Fuelling Uncertainty

As Opec begins its much heralded meeting in Vienna today, one thing is abundantly clear. No one has a clue about the likely course of oil prices for the next 12 months. But many observers are deeply worried.

The price rose to great heights last month, almost touching $50 (£27.70) a barrel, and has been hovering around $40 in recent days, with almost any potentially scary factor driving it higher, such as - until it veered away - the prospect of Hurricane Ivan hitting production in the Gulf of Mexico.

Those of us who have been in the macroeconomic observatory for longer than we care to remember were brought up in a world where cheap energy was taken for granted. The use of the "oil weapon" by the (mainly) Middle Eastern producers changed all that during the two famous oil shocks of 1973-74 and 1979-1980.

The price of oil became such an important factor in the macroeconomic equation that some economists, such as Professor Andrew Oswald of Warwick University, have made quite a name for themselves highlighting the close connection between macroeconomic developments - not least recession - and the price of that one vitally important commodity.

The days have gone when Opec - the Organisation of Petroleum Exporting Countries - used the price of oil as a weapon. Its members have long since reached an agreement with the industrialised west (now joined in its voracious thirst for oil by China) that both oil producers and consumers have to live together in the world economy, and a certain measure of stability suits both.

Thus, this week, Ali al-Naimi, the oil minister of Saudi Arabia, said: "We are producing 2m b/d [barrels a day] over the ceiling. Saudi Arabia is producing 9.5m b/d and the reason we are doing it is to bring the price down."

Nevertheless, the fact that he praises Opec (of which Saudi Arabia is the key member - the "swing producer") for having lessened the "upward pressure on price" and moved it "from close to $50 back to $40", says something about his measure of success.

Such prices are a significant level above the $22 to $28 a barrel target range which operated earlier in this young millennium, and well above the $20 a barrel which certain optimists thought would prevail in the event of a happy outcome to the invasion of Iraq.

Yes, there were such optimists, although it is difficult to believe. And most of them were at the top of the US administration.

But we are where we are. The combination of a not very impressive world economic recovery and the rapid industrialisation of China, has maintained strong demand for oil, against the background of a world oil production system running at virtually full capacity, give or take the odd supply bottleneck (for different reasons) in Venezuela and Iraq.

The sluggishness - indeed decline - in the real price of oil since the mid-1980s (when it was roughly the equivalent of a present day $80) has discouraged serious searches for new oil fields, as well as the development of known potential sources. And one must never forget that the fear of political instability in Saudi Arabia was a major motive behind the decision to invade Iraq.

On any serious reading, the prospects for oil prices are finely balanced. It was interesting that Gordon Brown, who is not only Britain's chancellor but also chairman of the International Monetary Fund's key political committee, sounded a worried note in an article in the Financial Times last Friday, whereas Jean-Claude Trichet, the president of the European Central Bank and the group of 10 leading central bankers, sounded desperate to be more positive earlier this week.

From the UK's point of view, the good news for the chancellor is that a higher oil price means greater revenues for the Treasury. But this is a temporary benefit. Recent statistics indicate that Britain's days as a net oil exporter are coming to an end.

William Keegan is the Observer's senior economics commentator