The price of oil has surged during 2004, after a period of relatively low prices.
This article was written on 29 October 2004 as a background paper for the cwi international conference. socialistworld.net.
A new oil crisis
The price of the benchmark Brent crude (the most expensive light, or low sulphur, crude) rose to $40 a barrel in May. It rose to almost $50/b on 20 August, fell back slightly, and then surged above $50/b on 29 September. In late October it was around $55/b. At the time of writing (29 October) it has fluctuated above and below $50/b for three months. This is virtually a doubling of the price since late 2003, though in real terms the price is still well below the March 1981 peak ($80/b in today’s values). In May 2004, many commentators dismissed the oil price rise as merely ‘sand in the wheels’ of the world economy, an irritant rather than the onset of a dangerous oil ‘shock’ comparable with 1973 and 1979. They attributed it to a panic reaction to the strengthening of the resistance in Iraq and attacks on Saudi oil installations. (See: The World Economy; Oil Shock? Socialism Today No.84, June 2004, www.socialismtoday.org). By the end of September, however, many capitalist representatives had come to fear that the world economy might well be facing an oil-driven recession.
Events have shattered the Bush regime’s fantasy of securing an abundant supply of cheap oil, one of its main aims in occupying Iraq. The war has rebounded with a vengeance on the US and the advanced capitalist powers. Last year, prices on the oil futures market reflected an expectation that oil would cost around $25/b in mid-2004. But in October, the managing director of Sueden, a UK-based commodities broker, commented: "$50 is no longer considered the ceiling… it’s now looking like the floor price and investors are now looking at other commodities in the same way they have looked at oil." (Commodity Index at Twenty-Three Year High, Financial Times, 8 October 2004) Speculative investment flows into the oil market were followed by similar flows into commodity markets. Early in October, the Reuters CRB index (a basket of 17 commodity futures) reached a 23-year high. (FT, 8 October) "Persistent high oil prices remain a shadow over the recovery," commented an economist with Global Insight Inc (Nell Henderson, Greenspan Cites Oil’s Restraint, Washington Post, 9 September 2004)
Interrupted supplies
The recent price surge is not the result of a producers’ embargo (as with the Opec embargoes of 1973 and 1979), but arises from a combination of supply and demand factors. There was a strong growth in demand for oil in 2003-04, mainly as a result of rapid economic growth in China and to a lesser extent the US. On the supply side, existing production facilities, transportation and refinery capacity could not readily meet the increased demand. At the same time, events in Iraq, Saudi Arabia, Venezuela, Russia and Nigeria, together with four hurricanes in quick succession in the Gulf of Mexico, disrupted supplies and provoked panic on international markets. Then, rising prices and the prospect of a prolonged rise in the price of oil attracted big financial speculators into the oil futures market, pushing the price up even further.
Rapid growth in China, particularly in the energy intensive manufacturing, transport, and construction sectors, increased the country’s demand for oil by around 40% between 2001 and 2004. China accounted for two-fifths of the world increase in demand for oil between 2000 and 2004. Desperate to secure sufficient oil to fuel its rapid economic growth, China’s importers have been prepared to pay premium prices, effectively bidding up international oil prices. A series of price leaps (oil has tended to jump in approximately $5/b increments over recent months) is typical of market conditions in which rising demand reaches the limits of available supply. Demand for oil from semi-developed Asian economies, which are more energy intensive than the advanced capitalist countries, has also generally grown. Relatively high growth in the US, moreover, where fuel taxes are low and use of gas guzzling SUVs (sports utility vehicles) has increased, also led to stronger demand. The US, which has 4% of the world’s population, consumes more than a quarter of the world’s energy.
Far from increasing the world supply of oil, as Bush’s advisors predicted (see Peter Beaumont and Faisal Islam, Carve Up of Oil Riches Begins, Observer, 3 November 2002), Iraqi production is still far below the pre-war level (producing not much over one million bpd since the US-led invasion compared with over three million bpd in the previous period). Moreover, Iraqi output has frequently been cut off by attacks on refineries and pipelines.
In 2003, the oil strike in Venezuela (in reality, a bosses’ lockout, a political weapon against Hugo Chávez) cut production for a period.
