Oil prices slide on war talk - High hopes for quick resolution drive markets

www.sfgate.com Sam Zuckerman, Chronicle Economics Writer Wednesday, March 19, 2003

Oil prices plunged around the world Tuesday as traders decided that a U.S. attack on Iraq will succeed quickly and cause little disruption of energy markets.

A day after President Bush issued an ultimatum to Iraqi leader Saddam Hussein, setting the stage for an immediate invasion, a wave of selling gripped the oil market. The price of contracts to deliver crude oil next month fell $3.26 to $31.67 a barrel on the New York Mercantile Exchange, a drop of nearly 10 percent.

Since last Wednesday, the cost of those contracts has fallen 16 percent, reversing much of the big run-up in oil prices that had occurred during the past year as Washington's showdown with Hussein approached.

If it lasts, the sharp drop in oil prices will be a real boon to consumers and help boost lagging economies around the world.

Unleaded gasoline in the Bay Area averaged a record $2.27 per gallon last week, up 71 cents from a year ago. Gas prices won't come down in lockstep with falling crude costs, but the decline will put downward pressure on prices at the pump.

Nationwide, money that's now going to fill tanks and pay heating-oil bills will be freed for spending on other items.

But analysts warned that there are reasons to question whether the drop in oil prices can be sustained. Oil-market participants are betting that U.S. forces will roll over the Iraqis in short order and that oil facilities will suffer little damage. Any deviation from that scenario could send oil prices shooting up.

"Traders are discounting the prospect that war will be a quagmire," said Severin Borenstein, director of the University of California Energy Institute. "They are missing the point of what a war premium really is -- a risk that war could go badly."

What's more, supplies are tight in the energy market even without a conflict, leaving little margin for error. Production by Venezuela, one of the world's leading exporters, has been crippled by internal political conflict. After a cold winter that produced heavy demand for heating oil, inventories of crude are down 18 percent from a year ago. Spare production capacity is significantly lower than it was at the time of the Gulf War 12 years ago.

"You would think oil markets would show more concern," said Merrill Lynch energy analyst Michael Rothman. "There is still significant upward risk in the price of oil."

Market participants are calculating that such producers as Saudi Arabia will make up for any war-related shortfall. In addition, the United States and other leading petroleum consumers may tap into strategic reserves, putting millions of additional barrels of oil on the market.

Much of the action on the oil market reflects the eagerness of traders to sell before war starts, analysts said. During the opening days of the Gulf War,

oil prices plunged by about a third when it became apparent that the United States and its allies were winning a quick victory.

The hard-pressed economies of the United States, Europe and Japan badly need lower energy prices.

Economists from Federal Reserve Chairman Alan Greenspan on down have cited geopolitical risk -- the danger of war -- as the main drag on the world economy now.

"When analysts talk about geopolitical risk, they divide it into two parts, " said Randy Moore, editor of the newsletter Blue Chip Economic Indicators. "One is the reluctance of businesses and consumers to spend and invest. The other is the effects on the economy of a rise in oil prices."

Partly because of those effects, economists have been cutting back their growth predictions for the U.S. economy. Early last year, forecasters polled by Blue Chip Economic Indicators predicted that the U.S. economy would grow 3. 2 percent in 2003. By this month, that forecast had been trimmed to 2.6 percent, with higher energy prices an important factor in the reduced expectations.

Chronicle news services contributed to this report. / E-mail Sam Zuckerman at szuckerman@sfchronicle.com.