OIL MARKETS BRACE FOR PRICE COLLAPSE AS MIDEAST WAR RAGES AMID OIL GLUT

Jan. 28, 1991
Oil markets are bracing for an oil price collapse in 1991 even as war rages in the Persian Gulf. With the perception growing that the long feared threat of losing more Persian Gulf oil supplies in a war has largely dissipated, market fundamentals have again overtaken the spotlight. With that threat diminished, and crude supply/demand essentially in balance ahead of the war's start, plans by consuming nations to draw down stocks have undercut whatever premium markets had placed on oil prices

Oil markets are bracing for an oil price collapse in 1991 even as war rages in the Persian Gulf.

With the perception growing that the long feared threat of losing more Persian Gulf oil supplies in a war has largely dissipated, market fundamentals have again overtaken the spotlight.

With that threat diminished, and crude supply/demand essentially in balance ahead of the war's start, plans by consuming nations to draw down stocks have undercut whatever premium markets had placed on oil prices during the Middle East crisis.

That can be seen in the record 1 day drop of oil prices within 24 hr of the outbreak of fighting, confounding all earlier predictions that oil prices would jump to $50/bbl or more when war started (OGJ, Jan. 21, p. 19).

MARKET UPDATE

Within hours of the onset of hostilities Jan. 16, U.S. spot crude prices had begun to fall upon reports that Iraq's retaliatory capability had been almost eliminated by massive U.S. led allied air strikes.

The initial euphoria that there might be a quick end to the war with little damage to other Persian Gulf oil operations helped push crude futures prices by closing Jan. 18 to their lowest level since early July 1990-before an agreement to adhere to quotas by the Organization of Petroleum Exporting Countries had bolstered prices. Contributing to market softness were announcements at the outset of fighting by several nations of plans to release strategic oil stocks.

That euphoria has since been tempered by Iraq's repeated missile attacks on Israel and Saudi Arabia with the threat of a wider war or damage to Saudi facilities. Israeli restraint and the general effectiveness of allied forces defending against those attacks had led oil prices to hover in a band of $20-25/bbl at presstime.

The price of Brent blend for immediate delivery, which fell to less than $20/bbl within 5 days of the start of allied air strikes, climbed $2.90 to $22.15/bbl in reaction to the Jan. 22 Scud missile attack on Israel and on reports Kuwaiti oil fields were afire. Light sweet crude futures on the New York Mercantile Exchange for February delivery jumped about $3 on the week to close Jan. 22 at $24.18/ bbl. Nymex crude for February delivery had slumped to $19.25/bbl on closing Jan. 18, the lowest since July 20.

Demand for prompt delivery of crude and products has been strong in the Pacific Rim and Europe. A cold snap in the U.S. also helped bolster prices. Gasoline and diesel price cuts were introduced in Europe as the price of premium gasoline dropped to as low as $210/metric ton from a prewar level of $312/ton. Stronger product demand and higher crude prices pushed the gasoline price back to $245/ton at closing Jan. 23. Over the same period, gas oil dropped to $225/ton from $335/ton before recovering to $265/ton.

In the U.S., Nymex gasoline for February delivery plummeted almost 25 in 2 days to close Jan. 18 at 57.72/gal, while heating oil in the same period plunged 300 to 61.52/gal. Both rebounded about 6-7 by midweek last week.

THREATS REMAIN

There remains a continuing if muted threat to tankers in the Persian Gulf region, and exporters are taking steps to minimize that threat.

That was underscored by unsuccessful Iraqi air sorties against allied vessels in the Persian Gulf late last week.

There also remains the threat to industry operations and the Persian Gulf ecosystem from oil spills and oil fires caused by sabotage or military action.

More important, say some analysts, is the longer term threat to the market if Iraq proceeds with its "scorched earth" threats against Kuwaiti oil facilities. They note Iraq and Kuwait currently have the only surplus crude productive capacity in the world, and resurgent demand later in the year could tighten the market sharply if either country's productive capacity is significantly reduced for a long time.

On the other hand, restoring both countries' production if hostilities end soon-especially ahead of the seasonally weak second quarter-probably would slash oil prices. Market analysts see an urgent need for OPEC to restore production cuts to sustain prices when hostilities end.

But the prospects for that are dim, given the OPEC combatants' urgent need to recoup revenues lost because of the international embargo against Iraq and Kuwait and war costs.

Meantime, oil companies are bracing for another onslaught of criticism of their actions during the standoff and ensuing war and for the political hammering they will take over expected record profits stemming from higher crude prices. Any widespread credence given to charges of war profiteering could result in hastily drawn legislation at state or federal levels to reregulate oil supply and prices. As was the case with price spikes following Iraq's Aug. 2 invasion of Kuwait, talk of reinstating the dreaded "windfall profits" tax has resurfaced in Washington.

SCENARIOS

If Iraq's invasion of Kuwait last August meant that OPEC and oil markets would never be the same again, that truism was underscored with the outbreak of war in the Persian Gulf.