In Russia, the prolonged confrontation between Vladimir Putin and Yukos, the giant oil and gas producer, headed by the jailed Mikhail Khodorkovsky, further reduced supplies and created great uncertainty about the future of the Russian oil and gas industry.
New attacks in May 2004 on oil installations and foreign workers in Saudi Arabia provoked panic on the international oil market. Early in May, insurgents attacked killed six people in an attack on oil company premises in Yanbu on the Red Sea. At the end of May, insurgents rampaged through Khobar, seizing hostages and killing twenty-two people.
Then, in August-September 2004, hurricanes Charlie, Frances, Ivan and Jeanne created havoc in the Gulf of Mexico, reducing output by around a third for several weeks.
In Nigeria, the insurgency in the Niger Delta region, which produces all of Nigeria’s oil, reduced production and further stoked international fears. The Niger Delta’s People’s Volunteer Force have threatened to launch Operation Locust Feast unless Shell and other big oil companies shut down production and evacuate their workers. The majority of the region’s Ijaw people live in abject poverty, while the oil companies sell crude oil for about $36 a barrel (which they aim to produce at between $2 and $1.5 a barrel). The militia leader, Mujahid Dokubo-Asari, converted to Islam and proclaims his admiration for Osama bin Laden. (Threat of New Conflict in Nigeria Helps Oil Price to hit $50 a Barrel, Financial Times, 28 September 2004) General strike action by Nigerian workers also affected oil exports.
Dwindling reserves, chronic under-investment
Surging demand and unexpected interruptions of supply have highlighted the extremely limited spare capacity available in production, refining and distribution. For the first time, global demand for oil in 2004 will outstrip worldwide capacity to refine and distribute oil, according to Goldman Sachs. (Robert Winnett, Speculators Hijack Oil Market, Sunday Times, 12 September 2004)
The head of commodities trading at Barclays Capital comments: "The oil system has cracked. There is a lack of refinery and distribution capacity. The spare capacity is now down to one million barrels a day…" (Winnett, ST, 12 September)
Despite their immense profits, the big oil companies have failed to invest enough in new development to ensure sufficient output to meet the current requirements of the world capitalist economy. Nor have they seriously invested in alternative, renewable sources of energy. This situation is a repetition of the serious, worldwide underinvestment in the period before the 1973 oil crisis. After an upturn of investment in production, tankers and refineries during the 1970s, when oil prices were high, there was a stagnation of investment during the 1980s and 1990s, when prices were mostly very low. Very few refineries, tankers, or pipelines were built. During the second half of the 1990s, however, when there was an upturn in the world economy, especially in the US and China, growth in demand for oil began to outstrip world capacity. At the beginning of 2004, most commentators simplistically blamed the oil price rise on surging demand from China. Now some government officials and media commentators are admitting that there is a structural problem, a mismatch between supply and demand, not merely a cyclical shortage. "It’s not fear that’s driving prices, it’s the market fundamentals that everybody overlooked," says Erik Kreil, an analyst in the US Department of Energy. (Jad Mouawad, Not a Ship to Spare, New York Times, 20 October 2004)
The head of energy research at Barclays Capital (London), Paul Horsnell, comments: "There’s been underinvestments in absolutely everything. What we’ve got here is payback throughout the industry for a market that’s relied too long on spare capacity." (Mouawad/NYT 20 October2004)
"According to Goldman Sachs, the capacity of oil tankers and oil refineries has been dropping since the early 1980s because of a lack of investment, and the crunch will come this year. Since 1983, real spending on exploration and production of energy has fallen by 49.5%. To build the extra infrastructure that is required will take years, possibly more than a decade, to complete. The International Energy Agency forecasts that over the next 30 years the energy industry globally will require $16,000 billion in new investment to catch up – and it is not clear where this money will come from." (Winnett/ST, 12 September)
Currently, there is a severe shortage of tankers. From a world fleet of 1,500 tankers, only two or three are available at any time. Tanker rates have soared. Between 1995 and 2004 the average price of renting a large tanker for a voyage from the Persian Gulf to Japan was $35,000 a day. Currently, the rate is $135,000 a day. On a journey of 40 days that adds $4 million to the transportation cost. "The tanker shortfall," comments Jad Mouawad (NYT, 20 October), "is just one of the pressures facing oil markets – a tightness that runs throughout the oil production chain, from fewer oil discoveries to a lack of refineries."
