Infusion of Oil from Iraq a Wild Card in U.S. Economy

<a href=www.menafn.com>Middle East Nort Africa • Financial Network--The Atlanta Journal-Constitution NewsStand - Sunday, April 27, 2003 MICHAEL E. KANELL, Staff

The war with Iraq is over, but the uncertainty is not. And one of the biggest unknowns is how much impact the return of Iraqi oil to the market will have on the wobbly U.S. economy --- and how soon. A lot is riding on the answer. Optimists say Iraqi oil holds the promise of keeping global energy prices down, limiting the influence of the Organization of Petroleum Exporting Countries and offering relief to beleaguered American consumers and companies.

"I think the war changed things in a big way," said economist Ujjayant Chakravorty of Emory University.

Few oil wells were torched by Iraqi troops. No missiles hit Saudi oil fields. No suicide bombers blocked oil ports. As those fears evaporated, the price for oil came down dramatically.

From a prewar flirtation with $40 a barrel, oil prices fell into the mid-$20s.

For a struggling U.S. economy that stumbled again in recent months, the higher prices had threatened a renewed recession, said Rajeev Dhawan, director of the economic forecasting center at Georgia State University

"We definitely dodged the oil bullet," he said.

Still, the ripple from the halt of Iraqi oil production when the war started has yet to even reach U.S. shores.

Oil from Iraq, which had been the fifth-largest supplier to the United States, stopped flowing shortly after the bombs started falling on March 19. Since it takes more than a month for oil to wend its way from the Middle East to the United States, it is too early to assess the effects of the shutdown, said Matt Simmons, chairman and chief executive of Simmons & Company International, a Houston-based energy investment bank.

Oil production in Nigeria has also been disrupted, by political violence.

If the cutbacks in those countries are going to mean higher prices, we should start to see them in the coming days, he said.

Most analysts expect a slow return of Iraqi production and relatively stable oil prices for a few months. And as the flow of Iraqi oil swells, that added supply should nudge prices down.

But there are other possibilities. Many analysts expect the Bush administration to dismantle Iraq's state-run economy in favor of a free market.

Privatization would be a tremendous shock and might delay full production, said Lewis Snider, professor of political science at Claremont University in California, who has lived in the Middle East.

"The politics of this could get really nasty," he said.

The issue is important because timing matters. America's need for gasoline peaks in midsummer.

With most of the world's producers pumping near capacity and the stream from Iraq slowly resuming, gas this year will be available at surprisingly reasonable prices, Snider predicted.

"I don't see too much reason to be anxious about the tightness of supply this summer," he said.

Still, inventories are at historically low levels. With so much oil coming from unreliable places, and with OPEC planning to cut production about 7 percent, an increase in energy needs will leave precious little room between supply and demand, said Jay Hakes, former administrator of the Energy Information Administration.

"I still think we are in the tightest market since the Persian Gulf War. Saudi Arabia helped, but it hasn't offset the oil lost from Iraq."

And other losses are possible. Balance shifts

Crunch time is from Memorial Day to Labor Day. If all goes right, which includes Iraq starting to export oil and Venezuela and Nigeria staying placid, then there will be enough modestly priced gas for Americans.

Unfortunately, that means depending on a lot of coins to come up heads, Simmons said. "The odds are really low that we will have an easy time."

"This market is very vulnerable to any little disruption," Hakes said. "I think OPEC may be misreading the world market. There is not a good supply of oil out there. That could make for fireworks in the next few months. If gas goes to $2 a gallon, that has an impact on the economy."

Short-term questions aside, the war has shifted the balance of oil power.

Iraq's oil reserves are second only to those in Saudi Arabia. While Iraq's decaying industry struggled in recent months to pump 2 million barrels a day, its capacity could be three times that.

As some war-backers argued, a U.S.-friendly Iraq would erode Saudi Arabia's power to shape prices.

The 2001 Cheney Report on energy argued that America must diversify sources for oil and make sure those sources are dependable. "The policy-makers want to move away from the Middle East --- to the Caspian Sea, to West Africa and Latin America," said Daphne Wyshan, a fellow at the Institute for Policy Studies.

A pro-U.S. Iraq would provide one more dependable source. But significant production needs to be resumed first.

Vice President Dick Cheney recently predicted that Iraq will be pumping 2.5 million to 3 million barrels of crude a day by year's end --- better than its production has been for years.

The experts are split on that projection.

First is the problem of legality: Will the United States win United Nations approval to sell Iraqi oil? Would the United States go ahead without an OK?

Niceties of international law aside, dilapidated equipment and transportation bottlenecks could throttle a return to full production, Simmons said. "But it's like a patient who needs an MRI and CAT scan. We just don't know yet."

Even the much-touted estimates of Iraqi reserves are unreliable, he said. "How much oil is there? Nobody has any idea." Politics plays a role

Iraqi oil's impact may depend more on politics than engineering, said Ken Miller, vice president of Purvin & Gertz, an international energy consulting company in Houston.

With the world's large economies weak, Miller said the supply will overwhelm demand and prices will come down.

For American drivers, the idea of cheaper gasoline sounds delightful. But that could spell political disaster.

Middle East oil producers have built economies around oil dollars. When the price plunges, it can savage the standard of living and undermine the compact between people and rulers.

Some analysts scoff at worries about revolution. Still, the danger is obvious from the numbers, Simmons argued. Saudi Arabia has a burgeoning population and a large royal family that has its own kind of welfare. The nation's income has fallen from about $26,000 per person to $6,500 in less than two decades.

"Do the numbers --- unless they are willing to produce another cash crop, they need an average of 10 million barrels a day at $50 a barrel," Simmons said.

Oil prices didn't get to $50 a barrel last year. But during the winter, higher energy costs were seen as a drain on the finances of consumer and company alike.

Price increases are not as costly to the economy as three decades ago, but America cannot run without oil. When the price goes up, we pay. Only if it stays high for a long time do consumers shift their habits and purchases.

That makes the short-run effect of oil prices potentially painful. So, if OPEC's cut forces oil prices up rapidly, that could put a nasty hole in hopes for a recovery. The price equation

High oil prices have been a factor in --- or the cause of --- most of the U.S. recessions since World War II. On the other side of the coin, low prices have added fuel to several booms.

While the fall from prewar levels is welcome, oil prices are still far higher than in late 2001 and early 2002. Back then, gas prices in metro Atlanta were below $1 a gallon. Still, if prices don't climb again, that is a very modest kind of good news.

With the U.S. economy struggling --- job losses up and business orders down --- oil prices are not helping, said John Silvia, chief economist of Wachovia Securities. "But it won't hold us back --- we're already stuck in the mud."

Hopes for renewed growth have been pegged to a resurgence in business spending. But companies have been unsure about the future and hesitant to spend, just like consumers. Higher-than-average oil prices only add to uncertainty, said Dwight Allen, a partner at Deloitte Research.

"At least we know we are not in for a dire, acute situation," Allen said. "But the future is as cloudy as it was before."

Allen is telling his corporate clients to come up with several backup plans, to consider various scenarios and to hedge their bets. This is not a time for gambling, big spending or padding payrolls.

"For the next 12 months, you make only a limited commitment," Allen said.