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It powers the world's economies ... but unrest in Saudi is fuelling fears it could also destroy them

FOR the second time inside a month, armed Islamic militants have attacked oil workers inside Saudi Arabia. The attack yesterday in the eastern oil city of Khobar, which struck three housing compounds and the offices of oil companies, left at least 16 dead and the militants holding up to 50 hostages.

The deaths add to those killed at the Saudi port city of Yanbu on May 2, when four oil engineers and one contractor, all from West ern countries, were killed in a gun attack.

At Yanbu, a body was dragged through the streets before Saudi security forces killed three of the gunmen. A McDonald’s restaurant was fired upon, a pipe bomb thrown at one of the city’s international schools, and gunfire exchanges took place outside a Holiday Inn. The media reports that followed said the deaths of the men– two from Britain, two from the US and one Australian – had been carried out by a group in Saudi linked to al-Qaeda. Yesterday an Islamic website carried a statement said to be from al-Qaeda, which claimed it had carried out the latest attack.

For one oil analyst at Seymour Pierce in London, the Saudi attack in Yanbu and the fact that Saudi nationals were involved “triggered’’ the rise in oil prices that is threatening a return to the oil crisis of the 1970s, global economic chaos and George W Bush’s chances of entering the White House for a second term. The latest attack in Khobar will hardly help.

The hike in the price of the world’s oil took it close to a 21-year high. Only last Thursday did the price of oil in New York drop back to just under $40 a barrel – the first time it had been under that level for more than a fortnight. In the US the impact of the rise took petrol prices well beyond $2 a gallon, a psychological barrier that no president seeking re- election wants to have linger for too long.

In the volatile oil market, security in the Middle East – with the Gulf states producing 70% of the world’s oil – is a crucial factor to price stability.

Opec, the 11-nation cartel of oil exporting states, meets in Beirut this week and is expected to agree to boost production levels by enough to make a “psychological impact” in an attempt to bring prices down. Chancellor Gordon Brown speaking for the G7 nations in New York last week effectively begged for just such action.

The European Union’s energy commissioner, Loyola de Palacio, wanted at least the appearance of normality when she said last week there was ‘‘no deep-seated problem with the world oil market”. But Brown made it crystal clear that the G7 expects Opec’s help. Saudi Arabia, the world’s largest oil producer, has already agreed to a unilateral hike in its production level by 10%. For Brown, the Saudi gesture was “important”. He believes when Opec gathers in Beirut there will be “added pressure on other Opec countries to do the right thing”.

However, even if Opec does agree, many analysts believe the current supply shortfalls are not the sole cause of the recent price increase. Opec is already operating beyond its own self-imposed quota levels, with some countries already near to producing the limit of their capabilities. And as the price is at a 21-year high, what else would they be doing?

Although the G7 has chosen to focus on supply, global demand is at least as big a problem. The overall world economy is strong, growth is positive, especially in the US, where a big “summer recovery” season can be equated with a “driving season”. In China, every season now is a season of economic growth – a rampant 20% last year.

Opec members supply about a third of the world’s oil and some believe the cartel is being blamed unjustifiably for a price level that it may be able to influence but not sustain, simply because it has a limited ability to respond to surging demand and political instability in the Middle East. Nigeria, an Opec state, has already said it can’t do more and is producing flat out.

Although the US is pressuring Opec for increased supply, the US energy secretary Spencer Abraham suggested the problem may lie elsewhere when he said: “We’re producing a substantial amount, more oil than we did a year ago. And inventories are substantially higher than they were a year ago.”

So while the G7 begs, the Saudis promise and others in Opec complain about the pressure, the ability to deliver more oil this summer is receding. Marshall Stevens, an analyst at Refco, doubts the Saudis can deliver. “[Their measures] won’t take effect till July, and any new oil won’t hit the US till August. And that wouldn’t do much to allay gasoline concerns.”

A “psychological gesture” by Opec this week, perhaps a temporary hike in supply, won’t be enough. Some analysts think that any small hike will be swallowed up by rising global demand, with some growing Asian nations desperate to do what the US has been doing for generations – stockpile reserves and somehow insulate themselves from future price shocks.

After the September 11 attacks President Bush ordered the US’s strategic reserves to be built up. The US reserve is 660 million barrels, but Bush has ordered it to be raised to 700m. However big this reserve is though, Bush knows it isn’t big enough to have a sustained effect on world prices. His plans to boost US production look unlikely to succeed. US environmentalists successfully lobbied Congress and blocked the opening of new oil facilities that would have meant drilling inside US nature reserves.

Most analysts agree that a crucial price determinant is now the current high risk of interruptions to supply. If post-war Iraq had seen oil production boosted and political stability installed, the concerns over Saudi would have been far less. But Iraq is not a picture of stability. The knock-on effect? Even the smallest jitters over Saudi – which controls 30% of the world’s proven reserves – are enough to justify what analysts are still reluctant to call a “security premium”. Of the current level of $40 a barrel, as much as $8 can be put down to this premium. Given the US government’s fears that al-Qaeda is planning another major attack on US soil this summer, that premium could soar to more than $15, cancelling out any potential success that comes out of Beirut this week.

For the US car industry, which has produced a fleet of 4.2 million unsold gas-guzzling 4x4s worth $100 billion (if they were parked nose-to-tail they would stretch half-way round the world ) that kind of price prognosis is bad news. Unless sales improve, the industry will respond with lower production levels, and jobs, worldwide, will go.

The Saudis recognise they may now be in phase one of an economic balancing act: they must ensure prices are not driven so high that it creates an uncheckable momentum to find and implement new energy technologies, and thus economically weaken the Saudi kingdom.

But there are more pressing problems for the global economy. If al-Qaeda continues to attack the international oil community in Saudi, or go further and carry out a major strike at the heart of the Saudi oil industry itself and succeed in disrupting supply for even a brief period, a revisitation of the 1970s oil crisis and the worldwide slump that followed could be one outcome. Opec’s meeting in Beirut will address only one short-term solution, because at the moment there is no long-term solution.

Editorial Notes: Unfortunately, no mention of the oil peak. As we head towards a period of oil descent, oil prices will continue to become more volatile and vulnerable to pipeline sabotage and other physical attacks. The half truth that 'terrorism' will be responsible for higher oil prices will, almost inevitably, be used to diguise the more fundamental underlying issue of oil depletion. - AF

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