Clearly, the oil majors seriously underestimated the growth in demand for oil. They have been extremely cautious, moreover, at risking huge investments in unstable areas like the Middle East, Russia and Central Asia.
In 2002, there was surplus production capacity of five million bpd. Now there is virtually no surplus. Saudi Arabia, still the world’s biggest oil producer, used to have spare production capacity of several million bpd, but it is now thought to have less than one million bpd.
"The world has less spare oil capacity than it did on the eve of the 1973 oil shocks. Despite that, big international oil companies are ignoring the incentive of record high oil prices and are not investing in finding and developing new fields." (James Boxall and Carola Hoyos, Oil Majors Put the Future on Hold, Financial Times, 7 September 2004) They have not been wooing their shareholders with the prospect of developing new oil fields. Instead, the big companies have decided to sooth their shareholders by buying back shares and increasing dividends instead of substantially increasing their exploration and production expenditure.
The profits of big oil companies have been pushed up to near record levels by the oil price surge. On 25 October, five big oil companies (ExxonMobil, BP, Royal Dutch/Shell, ChevronTexaco, and ConocoPhillips) announced quarterly profits which together totalled $19.6 billion (for 2004 Q2). At the same time, these companies announced that they would be concentrating on increasing production from mature oilfields such as the North Sea and the Niger Delta. Their focus would be on ‘capital discipline’, code for ‘making as little capital investment as possible and channelling maximum profits back to shareholders’. "Exxon is expected to lift buybacks from $2 billion to $3 billion, quarter over quarter, reaching $9 billion for the year, Chevron has restarted repurchases, and Goldman Sachs estimates BP could return $32 billion to shareholders between 2004 and 2006, equivalent to 15% of its market value." (James Boxall, Shareholders Scrutinise Oil Giants’ Results, Financial Times, 25 October 2004) One oil consultant, Art Smith, of consultants John S Herold, estimates that this year the big companies buybacks of shares from shareholders (which raises profits per share, thus keeps the share price higher) may exceed spending on exploration and development. ‘Capital discipline’, claim the oil company executives, is necessary because of geopolitical risks and high taxation in many oil-producing countries.
"… new oil no longer comes from stable areas such as Alaska and the North Sea but increasingly from risky and unstable parts of the planet." (Editorial, Fifty Dollars Oil, Financial Times, 29 September 2004)
Horsnell of Barclays Capital comments: "The market faces the prospect of years without sufficient flexibility or insulation from shocks during a period of extreme geopolitical stress." (Financial Times, 28 September 2004)
The oil majors, the handful of big oil companies that dominate the world industry, no longer have the adventurous, buccaneering attitude they demonstrated in past periods of expansion. In recent years, the oil majors have increasingly left oil exploration and the initial development of new fields to the smaller oil service companies. Ruthlessly competing with one another in this risky business, these companies frequently employ the predatory tactics used by the Seven Sisters (the major oil companies) in the early days of oil imperialism. Acutely aware of geopolitical risks, they are also acutely conscious that oil reserves are rapidly running out, posing serious problems for the industry in the next period.
According to a study by consultants, PFC Energy, the world already uses about twelve billion more barrels a year than it finds. "‘In almost every mature [oil] basin, the world has been producing more than it’s finding for close to 20 years.’ That can’t continue indefinitely." (Robert Samuelson, Oil Fantasies, Washington Post, 6 October 2004) "Outside Opec, mature fields in the US and North Sea are producing less and less oil while new discoveries have proved elusive, with 2001-03 yielding an average of 6.8 billion barrels a year of new oil found, compared with 11.4 billion a year between 1995 and 2000." (Kevin Morrison, How can Opec bring calm to the world oil market? Financial Times, 3 June 2004)
World demand, currently at 80.3m bpd, is expected to rise to almost 120m bpd by 2025, roughly twice the level of the 1970s. The only regions with sufficient new reserves to meet most of this demand are the Middle East and Russia/CIS. Most of the new oilfields in other regions are relatively small. For instance, if Bush succeeds in allowing US oil companies to drill in the Artic National Wildlife Refuge, which has possible reserves of about ten billion barrels, the output is only likely to be around one million bpd (about 5% of present US demand).
