Oil prices eased slightly yesterday, following calming statements from OPEC ministers and signs from the US that it would be willing to use its strategic oil reserves. However the cost of a barrel of oil has increased by some 40 per cent in recent months and looks set to remain high - and volatile - in the weeks ahead. This poses an immediate danger to an already-fragile world economy.
Conditions in the oil market threaten economic growth in a number of ways. Higher oil prices push up fuel costs - although this has been partly offset for Irish consumers by the weak dollar - and cause a transfer of wealth from oil consuming countries to oil producers. The volatile outlook for oil prices is also part of an uncertain global economic picture, characterised by a delay in investment decisions and general weakness in activity.
If war does start, it will add to an already difficult situation in the oil market, which is still affected by the aftermath of the Venezuelan strike and by high demand. Iraqi exports would stop and Kuwait might also close some of its production facilities close to the Iraqi border. Wider disruption to Gulf oil supplies cannot be ruled out.
OPEC ministers, meeting yesterday in Vienna, sought to reassure the market that they would pump more oil if required. Saudi Arabia, in particular, has the ability to increase production. However, the political delicacy of the situation was illustrated by a decision not to put in place a contingency plan in case of war. Some members, particularly Iran, argue that to agree such a plan would be to indicate support for US plans to attack Iraq, itself an OPEC member. It is thus clear that both political and military factors may affect the oil market in the weeks ahead.
Some market analysts have predicted that a quick military victory could soon lead to oil prices falling back below $30 a barrel, as uncertainty is removed and the prospect of new investment in Iraqi oil facilities signals new supply in the years ahead. There are clearly many risks to this scenario: the military campaign might not go smoothly; Iraq could inflict damage on Gulf oil facilities; the war could knock on to instability elsewhere in the Middle East; restoring political and economic stability to Iraq post-Saddam may prove difficult; and investment in Iraqi oil facilities would take some years to complete.
In the short-term OPEC appears likely to increase supply in the event of a shortage and the US indicated yesterday that, in a case of serious shortage, it would release some of its strategic reserves onto the market, as would other countries. However, high oil prices are already damaging economic prospects and there is the serious risk that they will continue to do so for some time to come.