The falloff of Iraqi oil production probably has contributed more to recent price increases than any so-called "war premium" risk factor of pending US military action against Iraq, said industry analysts at Petroleum Industry Research Foundation Inc. (PIRINC), New York.
"There is enough spare capacity among the other oil producers to replace the current low level of Iraqi exports several times over—and indications from producers that they would move quickly to make up any losses in supply," said PIRINC analysts in a recent report.
"If the issue were simply the likely loss of Iraqi exports, most experts would agree that the market impact of military action would be manageable and short-lived," they said. However, as in the Persian Gulf crisis of 1990-91, the analysts noted, "Most of the world's readily available spare capacity is held by Iraq's neighbors. While risks may not be high, there is always a possibility that spillovers from any military action, through Iraqi direct responses or political upheaval, could interfere with the deployment of spare capacity or, worse, threaten existing production."
Thus, markets will remain vulnerable to price fly-ups until it is evident that existing production is not threatened and spare capacity is deployed, they said.
US response
The US has a backstop to help manage oil prices during a crisis: the Strategic Petroleum Reserve (SPR). But during the last Persian Gulf crisis, no SPR oil was released until the start of the war in January 1991, well after oil prices had peaked and too late to prevent economic damage resulting from initial price spikes.
This time, PIRINC analysts advised, the US government "could exert a market-calming influence, even without drawing on the SPR, by at least announcing that it would be used promptly in the event that Iraqi production losses are not made up by other producers or in case of any impairment to existing production in Iraq's neighbors."
Unlike the 1990-91 crisis that "came as a surprise to world oil markets," the analysts noted that "the timing of any (new) action (against Iraq) will be known to at least the world's most important oil consumer, the US. With that knowledge comes the responsibility to put in place policies designed to minimize both immediate and potentially sustained oil market disruption."
However, they warned, "In assessing such policies, it should be kept in mind that while the US may decide the timing of military action, the consequences for the region—and ultimate impact on oil—remain unknown."
Iraqi production
In 1989, its "last commercially normal year," Iraq produced nearly 3 million b/d of oil and exported 2.5 million b/d—"levels not reached since" the United Nations first imposed economic sanctions against that country in August 1990, PIRINC reported.
There have been many interruptions of Iraq's oil exports in the intervening years, primarily as Iraqi officials tried to wriggle out of the terms of the UN oil-for-aid program. However, the most striking aspect of those exports this year is their very low level, the analysts said. They attribute that to the continued problem of illegal surcharges demanded by the Iraqi government and retroactive pricing practices adopted by UN overseers.
So far this year, Iraq's oil exports are averaging 1.14 million b/d, about 550,000 b/d below the average for all of 2001. Moreover, PIRINC reported, "Since mid-July, the gap vs. the same period last year has been much wider, averaging 1.1 million b/d."
As a result, the analysts said, "The amount of current oil production directly at risk in the event of military action against Iraq is thus modest compared to the immediate losses of August 1990."
At that time, Iraq was producing nearly 3.5 million b/d and Kuwait's production was nearly 1.9 million b/d, accounting for 22% of OPEC's total production between the two of them.
Moreover, PIRINC said, spare production capacity outside Iraq is even larger now than in 1990, including 5.5-6 million b/d among OPEC members plus some spare capacity in non-OPEC countries such as Mexico.
"Existence of ample spare capacity and signals (from key producers) that it would be used in case of hostilities are calming influences on the markets," the analysts reported.
