Little relief for those oil price blues

Ground Floor : The last time I talked about oil prices was at the beginning of April - the end of the "winter heating season…

Ground Floor: The last time I talked about oil prices was at the beginning of April - the end of the "winter heating season" as far as the oil industry was concerned and the interim period before moving into the "summer driving season", writes Sheila O'Flanagan.

Oil prices were then at all-time highs and so the question I asked was whether or not any downward pressure on the price as a result of a possible fall-off in demand at the end of the winter heating season should be considered a blip.

It's always interesting looking back at levels where people wondered whether or not prices had reached a turning point - often it's just hope rather than any real conviction.

And so it was with oil prices - although analysts were saying that the 21-year high of $38.18 reached on St Patrick's Day might hold things for a while, the truth was that the upward pressure was always going to be too great.

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In fact, the rise since then has been inexorable and now we're at new highs with West Texas crude rising above $44 per barrel for the first time since the Nymex exchange started trading in oil futures. Brent traded above $41 for the first time.

Global demand - and from China in particular - is still a driving force. OPEC's seeming inability to pump more oil, despite the hasty statement by its president that it did have around 1.5 million barrels per day of spare capacity, is a problem. As is, of course, the Iraq situation.

Added to that now is the eyeballing between Yukos, Russia's largest oil producer, and the tax authorities.

Yukos, which produces around 2 per cent of the global oil supply (thus helping Russia to be the second-largest oil exporting country after Saudi Arabia), is facing bankruptcy. It's accounts have been frozen, unfrozen and frozen again by the Russian government on foot of a $3.4 billion (€2.76 billion) tax demand due since 2000, a bill for almost the same amount for 2001 and the potential for more in the following years.

The bailiffs have seized its main producing plant and the government has threatened to sell the assets of the company.

Sometimes, when you think about savage movements on the futures markets, you simply see the numbers and tend to forget the underlying instrument. The problem for Yukos is that it only has the ability to store oil for a few days and it won't be able to afford to transport oil if its accounts aren't released for a significant period of time.

The former chief executive is on trial for fraud and tax evasion (hello capitalism!) and whether the arrests were politically motivated or not makes no difference to the price of the product and its transportation difficulties.

Despite the fact that plenty of analysts are happy to tell us that oil price hikes in 2004 are not the disaster they were 30 years ago, they still push inflation higher. There are predictions that if the current levels are maintained, about 0.5 per cent of a percentage point would be shaken off US growth and added to inflation - closer to 1 per cent in Japa.

Airlines are already adding fuel surcharges to transatlantic flights, manufacturing industries will follow and eventually consumers will have to cut back.

Visible price increases, particularly on transportation, may have more of an impact on George W Bush than on anyone else. Americans might be flying less but George doesn't want those gas-guzzling SUV owners of the mid-west feeling the pinch on higher oil prices before he asks them to vote for him in November. Nor does it suit him that equity markets react to rising oil prices by trimming prices of their own. But it's out of his hands.

The Chinese are doing their best to help since the government is trying to slow down its frenetic growth from 9.6 per cent in the second quarter to 7 per cent on an annual basis. So it has imposed credit limits on the amounts that banks can lend to a raft of sectors, including the construction and automobile industries.

The Central Bank of Ireland tried this in the late 1970s and early 1980s. I was never sure why. Such blunt measures of economic policy delivery were deemed inappropriate later.

The difficulty, of course, is that banks are private enterprises which are supposed to make a profit. But it's not easy if you can't actually lend money to the people who want to borrow it. What usually happens in these circumstances is that the banks decrease credit for everyone, since they don't want to have too high a loan weighting to the industries who are in a less able position to repay them. Or else they fudge the numbers. Either way it's a risky strategy from the Chinese.

It's difficult to see anything that will soothe the nerves of oil traders in the immediate future. Despite the efforts of the government, demand will stay strong in China.

Despite (or because of) the efforts of the government, production will remain precarious in Russia. And despite the price increases at the pumps, motorists will continue to use their cars.

Thirty years ago neither Russia nor China were on the economic radar. Now they're facing some of the problems that have hit Western economies in the past - including the tax and fraud scandals.

If the "war on terror" really was, as many think, all about oil, then the outcome could hardly be worse. The US doesn't have control of the Iraqi oil fields, OPEC production is still a problem and the current price level may yet be one on that we look back nostalgically at in a few months time.