A Price Inflamed By Fear

Hezbollah attacks on Israel are being watched by anxious oil traders as well as governments.
Hezbollah attacks on Israel are being watched by anxious oil traders as well as governments. (By Michael Robinson-chavez -- The Washington Post)
By Steven Mufson
Washington Post Staff Writer
Friday, July 14, 2006

Add this to the costs of political instability and violence around the world: The price of crude oil hit a record yesterday, topping $76 a barrel.

Oil prices rose as fighting spread in Lebanon, the standoff continued over Iran's nuclear program and a Nigerian newspaper reported that explosions had rocked two pipelines in the West African nation. Although supplies of oil were virtually unaffected, traders and analysts said anxiety about political violence and tension around the world had once again driven up the "political premium" for oil.

"The oil price has really become a Richter scale for geopolitical turbulence and upheaval," said Daniel Yergin, the head of Cambridge Energy Research Associates. "The market's fundamentals are actually getting a little better, but fear and uncertainty is mounting over Iran, the Middle East and Nigeria."

The record oil price -- benchmark crude for August delivery closed at $76.70 a barrel on the New York Mercantile Exchange -- set an ominous backdrop to the meeting of the Group of Eight major industrialized nations set to take place this weekend in the Russian city of St. Petersburg. "This is a market in which fear is very strong, and it certainly is a stark message to the G-8 meeting in St. Petersburg, which was planning to discuss energy security," Yergin said. "Right now, oil prices are reflecting a lot of energy insecurity."

Anxiety gripped other markets, too. U.S. stocks, already plagued by worries about interest rates and some disappointing second-quarter earnings reports, fell steeply on news of Israel's military offensive in Lebanon and record oil prices. The Dow Jones industrial average tumbled 166.89 points, or 1.5 percent, to close at 10,846.29, its second day of triple-digit declines. The Standard & Poor's 500-stock index fell 16.31 points, or 1.3 percent, to close at 1242.29. The Nasdaq composite index dropped 36.13, or 1.73 percent, to finish at 2054.11.

Gold futures, often a haven in turbulent times, rose $3.10 an ounce to close at $654.40 on the New York Mercantile Exchange. Major markets in Asia and Europe were also down about 1 percent or more.

In oil markets, the causes of the price increase were virtually all political and psychological as traders fretted that Israel's conflict with Lebanon could provoke wider fighting or unrest in the Middle East, where 31 percent of the world's oil is produced and where 62 percent of proved reserves lie.

Adam E. Sieminski, chief energy economist at Deutsche Bank AG, explained that one way to calculate the political premium would be to multiply the odds of a supply cutoff by an estimate of its effect. So if the chances of military action against Iran or of a supply cut there are even modest, given the huge impact such events would have on oil prices, then worries about Iran alone could account for $10 to $15 a barrel in the current world price of crude.

Sieminski said oil traders could also add $5 for possible hurricanes, $5 for risks in Nigeria (where militant groups have attacked pipelines and cut oil output by more than half a million barrels a day), and $5 for other risks.

"Supply and demand are not the only things people look at," Sieminski said.

Altogether, the political premium could make up a third of the price of crude oil. That premium translates into about 60 cents a gallon at the gasoline pump. And it's a source of political controversy, because even though the reasons for the high price may be psychological, real money is still transferred into the hands of oil-producing countries and companies.

Gas prices posted yesterday by AAA were $2.96 a gallon for regular unleaded gasoline, up 6 cents in the past month and 64 cents from a year ago, according to the auto club.

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