New year begins with oil market 'perfect storm'

Are oil markets approaching a "perfect storm" in terms of oil prices—where a sudden confluence of factors creates conditions for oil prices reaching levels that can be described only in the context of crisis?

There are a number of reasons that oil prices shot up by almost $5/bbl in the first 3 weeks of December and remain more than 50% above year-ago levels:

-- A surge in oil demand—unrelated to the state of the economy, it should be noted—owing to increased heating oil consumption prompted by the early winter storms across much of North America and to increased fuel oil use spurred by safety-related shutdowns of nuclear plants in Japan.

-- Proliferating reports that Al Qaeda or affiliated terrorist groups are planning to attack oil industry facilities, possibly even the critical tanker export terminals of the Persian Gulf.

-- The worsening crisis in Venezuela, where a national strike has not only crippled the oil industry there but also aroused fears of civil war in a key oil exporter.

-- The growing inevitability of US-led efforts to effect regime change in Iraq, with all of the supply-threatening possibilities that prospect entails.

Confluence of factors

Perhaps the most surprising of these market-inluencing factors is the recent bump up in oil demand, which otherwise had been languishing for most of 2002.

The wave of winter storms that hit the US around the Christmas holidays wasn't even the first of the season—the heating season, that is, considering that the earlier arctic express hit in the fall, around the Thanksgiving holidays. Other forecasters are beginning to express doubts about the National Weather Service's prediction of a winter warmer than normal for the remainder of the season, but the ensuing warm spell that was expected to greet the new year seemed to restore the viability of that forecast—for the moment.

In Japan, the staggered shutdown of 17 of the country's 53 nuclear reactors for maintenance to repair structural defects could hike oil demand by 300,000-500,000 b/d vs. last year during the next 3-6 months, estimates Raymond James & Associates' Marshall Adkins.

Supply concerns

Until recently, oil supply concerns were mainly driven by speculation: the prospect of a military strike against Iraq, the possibility of a terrorist attack on Saudi export terminals. But the loss of Venezuelan crude and gasoline exports in mid-December was a reality that helped push oil prices up toward $33/bbl at this writing. The immediate recognition by key energy players in Congress that the Venezuelan outages will have a direct bearing on gasoline and heating oil prices in the US later this winter led to their calls for a drawdown of emergency stocks from the Strategic Petroleum Reserve.

It is difficult to gauge the extent of a supply disruption caused by terrorist attacks on Persian Gulf export facilities. Suffice to say an attack that knocks out one or two of the bigger Saudi terminals for a period of months could by itself prompt an immediate drawdown of global emergency stocks and emergency rationing measures by governments worldwide.

In the reality of the present, the Venezuelan crisis must be viewed in a short-term context. The statement at the end of December from Ali Rodriguez Araque, former Venezuelan oil minister and current secretary general of the Organization of Petroleum Exporting Countries, that Venezuelan oil exports would return to normal was greeted with skepticism in some circles. But it's difficult not to believe that something will have to give soon between the strikers and President Hugo Chavez. Venezuela cannot be sustained without oil exports for long. Whether a coup or a peaceful solution ensues, the Venezuelan military (divided though it is for the moment) has a reputation for not dawdling in a crisis.

Which leaves Iraq. Despite the appearance of cooperation with United Nations arms inspectors, Baghdad's initial declaration of its weapons of mass destruction status, coupled with growing isolation even from other Arab nations and stepped-up preparations for war, point to the inevitability of armed conflict. And intelligence reports point to the likelihood of a scorched-earth exit for Saddam Hussein, as with Kuwait.

So we have a perfect storm of oil market factors. And it may well collide or combine with a perfect storm of simultaneous geopolitical factors facing the US: war with Iraq, a heat-up of the war on terrorism, the Israeli-Palestinian conflict boiling over, and a possible conflict with North Korea. As the Persian Gulf crisis of 1990-91 showed, massive military buildup alone can spike oil demand.

Hold your breath: Here comes 2003; can $40/bbl oil be far behind?

(Online Dec. 27, 2002; author's e-mail:

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