Oil price in the balance as attack rolls on

www.theage.com.au March 22 2003

Oil will always be at centre stage of any conflict in the Middle East, given the West's dependence on it. Barry FitzGerald and Richard Salmons report.

The slogan "No blood for oil" was scrawled in chalk on the pavement outside the Stock Exchange building well before the first missile attacks on Iraq.

Although it reflected the views of ardent anti-war campaigners, many of John Howard's "ordinary" Australians also have a suspicion that the war is really about oil and not an attack to take out a despot in control of weapons of mass destruction.

The conspiracy theorists take things further. Control of Iraq is the first step in a plan by the oil-hungry US to break open the Middle East's stranglehold on the world's biggest oil reserves.

Saudi Arabia will be next, not with bombs but through a US-inspired toppling of the ruling elite.

The result will be the dawn of a golden economic era, one underpinned by abundant and therefore cheap Middle-East oil produced by the US oil majors that also happen to be big supporters of their Texan president.

So the conpiracy theorists would have you believe. It does not matter that cheap oil would destroy the US oil majors or that the cost of the war, variously estimated at $US22 billion ($A37 billion) to $US140 billion, buys a lot of oil any day of the week.

Whether there is any truth to the claims and suspicions about the real reasons for the war will be debated for years to come. Right or wrong, they will not go away, even if Britain's idea of handing control of the Iraqi oilfields to the United Nations once victory by the "coalition of the willing" is secured sees the light of day.

What is known with certainty is that war in Iraq, or anywhere else in the Middle East for that matter, necessarily has oil at, or near, centre stage.

Iraq is, after all, a major, albeit frayed, oil producer and, more importantly in the long run, the owner of the world's second-biggest reserves. It had been producing 2.4 million barrels of oil daily under United Nations supervision since the oil-for-food sanctions came into effect in 1999.

Because of its huge undeveloped reserves Iraq could produce a lot more. But it has not had the capacity to invest in additional production and, technically at least, it remains part of the Organisation of Petroleum Exporting Countries.

OPEC's quota system on production by member countries is aimed at keeping the oil price as high possible without affecting demand. The target is a price between $US25 and $US28 a barrel.

The member countries, whose economies all depend heavily on oil, control two-thirds of the world's reserves, but they produce only one-third of the 78 million barrels of oil that the world gobbles up daily. In effect, the non-OPEC world produces all it can and buys the rest from OPEC.

But OPEC is the producer that can make a difference to the global oil price by adjusting its quotas. That also makes it the producer that can deliver the non-OPEC world a nasty shock every now and then.

Before a shot was fired in the war, Australians got a lesson on the interplay between war in Iraq and what it means for oil prices.

The lesson came at the petrol pump in the form of record prices of more than $1 a litre.

Yet even as petrol stations marked up their boards, analysts were predicting a flood of oil onto the market, as well as a big drop in demand that would ease pressure on prices.

It's early days in the war but the predictions are looking good. Oil prices have crashed from just under $US40 a barrel to $US28 a barrel. The global markets drove up the price on the fear of war and supply disruptions, and they have now taken it down on expectations of the war being short.

That wild swing in attitude highlights the precarious nature of the oil market. Despite being a fuel vital to Western countries, oil is still hugely volatile.

At present, the volatility is to the downside on price. Analysts believe that the start of the war could unlock vast supplies of the resource.

"The consensus is that there will be a correction back downwards but it depends on what kind of inventory comes back on line," said Salomon Smith Barney analyst Gordon Ramsay.

"Stockpiles and reserves will come onto the market, and that will limit the uncertainty. The question is, what do countries have in commercial reserves that have been hidden from official statistics."

Indeed, the oil markets have so far shrugged off concerns of big or long-lasting disruptions. In electronic trading on the New York Mercantile Exchange yesterday afternoon (eastern Australian local time), oil was trading at $US28.30 a barrel, close to a three-month low.

The price was 21 per cent down for the week leading up to the start of the war, again reflecting the belief that a war in Iraq would be quick and that there would be little damage to oilfields and facilities.

The question in the minds of analysts, though, is how much other factors - including additional production, the release of reserves, and falling seasonal demand in the West - will offset a cut in supply from Iraq and squeezes in other OPEC countries such as Venezuela and Nigeria.

Until the commencement of hostilities, Iraq was exporting at a rate of about 1.5 million barrels a day. Saudi Arabia's stockpile could make up for about a month's disruption of those exports, although Saudi officials have said the country does not plan to draw down all 50 million barrels. But Saudi Arabia is now producing about 9 million barrels a day, or about 1.5 million more than its OPEC quota. The country has about 1.5 million barrels of additional production capacity that it can bring on in a few weeks, if the need arises.

The US Government has a strategic reserve of 600 million barrels but has said it wants to rely on OPEC to fill any gap.

In addition, Ramsay noted that Venezuela, which had been the scene of a bitter oil industry strike, was increasing production again. He said output, of 1.6 million barrels a day in January, had reached 2 million by the end of February. Adding further comfort, the arrival of spring and summer in the Northern Hemisphere could reduce demand for oil by as much as 2.7 million barrels a day. In total, private and public oil stocks counted under the auspices of the International Energy Agency officially amount to more than 90 days of imports by Western countries.

Such figures seem to provide a sizeable cushion for any loss of Iraqi supply, but analysts say it will take time for new supplies to arrive, and the conflict comes at a time when Western reserves are at a record low.

Analysts are focused on industry crude oil stocks, which include oil held in refineries, petrol stations and in the supply chain. Such stocks total just 270 million barrels in the US.