The Fear Factor; Many analysts believe it's the No. 1 reason for today's high oil prices, and that it will last as long as Al Qaeda does.

Byline: Karen Lowry Miller and Rana Foroohar

How big is the fear factor? On June 1, the first day of trading after the deadly terrorist shooting spree on oil expats in Khobar, Saudi Arabia, the price of a barrel of oil spiked more than $2 to a record $42, or roughly double the amount that most oil companies consider the natural price in normal market conditions. This capped an 18-month price surge, propelled by what economists say is a witch's brew of abnormalities, from supply disruptions in Iraq and Venezuela to rising demand in China, but one factor seemed to stand out. As oil reached $42, estimates of the oil risk premium--a subjective surcharge that roughly reflects the market's fear of future shocks--reached as high as $12. By this analysis, the fear factor outweighed all others.

Three weeks later the price of oil remains well above its long-term trend, closing at about $39 last week, and concern remains high over how long this shock will last. Each $10 rise in the price of oil takes an estimated 0.5 percent off world GDP growth, so the stakes are huge. According to the International Energy Agency, world oil supply is more than meeting demand, so many analysts believe the main driver of current prices is psychology: the market is inflated by fear.

To get a handle on this phenomenon is not easy. The risk premium is a slippery measure, not hard information stored in a database somewhere. Though it's widely accepted and now hotly discussed in oil markets, many serious economists think the premium is a fiction, invented by lazy analysts to explain why their price predictions often fall so far off the mark. But let's assume, for the sake of understanding how terror hits markets, that it is possible to strip out and measure its influence. To help psychoanalyze the current market, NEWSWEEK asked the World Markets Research Centre in London to estimate how much geopolitical risk contributed to the decision to buy oil for each year going back to 1970 (chart). The results suggest that the market has been at least as, if not more, driven by fear in the past--and that the future is bleak.

The oil shocks triggered by the Yom Kippur war in 1973, the Iranian revolution in 1979, the 1986 Iran-Iraq tanker wars and the gulf war in 1991 all produced price spikes in excess of what could be explained by the disruptions of supply. In each case, according to the WMRC, the risk premium spiked and accounted for at least 30 percent of the total price. The WMRC believes it was back up to 25 percent at the $42-a-barrel peak.

Yet the nature of the risk has changed. There is nothing markets hate more than uncertainty, and Mohammed Ali-Zainy, a senior energy analyst at the Centre for Global Energy Studies in London, notes that earlier Middle East shocks "were centered around governments, rather than the more unpredictable threat of terrorists." True, the Yom Kippur war led to the creation of a cartel that wrest-ed control of the global market from Western oil companies and quadrupled prices in one hot summer. But OPEC would evolve into a force for price moderation and global stability--a trajectory Al Qaeda seems unlikely to follow.

Since no one can say when the war on terror will end, the fear factor now has a permanence that is entirely new. Even the obliteration of a major national oil industry in the Iranian revolution, which led to a record high of $75 a barrel (in today's dollars), "was a singular, quantifiable event, not a nebulous threat," says John Felmy, chief economist for the American Petroleum Institute. The same is true of the shocks of '86 and '91; they were passing events.