Uncertainty of War Unsettles Oil Industry

www.nytimes.com March 9, 2003 By DANIEL ALTMAN and NEELA BANERJEE

For months, the Organization of the Petroleum Exporting Countries has scrambled, with little success, to keep a lid on oil prices. With war threatening as the cartel's ministers meet in Vienna this week, prospects for the global economy are so cloudy, analysts say, there is not much left for OPEC to do.

The oil producers are not alone in their plight. Around the world, and especially in the United States, the dilemma of planning for the unknowable is upsetting the decisions of consumers, businesses and investors. That is hampering an economy struggling to better last year's meager growth, weighing on stock prices and subduing consumer spending.

Oil is a significant component of all those calculations. Crude oil prices have hit their highest levels since the Persian Gulf war of 1991, and Standard & Poor's estimates high energy prices have cost the economy $50 billion in consumer purchasing power, or 0.5 percentage point of growth, just since last fall. The Energy Department predicts that by April, consumers will be paying record-high prices for gasoline in much of the country.

In any effort to assess how prices will move — and how the economy will react — the echoes of history are inescapable. Just like in the fall of 1990, the massing of American troops near Iraq and fears that oil supplies from the Persian Gulf will be disrupted have lifted the price of oil well above $30 a barrel for weeks.

But most of the similarities end there, according to industry analysts. While few experts expect a war to lead to shortages of oil, most doubt there will be a replay of the events of the gulf war.

A dozen years ago, analysts noted, the world was awash in oil. Prices were less than $20 a barrel when Iraq invaded Kuwait in 1990. They began to climb when the United Nations imposed an embargo on Iraqi and Kuwaiti oil, removing a bit more than 7 percent of global oil supplies, according to Leonidas P. Drollas, the chief economist with the Center for Global Energy Studies, a London research firm.

Oil prices spiked to more than $41 a barrel by October 1990, but fell once OPEC moved to compensate by increasing production to make up for the loss of the embargoed oil. A few weeks after the United States-led attack on Iraq in January 1991, oil was selling for less than $18 a barrel.

Some traders are positioning themselves for prices to plunge again should the shooting start. "People realize that there is a tremendous downside risk," said Neal L. Wolkoff, the chief operating officer of the New York Mercantile Exchange, where crude oil is traded.

Most analysts say, however, that key indicators of the oil industry's health — notably low inventories of oil and petroleum products at American refineries — suggest that now, prices would remain steep regardless of military action.

A yearlong series of production cuts by OPEC in 2002 gradually reduced global oil supplies as world economies were growing stronger. Then a strike in Venezuela stripped 4 percent of the world's oil supply from the market. So the balance between supply and demand is much tighter than it was on the eve of the gulf war.

Today, a war in Iraq would remove about two million barrels of oil a day from the market, analysts estimate. Some believe that OPEC, which does not disclose its production, has the spare capacity — concentrated in Saudi Arabia — to replace that oil. Others say they think the cartel's members are already pumping at full capacity, both in an effort to keep prices from spiraling even higher, at the risk of stifling demand, and to take advantage of the unusually high prices.

"I think they're effectively tapped out," said Edward L. Morse, executive adviser at the Hess Energy Trading Company. "They're producing very close to as much oil as they can produce."

One step that helped drive prices down once the gulf war began was the decision by the White House to release oil from the Strategic Petroleum Reserve. Lately, the Bush administration has said that it would tap the 600-million-barrel reserve only if supply disruptions occur — not to rein in high prices.

Analysts, oil traders and even some Republican politicians have called on the White House to move more quickly, given the market's jitters. "They must release the oil because there is one fly in the ointment: consumer behavior," said Mr. Drollas of the Center for Global Energy Studies. "If people panic and start filling up their cars, the system will run dry."

Ultimately, the price of oil will likely swing with the progress of a war, industry executives and analysts said. If any fighting ended quickly, prices will probably fall — though not as sharply as in 1991, given generally tight supplies. But if the conflict dragged on, or if oil facilities in Iraq or neighboring countries were damaged, prices could remain high.

Faced with such uncertainty, OPEC will likely do nothing formally when it meets in Vienna, except pledge to continue at high levels of production, analysts said.

"It doesn't matter what they say in Vienna, because OPEC has only one option — that is, provide the barrels that are being asked of them," said Yasser Elguindi, the director of the oil and energy unit of Medley Global Advisors, a New York consulting firm.

The impact of a war on the broader economy is as hard to read as the prospects for oil prices.

If war comes, it could end in anything from quick victory followed by democratic change to chaos and terror worldwide. The rosiest outcome could bolster the United States economy by $50 billion this year, according to a much-cited report by the Center for Strategic and International Studies in Washington, while the worst case could cost $450 billion.

In the meantime, the suspense is taking its toll, said Laurence H. Meyer, the former Federal Reserve governor who wrote the report. "Timing is not unimportant," he said, "because it lengthens the weaker period early in the year and pushes the rebound later in the year."

During the gulf war, the allies' early success briefly emboldened consumers, but there was little of the customary wartime boom. The nation was already in a recession when Iraq invaded Kuwait. By the time President George Bush declared Kuwait liberated, the unemployment rate had already begun its usual postrecession climb and the president's wartime popularity evaporated.

That chain of events fit a timeworn pattern, said Gail D. Fosler, the chief economist of the Conference Board, a business research group in New York. "Whether you're looking at the Arab oil embargo, the Iran revolution that led to the oil shock in the late 1970's or the gulf war, it occurred towards the end of our economic cycle," she said. "You were susceptible, and you got sick."

This time, by contrast, the economy has recently endured recession and, some economists say, may be closer to the start of a new boom.

But the potential side effects of a war could place an unprecedented drag on the economy.

"During the gulf war, you didn't have people being put on heightened terror alerts," Ms. Fosler said. "There's too much emphasis that's put on the war, and not enough emphasis that's put on the terror."