According to the chief executive of ExxonMobil, Lee Raymond, "Most of the world’s biggest fields have probably already been found and the next opportunities are likely to come when large investments in countries such as Russia, Iraq, Libya and Saudi Arabia become politically possible". (Boxall and Hoyos, FT, 7 September)
"To increase output [in the Middle East] will require huge investments in the region, estimated at $27 billion a year. But for that to be possible there must be a favourable political climate, which is far from the case." (Nicolas Sarkis, Is There Really a Rise in Oil Prices? Le Monde Diplomatique [English edition], July 2004) The reference to "a favourable political climate" refers to the demand from the major oil companies to be allowed to break the monopoly control of the state-run national oil companies in countries such as Saudi Arabia. The majors are becoming more and more unwilling to cooperate with state oil companies, and want direct control of production, refining, and transportation, with ‘acceptable’ rates of taxation on production and exports. "Beyond that lies the big unknown, in the Middle East and elsewhere: when production will peak in one country after another, before irreversible decline." (Sarkis)
"The number of new finds is falling, as is their volume. Only one giant oilfield, Kashagan in Kazakhstan, has been discovered in the past 30 years and new finds do not compensate for the oil extracted every year." (Sarkis)
In the next ten to fifteen years, all the advanced capitalist countries, together with China, will become increasingly dependent on imported oil. Despite the long-term, slow but inexorable, exhaustion of oil reserves, the major capitalist powers and the big oil companies have been extremely slow to invest seriously in the development of alternative, renewable energy sources.
The growing dependence of the advanced capitalist countries on imported energy, particularly from the Middle East and Russia/CIS, and the oil majors’ increasing resentment at the role of national oil companies and the Opec cartel, lies behind the aggressive struggle of the big powers and their oil companies to gain control of oil reserves in the Middle East, Africa and Central Asia. Far from reducing ‘geopolitical risks’, however, imperialist intervention in Afghanistan and Iraq, and the accompanying build up of US bases internationally, have immensely aggravated instability in the Middle East and the so-called ‘arc of crisis’ which stretches into Central Asia.
Oil speculation
The surge in oil prices and the prospect of even higher prices to come has attracted a shoal of speculators into the market. This drive for short-term profits on the two main oil markets, Wall Street and London, has been described as a ‘black gold rush’ and a ‘new Nasdaq’. Speculative activity has, according to Opec and other commentators, added around $15 to the price of a barrel of crude, and sharply increased volatility in the oil market. "This is the hottest oil market I have ever seen," commented the head of one oil company. "There has been a massive increase in hedge fund activity. And what we call non-commercial interest [those who do not use oil for their businesses] has doubled recently a lot of new banks are coming in and all the speculation is very disruptive." (Winnett/Sunday Times, 12 September)
The Bank of International Settlements (BIS) reported that in the first eight months of 2004 the volume of oil future contracts increased by 25%. At a time of lacklustre gains on major stock markets, the speculators, who include investment banks, major commercial banks (eg Barclays) and hedge funds (clubs of wealthy investors), were attracted by the huge, short-term profits that can be made. "With prices in most major equity, bond and credit markets moving sideways or even declining, investors in search of higher returns have reportedly turned to commodity markets, oil in particular." (In Search of Black Gold: Speculation in Oil Markets, BIS Quarterly Review, September 2004, p6) In September, it was reported that major New York and London banks were offering $1 million sign-up fees to any oil trader ready to join their staff.
In the past, most crude oil was purchased on the ‘physical’ market, where petrol dealers, airlines, power generation companies and other big industrial consumers purchased oil directly from the producing companies. In the last 18 months, however, there has been a rapid ‘commodification’ of oil, with a larger share (currently around one sixth and rising) traded on the futures market. Out of about 680,000 crude oil outstanding future contracts (not all of which will be exercised) the share held by hedge funds and other speculators fluctuated in 2004 between 92,000 and 167,000. (Commodity Futures Trading Commission, reported by Jonathan Fuerbringer, Some Oil Speculators Are Starting to Bail Out, International Herald Tribune 30 August 2004; and Bloomberg News, Hedge Funds Helped Fuel Oil Price Stampede, BIS Says, IHT 7 September 2004)
Taking advantage of low interest rates, the hedge funds, securities firms and other finance houses purchased oil futures on the basis of borrowed cash (the BIS reported a 50% increase in borrowing by these institutions to finance oil purchases).
