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High Oil Prices Are Here To Stay

By Marc Davis, Managing Editor
September, 2002

The fate of the faltering North American economic recovery now appears to hinge on the near-term price of oil. Even the depressed global economy faces a major setback if heavy industry cannot rely upon affordable oil prices to spur on a recovery.

Indeed, OPEC's efforts to maintain prices within the $22 to $28 target range are being undermined by the prospect of another Persian Gulf war. OPEC leaders, however, decided against relieving upward pressure on oil prices at a key meeting in Osaka, Japan this month. Saudi Oil Minister Ali al-Naimi said OPEC would only increase production quotas by up to 500,000 barrels a day if oil spot prices remained firmly above $28 for at least 10 days in a row. (As an aside, it is worth noting here that the last four times the price of oil remained above $30 for one month or longer, the U.S. plunged into a recession. And the threat of a 'double-dip' recession still hangs over the U.S. economy). Meanwhile, the 11-member OPEC cartel is tightly restricting output to 21.7 million barrels per day, which is the lowest figure in over a decade.

Al-Naimi tried to allay Western concerns about inflationary high oil prices by pointing out that there is no fundamental supply/demand imbalance. Instead, it's the threat of war that is at fault, he argued. And if the $5 "war premium" on oil prices is taken out of the equation (for which he blames President Bush), then oil prices remain within OPEC's officially endorsed $22 to $28 a barrel comfort zone.

Meanwhile, on the home front, one of the only real bright spots in the tentative economic recovery is continued healthy consumer spending. This, however, would be negatively affected if energy prices spiked higher. Already, oil prices have risen almost 50 per cent in the U.S. so far this year. Some analysts are even predicting $35-plus a barrel in a worst-case scenario if Iraq bombs oilfields in Saudi Arabia and Kuwait. Higher prices than the current $30 level would surely cascade down to consumers and manufacturers, alike. For instance, the auto industry is already predicting a crunch in the sale of SUVs. And gas-guzzling consumers, who already face hefty charges at the gas pumps, will just trim their spending in other non-essential areas.

Another major concern for the U.S. economy is the cost of financing a potentially protracted war on the other side of the world. U.S. Federal Reserve Chairman Alan Greenspan is already warning that a costly war would hurt the economy and squeeze U.S. taxpayers further. It could even fuel inflation.

"Returning to a fiscal climate of continuous large deficits would risk returning to an era of high interest rates, low levels of investment and slower growth of productivity," he added.

Moreover, even if a war is quick and decisive, the repercussions could be unsettling for the U.S. economy. For instance, if the U.S. installs a new pro-American regime in Iraq, the threat of more acts of terrorism in America would surely escalate. This, in turn, would further undermine the confidence of both U.S. consumers and investors.

However the situation plays itself out in a looming showdown between President Bush and Saddam Hussein, the fact remains that the stock market and the U.S. economy will both remain jittery until the dust (or sand) settles. And that is sure to underpin high oil spot prices for the foreseeable future.