ENERGY MATTERS: How Will Oil Dance To Bush War Drums?

sg.biz.yahoo.com Wednesday January 29, 11:57 PM By David Bird A Dow Jones Newswires Column

NEW YORK (Dow Jones)--In his State of the Union address Tuesday night, U.S. President George W. Bush flatly didn't declare war on Iraq.

ADVERTISEMENT But the message couldn't have been clearer if he had dressed as Groucho Marx, the leader of Freedonia in the movie "Duck Soup," rousing the troops in song: "In case you haven't heard before, I think they think we're going to war...We're going to war!"

The end of the State of the Union address is the start of a State of Higher Anxiety for oil markets, with the sole focus now the timeline for an assault on Iraq.

Crude oil futures prices, trading above $30 for the last 30 days on Nymex, face the real prospect of a spike or collapse in coming weeks - with a good probability of both. It's quite likely we'll have seen crude near $40 and near $20 by the end of March.

The pace of the march toward war grows faster each day. The next major milestone will be Feb. 5 when, Bush revealed last night, Secretary of State Colin Powell will address the United Nations Security Council, disclosing thus-far secret intelligence showing Iraq is hiding weapons of mass destruction from U.N. inspectors.

The next key date will be Feb. 14, with what we see as the last report of U.N. weapons inspectors to the Security Council before war.

There's little reason to expect Iraq will reverse its policy of obfuscation of inspectors by then, but Germany, which chairs the Council next month, has asked for a further report. The U.S. and the U.K. have signaled they don't have a problem waiting a few more weeks, as this will allow further deployment of troops and materiel to the region.

Oil traders have to figure out how they are going to trade at what will be a crucial - perhaps decisive - time. That's because the New York Mercantile Exchange,- the world's biggest oil market, will be shut when the drums of war, no doubt, will bang louder.

Nymex Holiday May Put Traders On Ice

Nymex is scheduled to shut early (1300 local time) on Friday, Feb. 14, ahead of the Presidents' Day holiday on Monday, when the market will be closed. After-hours Access trading won't begin until 1900 local time on Feb. 17.

While no one is giving clear timing for bombs over Baghdad, we continue to hear that a U.S. offensive could begin much sooner than indicated and with fewer troops in position than are anticipated by the middle, or the foreboding Ides, of March.

The rhetoric on Iraq will reach fever pitch in coming days. Bush will be joined in Washington later this week by his chief ally on Iraq, British Prime Minister Tony Blair. Blair's foreign secretary, Jack Straw, declares Iraq in "material breach" of U.N. ceasefire resolutions signed at the end of the 1991 Gulf War. Simply put, that means that if the ceasefire isn't valid, the war is still on.

Saddam's top aide, Tariq Aziz, also sounds as if he thinks the 1991 war is still on. Aziz pointedly warns that Kuwait could face attack again, if it serves as a launching post for a U.S. strike.

While that isn't exactly surprising, it's clearly causing ripples in the region and fears that Saddam may lash out in all directions when he feels he has no other option. Saddam is nothing but unpredictable - who foresaw the lighting of the Kuwaiti oil field fires? - but the most optimistic in the Gulf hope that he'll decide on exile once - and only when - the bombs start falling.

Our soundings from Saudi Arabia these days are tinged with more concern about managing a fierce fall in oil prices after a quick conflict, rather than trying to cap a spike. While that may be overly optimistic, the thinking is that although oil prices will skyrocket with word of the first U.S. missile launch, Saddam's forces, by and large, will crack like an eggshell and refuse to fight, as in 1991.

There will be an inevitable cutoff of oil supplies - perhaps throughout the Gulf region - just at the time the fighting begins, but shipments (except from Iraq) will quickly resume.

There's widespread anticipation that the U.S. and its partners in the International Energy Agency will release crude oil from emergency stockpiles to assuage supply fears. And, if 1991 is an indicator, that will be the beginning of the end for high crude prices.

First A Spike, Then A Glut

While the Saudis have pumped up supplies to about 9 million barrels a day, as expected, and there's talk of going higher, if needed, the real concern is on how to avoid a coming glut.

That puts focus squarely on the Organization of Petroleum Exporting Countries and its March 11 meeting.

After boosting output to cover lost supplies from Venezuela and build a cushion ahead of war with Iraq, OPEC will likely have to focus on the seasonal drop of more than 2 million b/d expected at the start of the second quarter.

We're reminded that although OPEC's basket price is averaging $30.31 so far this year - well above its $22-$28 target range - the always-conservative Saudi budget is pegged at a price of under $20. And that speaks volumes to the difficulty OPEC will face in trying to put a floor under prices.

While low U.S. oil inventories and the need for restocking may soften the impact of a price freefall, the season of heavy refinery maintenance is near, cutting real demand for crude, too.

Latest data show U.S. stocks still hover near critical levels, with Midwest crude stocks at their lowest-ever weekly level since government data collection began in 1990. Midwest stocks are a crucial indicator because the region houses the delivery point for crude against the Nymex futures contract.

Tight U.S. stocks will continue as a prop for high prices as the war scenario develops.

Venezuela Can't Find Its Customers

Venezuela remains a wild card for the market. As a widespread strike nears the start of its third month, crude output has crept up to 1 million b/d from about 400,000 b/d earlier this month, but is still at one-third of its November level.

The third-biggest producer within OPEC still faces huge hurdles in getting operations anywhere near normal. The extent of difficulties is clearly shown in pleading notices posted on the state oil company's oil trading Website, Pepex.

State oil company Petroleos de Venezuela reveals on the Website that striking workers sabotaged company records. They don't seem to know who their customers are or how to find them, now that they've got some oil to sell.

PDVSA is now essentially pleading with former customers to tell them "as soon as possible" who they are, how much oil they were buying and under what terms, and - if it's not too much of a problem - provide "copies of sales contracts."

As prospects for peace look worse in a roiling oil market, here's a simple verse as Valentine's Day nears:

Roses are red,

Violets are blue.

Bush is ready for war.

So, are you?

-By David Bird, Dow Jones Newswires; 201-938-4423; david.bird@dowjones.com

(David Bird is senior energy correspondent for Dow Jones Newswires.)

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