Prices on the so-called long-term oil futures market (in which options to buy oil in five years time are traded) have also risen sharply. Over the last 20 years, the price per barrel has averaged around $20. Over the last 18 months, however, the price has soared to $35 a barrel, partly as a result of intensified speculation.
At the same time, calculations that long-term supply problems will steadily push up the price of oil for the foreseeable future have led some of the big investment banks to buy up physical supplies of crude to build up physical stores which they hope to sell at a big profit in the future. Morgan Stanley, for instance, has been acquiring warehouse space in the Netherlands and hiring tankers in order to accumulate a store of crude oil.
"… apart from the short-term speculators, the investment banks have also identified a looming ‘oil crunch’, which has encouraged them to move aggressively into the market." "The bleak, long-term outlook for oil prices is also why banks have begun to build up oil supplies directly. Morgan Stanley and Deutsche Bank recently bought the rights to 36 million barrels of oil between 2007 and 2010 direct from a North Sea oilfield." (Winnett/Sunday Times, Speculators Hijack Oil Market, Sunday Times, 12 September 2004)
The world capitalist market has failed to develop sufficient supplies to match currently growing demand. Instead of the planned development of energy resources (including renewable sources), there is market anarchy, dominated by a short-term drive for profit. Frenzied speculation on the oil market has aggravated the volatility and instability of both commodities and financial markets. (See: Black gold rush and casino capitalism, The Socialist, 23 October 2004; www.socialistworld.net)
Fears of geopolitical shocks
Leaders of the capitalist West and Japan have been desperately trying to play down the potential danger, but in reality they are haunted by the possibility of a new oil shock. Despite the weakness of Opec in the late 1990s, when oil fell to $10/b, the West still fears the possibility of concerted action by Opec to push up oil prices. They also fear upheavals in key oil-producing countries, especially Saudi Arabia, which hold two thirds of the world’s known oil reserves and currently supplies about 30% of Opec supplies (which, in turn, constitute almost 40% of world supply).
It is an irony of history that G8 finance ministers meeting in New York in May were obliged to appeal to oil producers "to provide adequate supplies to ensure that world oil prices returned to levels consistent with lasting global economic prosperity and stability". (Financial Times, 24 May 2004) By implication, the appeal was addressed primarily to Saudi Arabia, the only producer with significant spare capacity. Yet one of the main aims of the Bush regime in invading Iraq was to break Opec and reduce dependence on Saudi oil supplies. In fact, US and Western dependence on Saudi output has increased.
In February 2004, Opec announced that it intended to cut its output in order to maintain price levels. World demand for oil usually falls in the second quarter (after the northern hemisphere winter), and Opec members wanted to prevent Western importers from building stocks, which would tend to depress price levels for the rest of the year. The move was also prompted by the continuing fall of the dollar, which reduced the producers’ real income. Demand trends in 2004, however, did not follow the typical seasonal pattern. Demand remained high, and the Opec announcement triggered a wave of speculation on the oil market, which pushed up the price to $40/b by the end of May. Alarmed at the sudden rise, the Saudi regime retreated, quickly promising to push for a 2.5 million bpd increase in Opec output, mainly provided by Saudi Arabia itself. In due course, the Opec meeting in Beirut on 3 June agreed to increase Opec output by 2m bpd. Many commentators, however, claim that these Opec decisions made no difference in practice. Most Opec members were, in any case, already producing over their quotas. Experts were doubtful whether Opec could actually produce another 2m bpd because of limited production capacity.
Technical arguments about quotas, however, were blown aside in May by the attacks on oil facilities and foreign oil workers at Yanbu and Khobar. These attacks were the latest of a long series. The incidents spread panic through the New York and London oil markets. It appeared to confirm widely publicised assessments of the Saudi regime’s vulnerability. A former CIA officer, Robert Baer, had recently published a book, Sleeping with the Devil, which highlights the risk to Saudi Arabia’s refineries, terminals, and pipelines. "The choke points are too many to count," writes Baer. (Paul Blustein, Oil Prices Reach New Peak as Terrorism Anxieties Jump, Washington Post, 2 June 2004)
Concerns about demand outstripping supply were reinforced by fears of new terrorist attacks. As one oil analyst wittily put it, "It’s a struggle between the [market] fundamentals and the [Islamic] fundamentalists."
