Oil prices are once again the talking point in international economic and financial circles. In the wake of the third agreement between members of the Organisation of Petroleum Exporting Countries (OPEC) in March 1999 to cut production by 2.1 million barrels a day, oil prices have risen sharply from less than $10 a barrel (in the case of OPEC crude) to close to $25 a barrel. This agreement was the culmination of three phases of withdrawing supplies from the market, starting in April 1998, which had resulted in a sharp reduction in oil stocks worldwide. The effects of OPEC's efforts were aggravated by Iraq's decision to exploit the situation by stopping supply of 2.2 million barrels of oil a day under the United Nations' food-for-oil programme, till such time as sanctions were lifted. The consequent rise of oil prices to a nine-year high set alarm bells ringing, with prognostications of a return to the days of inflation and recession in the developed centres of the world economy.
 
The dramatic turnaround in prices is remarkable because till a year back, developed (and developing) nations had wallowed in a world of low and falling oil prices. From a peak of close to $25 a barrel at the beginning of 1997, oil prices had fluctuated around a declining trend, taking the prices of OPEC crude to less than $10 a barrel over a two year period. That decline had triggered the argument that a "new paradigm" had come to characterise commodity prices in general and oil prices in particular, with the World Bank suggesting that there was "evidence of a fundamental break in the level of commodity prices, due to rapid advances in technology and declining costs of production". Though initially it was admitted that the crisis in East Asia had depressed oil demand and tilted the supply-demand balance in against oil producers, analysts soon argued that demand stemming from a buoyant US economy should have substantially neutralised that factor. More 'fundamental' factors were, therefore, seen as having worked on oil markets, to take oil prices to levels that were appropriate. Included among them, besides the technological trends mentioned earlier, was a perceived long-term tendency towards reduced oil dependence in the developed world. The world, it was held, had put the danger of spiralling oil prices behind it.
 
It has taken little to shake that complacence. OPEC countries, dependent on oil incomes for balance of payments stability and growth, could hardly accept the prices that prevailed in early 1999 as appropriate. Yet, even as national budgets were being squeezed and the threat of civil strife perceived, oil producers squabbled over quotas and production volumes. Eventually, the damaging consequences of the steep decline on countries dependent on oil exports forced a degree of unity and discipline among them, resulting in the March 1999 agreement. And when expectations that the agreement would not work were belied, the rapid price increase seen over the last year ensued.
 
There are now two questions being debated among oil analysts. First, can these prices be sustained or is the "new paradigm" in oil prices to be one of intense short-term volatility, which implies a downturn in prices some time in the near future? Second, what would be the macroeconomic implications of a regime of relatively high oil prices, for a world which is just seeing a halting recovery from the poor performance that marked the last years of the last decade?
 
An answer to the first is now quite clear. It emerges from the evidence that oil price volatility is more the result of supply rather than demand factors. The collapse in prices during 1997-98 was the result of the overhang in oil supply, resulting from the tendency of individual oil producers to try and grab a larger chunk of world markets in order to finance domestic expansion. It was the realisation of the futility of such a strategy, that helped restore unity and discipline within and outside OPEC. That unity helped ensure the production cuts that wiped out the supply overhang and triggered the price recovery.
 
There is a clear perception, however, that oil prices cannot keep rising. Its impact on inflation and the balance of payments in the developed and developing countries would trigger immediate and medium-term trends that are adverse from OPEC's point of view. Rising inflation and a widening current account deficit can necessitate contractionary polices in some or all countries which would impact on oil demand as well. Further, sustained high prices can rejuvenate the conservation effort which began with the oil shocks of the 1970s, but lost momentum during the years of low real and nominal oil prices. The deceleration and possible decline in demand that could result, would necessitate production cuts which may be unacceptable to many of OPEC's members.