Some analysts fear a continuing threat to the market no matter the outcome. One scenario has Iraqi President Saddam Hussein's political survival-even amid a military defeat-posing a perpetual threat to the OPEC nations that account for most of the world's oil reserves and exports. Another has Saddam's downfall-especially if Israel joins the fray-resulting in heightened unrest among Arab populations in those OPEC nations, threatening the regimes that have done the most to undercut oil prices in the 1980s.

However, a contrary view holds that a quick, decisive allied victory and Saddam's elimination from the picture would serve as a prelude to an international effort to resolve Middle East disputes-notably the quest for a Palestinian homeland-once and for all.

Whether OPEC survives the war, a likelihood because it survived Iraq's blitzkrieg takeover of Kuwait, postwar efforts to hammer out another production agreement to bolster oil prices are certain to be contentious.

There remains another wild card scenario, regardless of war events or OPEC actions, that could tighten markets again in 1991. Mounting civil unrest in the Soviet Union could lead to oil supply disruptions there. Labor unrest in the principal Soviet oil producing regions created temporary shortfalls of domestic oil deliveries on several occasions in 1990, and it is conceivable long disgruntled Soviet oil workers could repeat or expand those actions in 1991.

The world's largest oil producer, the U.S.S.R. exported about 3.3 million b/d of oil in 1990 and is expected to export only 2.7 million b/d in 1991, according to an analysis by Salomon Bros. (OGJ, Dec. 31, 1990, p. 28).

KUWAITI REFINERIES DAMAGED

The only casualty resulting from Iraqi military strikes by presstime was the Japanese owned Arabian Oil Co.'s Ras al Khafji 30,000 b/d refinery in the Saudi sector of the Neutral Zone.

Iraqi artillery hit a storage tank at Ras al Khafji on the first day of fighting.

However, it appears the unit had been shut down or was in the process of being shut down as a precautionary measure. The smallest refinery bordering the Persian Gulf, it is not a major contributor to exports or the war effort.

U.S. military officials in Saudi Arabia confirmed Iraqi forces had set ablaze storage tanks at the 190,000 b/d Mina Abdulla and 187,000 Shuaiba refineries on the coast. The status of Mina Saud refinery and storage tanks in southern Kuwait was unknown at presstime.

Kuwait's three extremely sophisticated refineries at Ahmadi, Mina Abdulla, and Shuaiba, with a combined capacity of 670,000 b/d, were not operational before the war started.

If reports from refugees leaving Iraq before the war's outbreak prove correct, those units have been taken out of service by Iraq's policy of stripping key pieces of processing equipment.

Kuwait Petroleum Co. has no firm evidence about the extent of cannibalization but had begun making preparations for restoring capacity after Kuwait's liberation through early contacts with industry suppliers and contractors.

Industry sources say the major processing facilities at all three refineries are still intact.

However, reports reaching the Kuwaiti owners in exile indicate advanced computer centers that control the operations have been dismantled and taken to Iraq, along with extensive stocks of spares covering all aspects of the three plants.

The Iraqis began stripping the three refineries of their extensive inventories of spares almost immediately after the takeover of Kuwait last August.

Spares were moved by truck to Iraq for use in refineries there.

The removal of control systems took place during several months and was reportedly done in an organized fashion, apparently with the idea of reusing the equipment in Iraq.

KUWAITI OIL FIELDS AFIRE

Early reports indicated wells or storage tanks had been set afire in Wafra and South Fuwaris fields in the Neutral Zone and South Umm Gudair oil field in Kuwait.

Combined production of those three fields was 135,000 b/d in normal times.

U.S. military reports confirmed Iraqi forces had set afire storage tanks and oil wells in Wafra field.

Wafra fires led to speculation Iraq is conducting a dummy run for the destruction of production facilities in the much larger Burgan and Magwa fields in Kuwait.

However, industry sources point out Burgan and Magwa rely on water drive and that the low levels of associated gas in these fields could make it difficult to keep any wellhead fires burning.

In addition, sources noted many of Kuwaiti/Neutral Zone wells set ablaze would kill themselves quickly because they are on artificial lift.

Officials of Texaco Inc., whose Getty Oil Co. unit has operated facilities in the area since February 1949, said almost all 360 wells producing in Wafra, South Umm Gudair, and South Fuwaris fields were on artificial lift.

Early reports said the fires might have been caused by allied artillery.

That theory was discounted when aerial photos showed evidence the fires had been ignited by explosives set on wellheads.

The British government is not convinced the Iraqis have exploded wellheads in Wafra field. It points out the fires could be oil filled canals set ablaze, which proved an effective tank barrier in the Iran-Iraq war.

Storage tanks are another possible source of burning crude oil in the area. Storage tanks in a gathering area adjacent to Wafra have a combined total capacity of 900,000 bbl. Field storage capacities are 230,000 bbl in Wafra, 100,000 bbl in South Umm Gudair, and 5,000 bbl in South Fuwaris.

When Texaco left the area last August, storage there was less than half full.

Iraq may have set the fires to limit the visibility of attack aircraft. U.S. Air Force Lt. Col. Greg Pepin said, "Obviously if there's heavy smoke, it will affect operations somewhat."

The Iraqis might also be using the dense smoke from the fires to screen military movements from allied scout aircraft and satellites.