Western leaders and market traders are not just concerned about the disruptive effects of multiplying incidents of sabotage, hostage taking and killings. They fear that the escalation of attacks points to the fundamental instability of the Saudi regime. An anonymous economist based in Riyadh told the Financial Times: "If the attacks create the sense that Saudi Arabia is sinking towards civil war, it would have a massive effect on the markets, more worrisome than an attack on supplies. If you stop and think of it, such perceptions could drive oil to $100 a barrel. But we’re not there yet." (How Can Opec Bring Calm to the World Oil Markets, Financial Times, 3 June 2004)
"They [the Saudi regime] appear more vulnerable than they have been since 1991," when Saddam invaded Kuwait, comments Joseph Stanislaw, president of Cambridge Energy Research Associates. "But remember, nothing has ever happened to them." (Market Worries, Financial Times, 2 June 2004)
Whatever they say in public, oil industry strategists do not lightly dismiss the possibility of upheaval and regime change in Saudi Arabia. Fadel Gheit, for instance, warned after 11 September 2001 attacks in the US of a "nightmare scenario" of Saudi Arabia’s main oil export terminal at Ras Tanura being wiped out by insurgents, massively disrupting world oil supply. The Egyptian-born American, who previously worked as a chemical engineer for Mobil at Yanbu, is now an oil analyst for the investment bank Oppenheimer & Co, New York. The Guardian reported his views in June: "Not only is Ras Tanura or the refining centre of Abqaiq dangerously exposed to being knocked out of action by militants, but Mr Gheit also believes regime change in Saudi Arabia to a more hostile Islamic government is an inevitable as it was in Iran a quarter of a century ago. ‘It’s only a matter of time,’ he claims." (Terry Macalister, Once seen as an alarmist fear, an attack on key Saudi oil terminal could destabilise the west, 3 June 2004)
Another oil analyst, Julian Lee, accepts that the $100/b oil scenario could result from the sabotage of a major Saudi oil complex or the overthrow of the regime. "I think it would be difficult to put an upper limit on the kind of panic reaction that you would see in the global oil markets following the loss of Saudi supplies." The Guardian sums up Gheit’s view: "[He] remains convinced that there is a real and continuing threat which would cripple the world economy. He was in the past accused of being irresponsible by critics who said doom mongers had been predicting regime change in Saudi for 20 years, but the current situation frightens economists and consumers alike…" (Macalister)
In public, capitalist leaders put on a brave face, minimising the prospects of another oil shock. However, after attending a recent meeting of the Group of Seven finance ministers, the Observer columnist, William Keegan, commented: "My sense of last weekend’s meetings is that there is an atmosphere of suppressed panic about the oil price, and about the danger of a serious crisis…" (Pouring Oil on Troubled Economists, Observer, 10 October 2004)
A new oil shock?
"An oil driven recession does not look all that far-fetched," wrote Paul Krugman, economist and New York Times columnist (15 May 2004). Most capitalist leaders and economic commentators, however, have so far dismissed the idea of a new oil shock comparable with 1973, 1979 or the smaller shock of 1990 (when Saddam occupied Kuwait). There is no Opec embargo, they say, only a temporary shortage of capacity which can be overcome. Moreover, world inflation is generally very low, nothing like the accelerated rise of inflation in the late 1960s and the 1970s. In that situation, sudden, massive increases in the price of oil simultaneously hit industrial output and triggered big price rises for both manufacturers and consumers. That was followed by demands from workers for compensatory increases in wages, so-called ‘second round effects’ in economic jargon. The 1970s became the era of ‘stagflation’.
Today, the advanced capitalist countries (though not the industrialising, developing countries) are less energy dependent than in the 1970s. In the US, it takes about 20% less energy per dollar of GDP than it did during the last oil price increase, at the time of the 1990-91 Gulf war (partly, of course, because of the reduced contribution of manufacturing to the US’s GDP). Further rises in the price of oil, the optimists argue, will stimulate investment in energy saving and alternative energy sources. Finally, the market mechanism will correct the current imbalances: higher oil prices will cut demand, leading to slower growth, with a subsequent fall in oil prices. However, all this (the optimists admit) is based on the assumption that there will not be a massive upheaval in Saudi Arabia or another big oil producing country.
