Oil prices: how big an increase can the West take? David Blake ln3y the . inevitability of another increase in oil prices is certain at the moment. Dissension within the Organiza. ion of Petroleum Exporting Countries means that we do not know. by: how much the price will go up,. Uncertainiy within the Weti (which . may be partially resolved at the current summit of the European Economic Community),means that we are unclear what wvill be done 'td protect 'the weakest developing nations from the effects of a new rise in their mos; important source of energy. Continuing uncertainty abou= what is happening to the western economies means that it is hard to predict confidently how great the impact of a price rise will be on them, and even harder to be sure that we shall be able to measure its effect after it has happened. But there is a strong pos- sibility that, initially at least, the Opec countries will content themselves wvith a fairly moder- ate rise; and an examination Of the reasons why they might do this can help guide us through the probable imtpact wlhich it will have in the future. The most important single point to grasp is that 1976 has been a good year for the oil-. producers-far better than the black days of 1975. Whereas last year falling oil prices and widespread discounting seemed to give credibility to the often- repeated American view that market pressures might. drive the Opec price dowvn, 1976 has seen a renewed strengthening of demand, and wiith it a higher price for the governments of Opec counttries. In part this provocation to O.pec to push up its prices in the forthcoming price round has been a wound inflicted on itself by the West. There is no doubt that a large element in .the increased demand in the past fewv months has come from efforts to stock up in anticipa- tion of an Opec rise and there is also no doubt that this policy has made such a rise all the more likely. The increase in Opec revenues, however, has not been accounted for solely by an in- creased volume of sales. The price which the couinf.:`c re- ceive has also been going up, even in the absence of any formal price rise, because dis- counts have been reduced, as Table 1 shows. The net effect of this, accord- ing to authoritative calculations by Morgan Guaranty, is to in- crease oil revenues to $112,O00m in 1976 compared with $97,000m in 1975. This in- crease ought to be compared with a world inflation rate for industrialized countries of about 8 per cent. Part of the increase in sales has been due to a recovery in output as the world picks itself up after the recessionary,shock of the huge price increases of 1973, but part has been due to a series of delays which have cut back production in areas like the North Sea and Mexico which are not part of Opec. These fields are likely to start coming on stream in quan- tity next year, eroding the Opec dominance of the increase in world consumption. That alone imposes some slight con- straint on the size of ,price increase wrhich can reasonably be expected. But even more important is the knowlvedge that the recovery in world economies is now at a very difficult phase and another really large price increase could have devastating effects. The arithmetic is fairly simple. For every 1 per cent that oil prices go up, the direcr impact through the external account of industrial countries is 0.03 per cent. But oil accounts for only about a third of total energy consumption in the industrialized vorld. and other energy sources alvays follow oil in price. Because of this, the total im- mediate impact is nearly three times as large, or just under 0.1 per cent.' The reverbera- tions of this price rise as it goes through the systenm mean that to reach the final impact, it is again necessary to multiply by three, giving just under 0.3 per cent. If the moderates witihin Opec are successful and the price rise is restricted to just under 10 per cent, that would mean an inflationary imp)ulqc of about 3 per cent tioughi this would, of course, have a vc,y different impact on differei countries. That impact would not, ol course, express itself simply ir terms of higher prices. Westerr nations have become far mnorE sensitive in the past few year. to the idea that thev shou' sacrifice goals such as growt! in an effort to hold dowr pr-ices, so we could expect tha through suchl measures as tigh monetary control the effect oa any large rise in oil price wvoulc be mostly deflationary, causinl Shaikh Yamani, the Saudi Arabian oil minister, who last week drew attention to the threat of further world recession if there was a drastic increase in oil prices. another recession, just as it did in 1973. Most experts predict that it the increase is limited to aboust 10 per cent then the impact on western economies, although harmful, would be bearable. l: wvould mean a little more inflation and a little more' finemployment, but it-ought not to be decisive in deterrining- the prospects for the West in the coming years. In an inflationary world one more price rise (even for a vital commodity like oil) is not crippling if it is not out of line with the general rate of infla- tion. This fairly- sanguine view, however, makes two assump- tions. The first is that Opec does not come back for a second increase later next year which wvould push up the total price rise to a far higher figure. A two-stage increase in itself need not be damaging, and could even make it easier for oil consuming countries to adjust to the new price levels, but only if the total rise is not excessive. The second requirement is that those countries which have settled down as large surplus nations should invest their money in such a way as not to threaten the. financial stability of the world monetary and banking system. Next year Opec is expected to have a surplus of some S35,000m, if prices go up by about 10 per cent. This is higher than the surplus this year or last, though still a long way below -the S65,000m recorded in 1974 when even countries with large popula- tions and moderate production earned more than they could spend. By the end of next year it has been estimated that the total of Opec overseas financial assets will be about $180,000m. Most of the surplus is now in the hands of the countries on the Arabian side of the Gulf and although there has been an obvious concern for stiability there has- been noticeable change 'in recent years in the direction in which Arab funds have flowed. Esientially, the Arab coun. tries have been moving their resources !'out of short-term assets, such as tueposit accounts, and into longer-term invest- ments, such as bonds and shares. That is a healthy sign for the West, since it shows that the Arab countries are prepared to go on investing in our long- term future; Much less reassuring is the changing geographical spread, with an increasingly obvious switch into the United States as the largest and strongest s capital market, with a 'cor- comitant move out of the United Kingdom.. The net effect of this is,- as we have seen to our cost' in Britain, to bring forward in a new and acute form the prob- lem of recycling, at least as far as weak countries are con- cerned. Spending more of the Opec surplus on investment iri the United States means that the'United-Kingdom is, in one i sense at least, now being forced l to ask its industrial partners to act as guarantors on money vhich it has borrowed from the ^ Arab countries. In the short term, then, "? Britain has been one of the S hardest hit of all developed nations by the rise in oil prices - and is likely to suffer next year S as well, since our oil bill will, be higher. Against that, ho6w- ever, there are twro more posi: tive elements in the equation. The first is that the prospect of an enlarged Opec surplus next year may reduce the pres- sure on surplus countries to try to move their money out of Lon. don because of the falling value of the pound. Since the virtual drying up of the capital inflow of 1974 was followed by sub- stantial disinvestment in the first half of this year, with a very damaging effect on our capital account, that ought -to provide some reassurance for the Government. The second is, of course, ;North Sea oil. What matters in the world at the moment is our ability to compete with other nations both at home and in overseas mark-ets. A rise in the oil price means that the advan- tage which comes from having energy sources, both in the form of oil in the North Sea and indeed in the form of coal underground, is that much greater. 'Oil prices: how-big an increase can the West take?