UK: As Opec flexes its muscles and the price of oil rises, recession becomes a frightening reality

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Source: The Observer Publication date: Mar 05, 2000

A MAN ALMOST no Observer readers have heard of has spent the last few days in urgent discussions trying to save your job and, if you've bought a house recently, from you collapsing into negative equity because you've almost certainly borrowed too much. We won't know until a key international meeting at the end of the month whether he's succeeded or not, but some very good economists say it's already too late. We know from past experience that a recession is now under way.

Bill Richardson is the US Energy Secretary and his visit to Kuwait and Saudi Arabia last week was prompted by the new $30 a barrel oil price. Opec, which was thought by the world to have lost its teeth, has struck again by limiting production rather as it did in the autumn of 1973. The oil price has now trebled in 12 months.

The consequences are already beginning to ripple round the world. In the United States, petrol at 85 cents a gallon has passed into history; petrol prices have soared to $1.50 and by the summer they promise to move up to $2. Poorer families are already complaining they can't afford to use their cars, while even the rich are discovering that their gas-guzzling automobiles are becoming insupportably expensive. In Britain, petrol taxes are so high that only a small fraction of petrol prices reflects the underlying oil price, but even so prices are rising here as well.

In Congress, the recriminations are beginning; Democrats blame Republicans for obstructing any initiative to develop alternative energy use or check the over-reliance on cheap gasoline while Republicans blame Democrats for allowing the US to become overdependent on foreign oil. And President Clinton has said he would consider releasing some of the US' s strategic oil reserve to lower prices. It's the first time any US President has suggested using the reserve for any purpose other than guaranteeing security of supply; to suggest the reserve should be use for price manipulation when supplies are secure is a signal of desperation.

But Richardson's and Clinton's concerns are well-founded. In the post Second World-war era, the oil price has traded at or below $15.27 ( in constant prices) for half of the last 55 years ; it has only ever gone above $22 in response to war or conflict in the Middle East after the Yom Kippur War in 1973, during the Iran/Iraq war in 1979 and again in 1990, after the Iraqi invasion of Kuwait.

And after each of those price hikes, the world has been plunged into each of its three postwar recessions.

The current price rise is now as rapid and as continued as the rise after the Iranian revolution in 1979; worse still, the price has been above the key $22 level for eight months.

Opec, after nearly 20 years of futile squabbling, has reasserted itself with a vengeance. Two years ago, the Mexicans were midwives to a deal between the Venezuelans and the Saudis, in which they agreed to cut production substantially if Opec followed suit,which it did. It has taken three attempts to get there, but by last March, despite lots of cheating, Opec's production was down some 15 per cent while world oil demand had risen, driven mainly by the US boom. In the first three months of this year, world demand averaged 77 million barrels of oil a day; supply stood at some 74.6 million barrels, with the gap being made up by running down world stocks. The result an oil price rising 7 per cent a month.

Alarm bells have been ringing since the autumn, but Opec is reluctant to unscramble its deal so quickly; it wants its share of first world riches and unlike other third world commodity producers it has power and is glorying in the reaction. Above all, it needs the extra revenue. But the Americans are putting on intense diplomatic pressure for Opec to agree to relax its production cuts at their next meeting in Vienna on 27 March.

Last Thursday, Richardson won a statement from the Saudis, Venezuelans and Mexicans that Opec finally would increase production to ease prices. But the amount was not specified; indeed the statement was so vague that oil prices climbed to new highs on Friday night.

As Leo Drollas of the Centre for Global Energy Studies remarks, Opec will have to agree in Vienna to lift production by more than two million barrels a day to secure any downturn in price, and that scale of increase will be opposed by the cartel's hawks (who don't like Israel's stance in the Lebanon and anyway need the revenue); any increase is thus sure to be too little too late.

In any case, whatever relaxation is agreed, it takes 40 days for shipments to cross the Atlantic to the US the key oil market which is just increasing petrol production for the annual summer holiday season.

Drollas thinks prices are certain to carry on rising before any possible fall in the autumn; the only issue is by how much. And even any subsequent fall promises to be small; the futures markets are trading oil in12 months' time at $23 a barrel lower than today but still above the $22 benchmark.

On past evidence, what has already happened is sufficient to trigger an economic slowdown the open question is whether it will turn into recession. Andrew Oswald, professor of economics at Warwick University, argues forcibly that the short-run impact of a rise in the oil price is an inescapable rise in real business costs that necessarily lowers the share of profits in GDP and precipitates cutbacks in business activity and thus recession. What generated the new economic paradigm in the US was not the genius of Bill Gates and the Internet, he insists, but the lowest oil price for 50 years, which prompted a profits boom.

In the UK, profits reached a peak of 16 per cent of GDP in 1998, but are now falling back to 13 per cent and heading towards the 11.5 per cent of GDP that characterised the last three recessions. Already, there are portents of a slow down rising joblessness in the US and falling manufacturing production in Britain.

Each slowdown has its own special factors that cause recession; this time round it is the fantastic bubble in stock market and house prices on both sides of the Atlantic. Once the markets get wind that the economy is slowing down, the downward reaction in share prices will be self- feeding and possibly hysterical, interacting with the effects prompted by the oil price hike.

Oswald and Drollas may be overstating their case, but the numbers and history are persuasive. Time, I suspect, to be careful about buying a house or shares at current prices, for Gordon Brown to err on the side of generosity in his Budget this month, and for pondering whether the current structure and management of the world economy is sustainable. In today's world, national economic sovereignty is a myth. Will Hutton is chief executive of the Industrial Society

Publication date: Mar 05, 2000 ) 2000, NewsReal, Inc.

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-- Crossposter (helping@bring.the.news), March 05, 2000

Answers

Thanks for the post, Crossposter. I read Friday that Northwest Airlines is postponing planned orders for new planes. Other airlines will probably follow suit. This can only mean layoffs at aircraft manufacturing plants. Other buisnesses that rely on oil will probably also postpone new equipment. This spells RECESSION.

-- John (litmajt@aol.com), March 05, 2000.

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