So all is well in the world economy? Even without the surge in oil prices, the world economy would still be facing the prospect of a new crisis in the near future. Weak global growth is driven by the US and China. The US’s huge twin deficits (the federal budget deficit and balance of payments deficit) are unsustainable. It is only a matter of time before there is a sharp decline of the dollar and a slowdown in the US economy. That would mean a downturn in the world economy, with the likelihood of a convulsion in the world financial system. A world downturn, of course, a decline or even a slump in demand for oil, and the price would fall. Meanwhile, however, a period of high oil prices ($50/b and above for even a relatively short period) would have done the damage to the world economy. In combination with other factors, the oil price rise, even though it is not (yet) on the scale of 1973, is likely to trigger a world downturn or even a serious slump.
‘But it is not like the 1970s’, the commentators continually repeat. However, the oil price shocks of the 1970s are usually referred to in a very simplistic way, as though they were entirely external (exogenous) ‘shocks’, political oil embargoes by the Opec countries. The embargoes arising from the 1973 Arab-Israel war and the 1979 Iranian revolution were, of course, the immediate, precipitating events that triggered economic slumps. At the same time, most of the conditions for economic crisis were present before the sharp increases in oil prices. Among other things, accelerated inflation cut the real income of the oil producers (as oil was almost entirely priced in US dollars at that time). Today, we face a different conjuncture, the factors are not the same as in the 1970s. Nevertheless, the oil price rise is once again a symptom of a deeper crisis, and once again there is an interaction of cause and effect, with higher oil prices accelerating the development of a new world economic crisis.
Worldwide inflation is currently relatively low. But higher oil prices, as in the 1970s, will inevitably have inflationary effects (increasing manufacturers’ costs and consumer prices) and deflationary effects (cutting demand for goods and services, since money spent on energy cannot be spent on other things). This will inevitably mean slower growth. The only question is, how much slower? Conventional wisdom suggests that a $10/b increase cuts 0.5% off global GDP. If oil prices remain around $50/b or above for six months or more, this implies that around 1% could be cut from global growth. Such calculations, however, suggest a smooth adjustment to the new oil price level. In reality, there is likely to be a much more volatile effect, with convulsions in the world economy.
Greenspan, head of the US Federal Reserve Bank, and other capitalist leaders claim that, in contrast with the 1970s, there is no danger of oil price increases triggering an inflationary spiral. "Around the globe today," says US Treasury undersecretary, John Taylor, "people [capitalists] have been more confident that central banks are not going to allow such shocks to feed into more long-term inflation." This is based on the assumption that the reduced bargaining power of workers, reflecting fragmentation of the labour force, weakening of unions and anti-union laws, has reduced if not eliminated so-called ‘second round effects’ – that is workers struggling to gain higher wages in compensation for price increases. One US Federal Reserve governor, Ben Bernanke, however, has sounded a note of caution. If it were certain, he said, that oil price increases would not lead to generalised price increases followed by wage increases, then central banks could stimulate growth through maintaining low interest rates and an easy money policy. "But in practice, you don’t know how well anchored inflation expectations are so [we] must be very cautious in responding." (Chris Giles, Why This Time the World Economy Can Cope with an Oil Price Shock, Financial Times, 20 October 2004). Bernanke, at least, is not ready to rule out an inflationary impact from sustained oil price rises. Real economic forces are stronger than ‘expectations’. It is inevitable, if there is a surge of price inflation, that big sections of workers everywhere will engage in fierce struggles to protect their living standards. While it may not be an immediate prospect, the ghost of stagflation still haunts the bourgeoisie.
The US especially, which imports around ten million barrels a day, is likely to be hit hard by the oil price rise. Increased oil costs have pushed up the US trade deficit, already running at record levels. The 2004 trade deficit is likely to be over $590 billion, 19% higher than last year’s record $496.5 billion imbalance. Last year the US had a trade deficit in crude oil of around $100 billion.
The chronic US balance of payments deficit is the main factor behind the decline of the dollar. Although some producers are now pricing their oil in euros, most oil is still priced in dollars. By cutting the real income of the producers, the decline of the dollar is exerting continuous pressure on the producers to sustain their income through higher dollar prices for oil.
Higher consumer expenditure on gas (petrol) and diesel for vehicles and home heating fuel (which, as winter sets in, is now in short supply in the US) has already cut the growth of US consumption, the driving force of the economy. Slower growth and a loss of jobs is the inevitable consequence.
