Oil prices are soaring and show no sign of slowing. We analyse the cause and what the rise means for the economy
The rise has been sudden and dramatic. Early this year a lone trader in New York pushed the price of oil above $100 a barrel for the first time, taking the world into a new era.
It did not last, sparking suggestions that the trader had ensured his place in history but very little else. Then, a few weeks ago, the upward march began again. Last weekend, with oil markets twitchy about the closure of the Grangemouth refinery in Scotland and a dispute affecting Nigerian oil output, prices came within a whisker of $120 a barrel.
The president of the Organisation of Petroleum Exporting Countries (Opec), the Algerian energy minister Chakib Khelil, helpfully added to the mix by suggesting that the price could hit $200 as investors fled the weak dollar.
As it turned out, prices spent much of last week slipping back, dropping to just above $110. But on Friday they were up again, responding to Turkish airstrikes on Kurdish rebels. Oil is a great barometer of international tension.
Is the head of Opec right about a $200 oil price? Will a more realistic target, $150, be reached this year and what would be the consequences of that for the economy? Why has oil been surging anyway, doubling in price in a year?
The rise in oil prices reflects a series of factors. In the 1990s, China was an oil exporter, capable of fuelling its own economic boom. Now, apart from being the world’s second largest consumer of oil, it is also a big importer.
Opec, which five years ago had a target range for oil prices of $22 to $28 a barrel, appeared initially worried when the price began to rise sharply, its members fearing that a sudden climb would be followed by a precipitous fall.
Now Opec, and in particular normally moderate voices such as Saudi Arabia, has changed its tune. Some attribute this to the cooling of relations between the mainly Arab Opec members and George Bush’s America in the wake of the Iraq war. Bush’s State of the Union address of two years ago, when he declared his aim of ending US dependence on imported Middle East oil, also rubbed the producing countries up the wrong way.
The result is that even Saudi Arabia appears happy with $100-plus oil, insisting that the market is well supplied and refusing to turn on the taps.
The fundamental question about whether oil prices will rise further is one of supply and demand. Over the past four years the global economy has been growing at its fastest rate since the early 1970s, pumping up demand for oil. Even the slowdown now under way will leave it relatively strong, according to forecasters.
The supply of oil, however, has risen more slowly, either because of production cuts by Opec, political problems or as a result of a lack of investment during the years when prices were very weak.
Adding to this, in the months since the credit crisis broke last summer, is the fact that investors have seen oil and other commodities as “safe haven” investments. Lehman Brothers, the investment bank, calculates that 20-30% of the current oil price reflects speculative demand from investors. That means the price could fall when this “hot” money is moved elsewhere, though most experts thinka price of around $100 is likely for some time.
If so, motorists will have to get used to a new era. There was an outcry a few years ago when it emerged that Mondeo Man — Tony Blair’s target voter — would have to pay £50 to fill up the car. Now, if Mondeo Man still exists, he will have to fork out more than £75, or over £82 if he drives a diesel.
How does £5 a gallon compare with petrol prices in the recent past? The first time motorists paid £1 a gallon was shortly after Margaret Thatcher was elected in 1979 but it took until the eve of her departure from office in 1990, and the first Gulf war, before the £2 a gallon barrier was breached.
In September 2000, when the country was almost brought to a halt by nationwide fuel protests, petrol was 82p a litre, £3.73 a gallon. Ten years earlier, in 1990, prices had been half that level, 41p a litre, 186p a gallon.
The rise during the 1990s, however, had little to do with soaring global oil prices; in 1998 they dropped to just $10 a barrel, though that same year petrol rose above £3 a gallon for the first time.
Rising prices did, however, have plenty to do with the infamous fuel duty escalator, introduced by Kenneth Clarke and embellished by Gordon Brown. This was the policy of raising the tax on petrol, excise duty, by significantly more than inflation each year.
Brown reluctantly abandoned the escalator and for the next four years petrol prices fell, not reaching their 2000 level again until the spring of 2004. But then, as the effect of higher global oil prices came through, forecourt prices moved inexorably higher, hitting £4 a gallon in the summer of 2005.
Adjusting petrol prices for inflation to provide a comparison with current levels shows that the average has been around £3 a gallon.
There have been periods of higher prices — during the first world war motorists paid the equivalent of nearly £7 a gallon — but the current price is about 60% above the long-run average, explaining why motorists are feeling the pain.
What is not clear is whether the pain is making people cut back on their car use. According to the AA, high- mileage drivers and people in rural areas are feeling the pinch hardest. Most of us, however, are unwilling to give up the comfort and convenience of the car, even at £5 a gallon.
“Better-off motorists are absorbing the extra cost into their family budgets and cutting back on other spending, such as going out and home improvements,” said Luke Bosdet of AA Public Affairs.
“High street businesses are feeling the real impact of fuel prices siphoning off money from consumer spending.”
Petrol is one of the most visible prices in the economy. As a regular purchase, people are only too aware of its rising cost. So far, official figures show car use has been steady, even amid the rising cost of fuel and other motoring expenses. Annual mileage per car owner has been flat for a decade. As £5 threatens to turn into £6 a gallon or more, that could change.
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