May 2004 Financial News

Oil price spike puts inflation back on agenda

May 07, 2004

Source: Financial Times

The surge in oil prices this week above $40 has made central bankers and political leaders increasingly nervous about the inflationary impact of high energy prices.

The attack on a petrochemical complex in Saudi Arabia last weekend increased concerns about supply disruptions in the Middle East, while the very tight supply and demand conditions in the US gasoline market, which accounts for more than 11 per cent of global oil consumption, has also put pressure on prices.

The benchmark crude futures on Friday popped through the key psychological $40 barrier on the New York Mercantile Exchange for the first time since October 1990, just two months after Iraq invaded Kuwait and triggered the Gulf war. But the June Nymex WTI crude futures contract slipped from its peak to trade at $39.77, a rise of 43 cents on the day. More worrying is the fact that oil prices are at their highest continuous level since crude futures trading began in 1983.

IPE Brent for June delivery gained 53 cents to $37.06 a barrel yesterday, having hit a 13½ year peak of $37.20 on Thursday.

Energy analysts said the 5 per cent price spurt this week reflected sensitivity about rising tensions in the Middle East, following the killing of six expatriates in the Saudi attack last week.

The bulk of the oil price increase of more than 20 per cent so far this year reflects the tight US gasoline market. This is underlined by the 40 per cent rise in US gasoline futures this year, with the Nymex June gasoline contract reaching a record of $1.3290 a gallon this week and trading less than half a cent below its peak in early afternoon trade yesterday.

JJ Traynor, an energy analyst at Deutsche Bank, said the attack by Saudi militants highlighted the fact that the risk to Saudi oil infrastructure was more acute than previously thought.

Mr Traynor pointed out that there had not yet been any attacks on oil facilities, and with exports spread over several ports and security tight, the Saudis had done what they could to protect capacity.

"Any attack, however small, would have a major impact on pricing, given that over 60 per cent of the world's spare capacity sits in the Kingdom itself," he said.

The foiled attack on the Basra oil terminal in Iraq two weeks ago has highlighted the focus by militants on attacking oil infrastructure in the region.

Analysts are predicting further oil price spikes. "As far as crude oil is concerned, in the short term a close above the psychologically important $40 a barrel level looks inevitable given the weight of technical funds now flowing into the market," said Paul Horsnell, energy analyst at Barclays Capital.

"Prices could go higher still, and $50 a barrel is possible should the wrong kind of headlines emerge from the Middle East."

An increasing chorus of politicians are entering the debate about high oil prices with Tony Blair, UK prime minister, adding his voice this week.

"We have learnt from history [that high oil prices] can have a severe impact on our economy, quite apart from obviously the consumer," said Mr Blair.

The oil price spike to more than $40 in 1990 and a 40 per cent jump in oil prices over the summer of 2000 were followed by US recessions.

Although no economists are forecasting another recession, they are worried that stubbornly high oil prices could stall global economic growth.

There seems little relief in sight with Middle East tension likely to linger for years rather than months, and the US gasoline market affected by structural issues such as a shortage of refining capacity. No new refineries have been built in the US for about 20 years, an issue that is unlikely to be resolved in the near term.

The Organisation of Petroleum Exporting Countries meet twice in the next month but Opec officials have thus far given few indications that they are prepared to increase output to reduce prices. One official said there was little the cartel could do to alleviate the pricing pressure.