Could the US and other advanced capitalist economies draw on their strategic reserves to restrain the oil price rise? The US has around 700 million barrels in its strategic oil reserve in Louisiana, and the advanced capitalist countries together have reserves of over four billion barrels. Up until now, US reserves have been used only to make up for interrupted supplies, as when the US released reserves to make up for the loss of oil from the Gulf of Mexico during the hurricanes of September-October 2004. If the US or other major economies attempted to use strategic reserves to hold down the world price of oil, the producers would undoubtedly retaliate by cutting output. In any case, the strategic oil reserves would rapidly run out if it were used for active market intervention.
‘Market forces’ will, sooner or later, bring demand into line with supply, but inevitably with painful results. One oil strategist, Adrian Binks, writing in the Financial Times, sums up the process quite well: "Eventually, high oil prices will dampen economic growth and the oil supply system will move back into balance. The adjustment, however, must be on the consumption side as this is a demand crisis; and it will be painful, for both producers and consumers. Consuming countries will suffer economic slowdowns and will have to take robust steps to reduce oil consumption. This will harm oil producers’ long-term market share. The most effective short-term measure to reduce demand in the world’s main oil market would be higher US taxes on transport fuel. But neither US presidential candidate will address this as the election approaches. China needs to slow down its overheating economy, but risks a hard landing if it applies the brakes too quickly. This is an energy crisis with no easy solutions." (Adrian Binks, Oil: Is the Sense of Crisis Overdone? Financial Times, 19 October 2004)
In recent years, growth rates in Europe and Japan have been much lower than in the US. Higher oil prices will depress growth rates even further. Both the IMF and the European Central Bank have reduced their growth forecasts for 2004. The semi-developed and undeveloped poor countries of Asia, Latin America and Africa will be hit even harder by higher oil prices. "China and Africa are more than twice as energy-intensive as the OECD average, and India almost three times in terms of oil use per dollar of GDP. The IEA (International Energy Agency) estimates that a $10 oil price rise sustained for a year would take 0.8% from the GDP of China, 1% from India, 1.8% from Thailand, and 3% from Sub-Saharan Africa." (Ed Crooks, The Next Oil Shock, Financial Times, 17 May 2004)
Another volatile, potentially explosive element in the current situation is the massive financial speculation in oil futures and other commodities. Phenomenal amounts of liquid, speculative funds are involved in this speculative trading. The possibility of financial crisis is inherent in this process, especially in the event of a decline or sudden fall in oil prices as a slowdown develops. The US hedge fund, Long Term Capital Management, failed in 1998 as a result of speculation in Russian rouble bonds, following their collapse. This brought the world financial system to the very brink of meltdown, only prevented by the intervention of the Federal Reserve Bank. It would only take the collapse of one or two of the hedge funds or investment banks involved in this activity to trigger a major crisis. The collapse of one or more of the ‘market makers’, the finance houses which organise and underwrite the various commodity markets, could also trigger a meltdown. The frenzied speculation in commodities now taking place very much resembles similar speculation in the period before the 1973 oil shock.
Capitalist Chaos
The new oil crisis once again demonstrates the chaotic character of capitalism, with the inevitability of crises and upheavals.
The capitalist market, dominated by the big powers and the major oil companies, has failed to match supply with demand. For decades, following short-term, profit-maximising policies, they have failed to invest in adequate new capacity for production, refining and distribution. Thus, a long-term structural problem has emerged from the conjunctural crisis, initially blamed on unexpected demand from China. In the face of ‘geopolitical risks’ and ‘unacceptable’ tax regimes, the big oil corporations have virtually declared an investment strike.
The conjunctural oil crisis has been enormously exacerbated by frenzied financial speculation on oil and other commodity markets. This has made the situation even more volatile, and uncontrolled speculative activity itself threatens to provoke a crisis in world financial markets.
Increasingly aggressive policies of US imperialism and its allied powers, with military intervention in Afghanistan and Iraq, have enormously aggravated all international tensions and conflicts. As a result, economic, political and national conflicts and convulsions have become much more likely. Far from guaranteeing the US and the West an assured supply of cheap oil, imperialist military aggression has made the supply of oil much more precarious.
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