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Tuesday, July 6, 1999 Published at 15:39 GMT 16:39 UK


Business: The Economy

The power of essential oil

The price of oil has put on a spurt this year

Glut Causes Trouble for Opec, North Sea Producers Cautious, Revenues Well Up: headlines from the world's press reflect a global obsession with the price of oil.

At $18 a barrel, the price has almost doubled this year, after hitting a low of under $10 in December.

Among people who worry about these things, there's been a collective sigh of relief.

But why is there so much fuss about oil prices?


[ image:  ]
The answer is that oil is crucial to the world's economy. Forget gold - the world thrives on oil.

Think how many things rely on electricity, from home appliances to heavy industry, factories and world stock markets. Most power stations use oil or gas to generate electricity and oil accounts for about 40% of all the world's energy.

Oil is fundamental to the running of the civilised world. The plastics and petrochemical industries rely on oil, as does the farming industry.

We may not realise it, but everyone is affected by oil prices.

Higher prices raise production costs for industry, which slows down economies.

They also mean dearer petrol. That hits drivers, increases transport costs to business, can put jobs at risk, and fuels inflation - pushing up the price of everyday goods such as bread and butter, computers and clothes.

Anyone who remembers the 1970s will testify to the crisis which forced the price of petrol at the pump above the important 50p a gallon barrier, and the knock-on inflation.

That sinking feeling

But if oil prices are too low, there is a risk of the natural resource being wasted, and oil producers suffering - especially developing countries.


[ image: Drivers feel the squeeze when prices rise]
Drivers feel the squeeze when prices rise
Last year, oil prices started to drop, eventually hitting a 30-year low of less than $10 a barrel as a glut of crude oil flooded the market.

Some even feared it could hit $5 a barrel. Oil revenues were down 30%, or $50bn, for Opec countries in 1998.

Weak demand, especially in Asia after last year's financial crisis, was the major cause.

Opec reacted by agreeing to slash production by 3m barrels per day, to force the price back up. But some producers, especially Latin American nations, were suspected of ignoring the agreement.

The organisation has historically had difficulty enforcing deals and preventing cheating.

New blends

Another effect of last year's slump in prices has been merger mania between the oil giants. BP Amoco was created by the takeover of Amoco by BP in December. Then the new company took over US oil group Atlantic Richfield. TotalFina has made a hostile bid for rival oil concern Elf Aquitaine.


[ image: Oil rig workers produce a precious commodity]
Oil rig workers produce a precious commodity
Speculation has begun on the next takeover target - and bets are on Texaco and Chevron. But in the immediate future, what worries the oil giants and their shareholders is how well the current price will hold up.

There have always been fears, supported by green campaigners, that the world's supply of oil is going to run out. Those fears are unlikely to ever completely disappear.

But a recent review of global supplies by BP Amoco concluded that existing wells are not being exploited to the full, and there are enough untapped reserves to last another 41 years, at current consumption rates.

Nonetheless, experts say that with production limits still in place, cheap prices are a thing of the past.

Minimal prices effect

But they are divided over just how far they will rise.

Mark Redway, of natural resources broker T Hoare Canaccord, believes they may reach $20 a barrel next year.

And investment bank Goldman Sachs predicted oil prices would at least double by the end of 1999.

But the Economist Intelligence Unit predicts oil prices are likely to average $14 or $15 a barrel this year and stay at that level.

Oil expert Fares Ghneim said: "We don't think prices will keep rising indefinitely - we think they'll stay in the mid-range.

"Opec is trying to enforce the production cuts and the incentive to cheat will increase by the end of the year. Demand for oil will still be slow."

The natural consequence of the rise in prices would be growth in inflation, just as the UK is enjoying its lowest rate of price rises for years.

But Michael Hulme of Lehman Brothers forecasts a minimal knock-on effect.

"The sort of rises we've seen might be worth 0.3% on inflation by this time next year and the same the year after, and a similar effect in Europe - less than in the US."

Companies are less reliant now on oil than in the past, so an 80% price rise over the last six months, although it looks large, is not so great in real terms, he said.



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