War euphoria is flooding the crude oil market, which yesterday posted its biggest price drop in 16 months.

www.thestar.com Mar. 19, 2003. 07:56 AM STEVEN THEOBALD BUSINESS REPORTER

The expectation of a quick and clean victory following a U.S.-led invasion of Iraq prompted crude oil prices to fall 9.3 per cent to $31.67 (U.S.) per barrel on the New York Mercantile Exchange.

That capped a 16 per cent decline in the past four trading days.

Assuming all goes well on the battlefield, traders are expecting crude prices to reach about $25 per barrel by mid-April, said Brian Prokop, an analyst with Calgary-based oil & gas investment dealer Peters & Co.

The market simply is starting to extract the war premium built into oil prices, he said.

"These are stupidly high prices," Prokop said. "We had $26 oil in September of last year then Bush started saying, `We are going into Iraq,' then boom."

Following the 1991 Gulf War, oil prices plunged after hitting highs above $40 a barrel.

Things are a bit more complicated this time around, Prokop said.

In particular, OPEC countries already are running at ramped-up levels, leaving far less spare production capacity to meet any possible shortfalls.

As well, inventory levels are low and Venezuela is still struggling to regain its pre-strike output of 3 million barrels a day, Prokop said.

"You have a couple of more wrinkles that are arguably bullish for oil prices."

Stock markets took a breather yesterday after posting big gains Monday, as all major North American indices gained about half a percentage point.

"The market is having a reality check," Peter Cardillo, chief strategist at Global Partners Securities Inc., told Reuters.

"We have come up sharply on the pretense that we will have a short war but we are not engaged in war just yet. Once the bombs start to fall, the progress of the war will be noted."

While uncertainty over Iraq has been lifted, the outlook on interest rates got a whole lot fuzzier yesterday.

Following its scheduled policy meeting, the U.S. Federal Reserve left its trend-setting interest rates unchanged, as expected. The surprise came in the Fed's accompanying statement.

The Federal Open Market Committee refused to provide an assessment of the risks the U.S. economy faces.

Given geopolitical unknowns, "the committee does not believe it can usefully characterize the current balance of risks with respect to the prospects for its long-run goals of price stability and sustainable economic growth," the statement read.

"It's striking," said Marc Lévesque, senior economist at the Toronto Dominion Bank. "It says basically they don't have a clue."

Stock market investors also would be wise to realize that the future is uncertain, suggested Roger Mortimer, a portfolio manager with San Francisco-based AIM Funds Management Inc.

The overthrow of Saddam Hussein won't solve all the U.S. economy's underlying problems, Mortimer added.

"There has been the tendency to associate Iraq with any number of ills affecting the U.S. economy."

Following the 1991 Gulf War, stock markets soared as much as 30 per cent over the year.

But this time around, corporate earnings for the first quarter of 2003 are expected to be quite weak, Mortimer warned.

"If the markets are feeling optimistic and the Iraq situation is behind us, they may shrug that off and go higher, but there could be hiccups."

Earnings are expected to improve, but it could take several more months, Mortimer said.

"The stock market's ability to rally at the back end of the year is really a function of economic recovery."

Ron Meisels is far more confident the current bounce in stock prices is the beginning of a bull run.

Meisels, a technical analyst with Montreal-based NA-marketletter.com, is predicting that North American stock markets will rise between 18 and 25 per cent by year's end.

A resolution of the Iraq situation is the trigger but the key is that significant uncertainty has been removed from investors' minds, Meisels said.

"If Iraq wasn't there, we would have found another reason to worry," he said.

"Bull markets always climb a wall of worry."