The movement of goods and commodities at the Suez Canal in Egypt remains normal, despite the protests in Cairo.
The movement of goods and commodities at the Suez Canal in Egypt remains normal, despite the protests in Cairo.

Despite familiar patterns from past, no new oil shock



A pipeline blazes in Egypt, global oil demand surges surprisingly, inflation returns and oil prices jump above US$100 a barrel for the first time since the financial crisis.

These are familiar elements from oil crises of the past. The first great oil shock, of 1973, accompanied rising inflation as the US printed money to pay for the Vietnam War, and was triggered by the October War between Egypt, Syria and Israel.

The second, in 1978-1979, came as millions flooded on to the streets of Tehran to demand the removal of a western-backed dictator.

So far, we are not in oil-shock territory. Indeed, prices fell back on Friday after violence in Egypt receded. But should the fragile world economy fear another round of higher prices?

The first key point is to untangle a slow-motion demand shock from a faster supply shock - or rather, the threat of one. So far, the drama in Egypt has not interrupted the flow of a single barrel. The country is barely an oil exporter, only a moderately important exporter of gas, and the vital Suez Canal is so far operating normally.

What is more important is fear - the fear that unrest might spread to a major energy producer or that transit might be interrupted. With such a threat, even if relatively unlikely, it is sensible for consumers to protect their interests.

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A taxi driver cannot risk losing hundreds of dollars of fares for the sake of $40 of petrol - better to stock up ahead of a possible shortage. This precautionary demand was a key factor in driving prices to record heights in the 1970s.

There is no panic buying yet, but a milder form encourages traders to drive up prices - not "speculation" but a rational provision against an unknown future.

The other strand, demand, was a factor well before Egyptian protesters filled Tahrir Square or Zine el Abidine ben Ali abandoned the Tunisian presidency and boarded his flight to Jeddah.

Global demand increased by 3 million barrels per day (bpd) in the second half of last year. Short-term events - the cold winter in Europe and the US, and Chinese burning of diesel for power to offset coal rationing - combined with more fundamental triggers: a surprisingly strong recovery in US demand and a successful government stimulus in China.

Supply and demand were joined by a third actor at the end of last year: monetary policy. The second round of quantitative easing in the US drove down the dollar - good news for American exporters - but it pushed dollar-denominated commodities higher.

The second key is how oil prices, a host of other commodities and events in the real world are becoming entwined. As in 1978 and again in 1990, oil prices drive geopolitics and vice versa.

In 1978, a recession induced by a fall in oil prices and rampant inflation triggered the Iranian Revolution. Immediately after the fall of the Shah, Iraq and Iran fought a brutal war with the high-tech armaments accumulated in the boom years.

In 1990, low oil prices combined with accumulated war debts to drive Saddam Hussein into his desperate, disastrous gamble of attacking Kuwait. His former supporter, the Soviet Union, was collapsing; its oil-dependent economy no longer able to feed its people.

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This time, the links are working the other way. High oil prices push up food prices, as the costs of farming, fertilisers and shipping grow. Those countries unlucky enough not to be major oil exporters, such as Tunisia and Egypt, cannot afford to maintain lavish subsidies.

In a phrase variously attributed to Marx and Mao, "No government is more than three meals from a revolution".

Following this logic, Jordan, Morocco and Yemen should be the countries to watch. And hoarding of food by oil exporters against possible shortages and instability, as Saudi Arabia and Algeria are doing, is more to be feared than their restraining oil supplies.

Yet analogies should not be overplayed. This is not 1973 or 1978; there is no war and the oil producers themselves are not embroiled in revolution.

It is not even mid-2008, when oil prices reached their record high of $147 a barrel. Then, refineries were unable to process the heavy oil that was the only surplus production, the needle of Opec's spare capacity was hovering dangerously close to "empty" at a bare 1 million bpd, and most forecasters missed the impending signs of economic doom.

Today, refining output is ample, Opec's spare capacity sits at 5 million bpd, stockpiles are close to five-year highs, and the exporting countries are much more aware of the world's economic fragility. There will be little physical tightness in the oil market this year.

Oddly, Saudi Arabia, although it is the one holding back production, always manages to appear as a price "moderate". The hawks, Venezuela and Iran, are producing close to flat out. But having worked so hard to reach a rare producer-consumer consensus on a price band around $75, the Saudis have quietly been stepping up output as prices exceed this target.

If the Middle East tensions subside quickly, prices could drop sharply as precautionary inventories empty. But if the demand surge is the key factor, a sustained increase in production is called for, especially if high inflation triggers interest rate rises.

For the central bankers of oil, uncomfortable reminders of past oil crises have to be weighed against balancing supply and demand, their perennial, insoluble task.

Robin M Mills is an energy economist based in Dubai, and author of The Myth of the Oil Crisisand Capturing Carbon

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