the profits of the big corporations, especially when intense international competition makes it hard for them to pass on higher costs to consumers. Most of the costs, however, will inevitably be passed on. If consumers are forced to spend more on petrol, heating fuel, public transport fares, etc, they will have less to spend on other goods and services. In the US, consumer spending has been the main locomotive of growth in the second half of the 1990s. Any decline in consumer spending will spell a general downturn in the economy.

While the organised working class of Europe and North America are not in such a strong position as they were in the early 1970s, which followed the peak of the post-war upswing, higher consumer prices will nevertheless lead to increased demands for wage increases. Fear of a revival of inflation will almost certainly push governments and central banks into curbing growth through higher interest rates and tighter monetary policy. A tightening of monetary policy by the US Federal Reserve preceded the slump of 1979-81 and the prolonged recession after 1990. Heightened volatility on oil trading markets will feed into the volatility of financial markets generally.

The trajectory of oil prices over the coming months cannot be predicted with any precision. There may be extreme price volatility, rather than a sustained rise. The US administration may even draw on its strategic oil reserve, which could for a time relieve shortages and dampen prices. Whatever the timescale, however, it is clear that the current oil turmoil is the harbinger of a massive upheaval in the world economy.