Iraq war expected to trigger oil price spike, but for how long?

www.canada.com JAMES STEVENSON
Canadian Press Wednesday, March 19, 2003

CALGARY (CP) - With war being waged half way around the world, perhaps the first impact of the Iraq conflict for most North Americans will be when they pull into their neighbourhood gas stations.

Thursday's attack on Iraq by U.S. and British military forces could put potentially severe upward pressures on the global price of oil. And that directly affects the cost of gasoline, home heating fuel and other sources of energy. Many factors including the length and severity of the war - and whether Iraqi oilfields are destroyed - will dictate how high the price of oil will eventually rise.

In recent weeks traders pushhed crude prices to nearly $40 US a barrel, mirroring levels seen during the Gulf crisis of the early 1990s. But in recent days prices dropped to the low $30s and below amid speculation the war against Iraq will end quickly, with limited disruption to Persian Gulf oil shipments.

At the beginning of the last Gulf war, oil soared to more than $40 US a barrel. Given inflation, that would equate to about $50 US today.

Using the rough calculation that each $1 US rise in the price of crude increased Canadian gasoline prices at the pump by about one cent, $50 oil could send pump prices jumping by 10-13 cents in the short term.

But Vince Lauerman, a global energy strategist with the Canadian Energy Research Institute in Calgary, cautions that the price of oil might react differently during this war.

"It was a pretty soft market going into that last war, but now the market is extremely tight in terms of stocks," said Lauerman.

Tight global oil supplies will indeed be a major factor.

A recent report from the U.S. Energy Department report suggested American inventories were 16 per cent lower than a year ago and nearing a 28-year low.

And even though Iraq produces only about three per cent of world supply, it is now an open question as to whether the Organization of Petroleum Exporting Countries has enough spare capacity to make up for Iraqi production, let alone other potential disruptions from neighbouring states like Kuwait.

Though non-OPEC countries like Russia and Canada have been increasing their oil production yearly, Lauerman says they generally have no spare capacity and no way to turn on the taps harder at times of need.

Suncor Energy, one of the main producers in Canada's oilsands in northern Alberta, agrees.

"We are at production capacity at over 200,000 barrels per day," says spokeswoman Darlene Crowell recently. "We're not like a conventional oil producer who can ramp up more wells in a heightened environment."

Angus McPhail, an analyst at ING Financial Markets in Edinburgh, Scotland, says he believes markets would be awash in crude after a swift war, particularly if Venezuela continues to recover from an oil industry strike and other members of the Organization of Petroleum Exporting Countries keep breaking their output quotas. For the second half of the year, ING Financial Markets foresees an average Brent crude price of $18.50 US a barrel.

"We are adamant that oil prices will fall," McPhail said.

Chris Heggtveit, a federal Finance Department official, says there are too many variables that could come into play to determine the economic cost of the war and high oil prices.

Not only are complex Middle East geopolitical issues at play, but also other events such as Venezuela's ability to ramp up oil production again after months of internal strife that saw the world's third-largest producer at a standstill.

Still, Heggtveit says Canada should be in a better position than most countries to weather any economic storm.

"It's important to note that Canada's economy would be buffered against serious economic shocks by a number of factors."

Firstly, Canada's in a better financial position right now than any of the G-7 group of industrialized nations.

Also, because Canada is a net exporter of oil, there will be some offsetting benefits to very high oil prices. The oilpatch will revel in extremely high profits, but federal and provincial governments will also see an bump-up in royalty payments.

As well, Canada is a member of the International Energy Agency, which is a group of 25 countries formed during the energy crisis of the 1970s.

Net oil importing countries in the IEA are required to keep oil stocks of at least 90 days supply and the group has said publicly that it is poised and ready to put additional oil on the market to control price spikes in the event of an Iraq war.

The question really becomes, how long will a spike in oil prices last?

Craig Alexander, a senior economist with the Toronto Dominion Bank, says the price of oil will fall quickly if U.S. military might becomes apparent.

"The financial markets, if they start to see signs that we are getting a very quick military campaign, will immediately start to price in lower prices for crude oil," he said.

And while the political ramifications of war in Iraq will likely last a long time, oil markets will likely rebound a lot quicker.

"Iraq will remain in the headlines and news long after the military conflict is over," said Alexander. "But those developments are unlikely to be weighing on the price of crude."

"Once the risk of Iraq affecting its neighbour countries diminishes, and once we know for certain what happens to the Iraqi oilfields, at that point the market will begin looking beyond the conflict."

As such, the TD Bank is expecting Canada's economic growth to be a roaring four per cent in the second half of this year.

That forecast assumes that the price of oil will be declining substantially and the geopolitical situation becomes a lot more certain than it has been in the past several months.