U.S. Energy Sec. James Watkins said, "This dictator has now ignited Kuwaiti fields for some reason. Nobody knows quite why. It doesn't seem to make any sense from a military defensive point of view, nor does it turn off the war. What is he doing it for?"

POSTWAR RECONSTRUCTION

Months before Operation Desert Storm began, Kuwaiti government officials were planning a massive postwar reconstruction in response to earlier reports Iraq had planted explosives in Kuwaiti oil facilities.

Last week, Bechtel Group Inc. denied trade press reports it had reached formal agreement with Kuwait to lead reconstruction efforts.

Companies reported to be seeking subcontracting work from Bechtel confirmed their interest in participating in the reconstruction but, citing the threat of Iraqi terrorism, would not comment further.

However, three Houston area companies-Red Adair Co. Inc., Boots & Coots Inc., and Joe Bowden's Wild Well Control Inc.-were planning to move men and oil field fire fighting equipment to the Middle East. Airlifts and sea transports were being considered.

If circumstances prove critical enough, crews and equipment of all three companies could be dispatched.

SAUDI FACILITIES THREAT?

Within range of Iraqi missiles and strike aircraft are major Saudi export refineries at Jubail and Ras Tanura on the Persian Gulf coast and the 135,000 b/d Riyadh unit that normally serves the domestic market.

The 280,000 b/d Jubail refinery, a joint venture of Royal Dutch/Shell Group and the Saudis, is closest to the fighting at about 150 miles south of Ras al Khafji.

Saudi Arabian Oil Co. has cut throughput to about 300,000 b/d at its 520,000 b/d Ras Tanura refinery because of a fire in a 250,000 b/d distillation column at yearend 1990 (OGJ, Jan. 7, p. 30).

Saudi Arabia has 875,000 b/d of processing capacity on the Red Sea coast in its refineries at Jeddah, Rabigh, and Yanbu.

Those plants, at least 500 miles from Iraq and Kuwait, are thought to be outside the range of Iraqi attack.

IRAQ'S FACILITIES POUNDED

Iraq's refining capacity is believed to have taken a considerable pounding in the early days of the air war.

The Pentagon has not disclosed how many air attacks have been made on Iraqi oil refineries and production facilities.

But Kurdish rebels in Iraq said four refineries have been hit. The Kurdistan Democratic party, which has agents throughout Iraq, said refineries have been attacked at Kirkuk, Doura, Baiji, and Qaiyara. There was no confirmed information on the extent of damages at presstime.

The British government believes air attacks have cut Iraq's processing capability by half.

The 70,000 b/d Daura unit near Baghdad is known to have been hit several times during the first week of allied attacks, with a substantial fire observed there.

Industry sources assume the much larger and recently expanded 300,000 b/d Baiji refinery between Baghdad and Mosul has been a target, although there is no information about its fate.

A similar lack of official information applies to the 150,000 b/d Basra refinery, although there have been reports from just across the border in Iran of very heavy allied air action in the area around the plant.

Iraq has five other small refineries with capacities of 12,000-30,000 b/d near main producing areas.

SHIPPING THREATS

With allied forces having established air superiority in the Persian Gulf and mostly neutralizing any Iraqi missile threat, the biggest threat to industry operations probably is Iraqi mining of the gulf.

The Maritime Liaison Office in Bahrain told shippers several mines had been destroyed about 90 miles north of Bahrain and another four mines had been eliminated farther south in the gulf.

Still, the threat of Iraqi strikes prompted exporters to revive shuttle tankering, which proved so effective during the Iran-Iraq war.

Middle East sources said reluctance of some Japanese owners and resistance from the Japanese seamen's union had reduced the number of vessels visiting terminals nearest the fighting.

A line of 80 vessels was reported to be waiting off the Indian Ocean coast of Oman and Fujairah, reminiscent of the worst days of the Iran-Iraq war when tankers used this area as a safe haven while waiting for orders to load in the gulf.

Immediately after the first air raids on Iraq, the allied naval command advised tanker owners to restrict vessel movements to an area east of 54 E. Long. Most export terminals in the region are west of that point.

By the end of the day the advice had been revised, identifying the danger zone as an area north of 27.5 N. Lat., which put all the major gulf terminals in Saudi Arabia, Qatar, and the United Arab Emirates outside the danger zone, leaving only Iran's Kharg Island still in the danger zone.

Owners of Japanese flagged vessels agreed with the seamen's union not to enter terminals in Saudi Arabia, Bahrain, at Kharg Island, and the onshore Qatar terminal at Umm Said. Offshore loadings in Qatar are unaffected.

Iran and Qatar have chartered tankers to move crude from export terminals within the theoretical range of Iraqi strikes by warplanes and missiles. The oil is offloaded into customers' tankers in safer areas.

Shipping industry sources said Saudi Arabia does not want to introduce a shuttle service solely to accommodate Japanese tankers trading with Ras Tanura and Juaymah terminals or lifting products from Jubail refinery. However, the sources point out the Saudis have the capacity to introduce a shuttle if a serious threat to safe loadings materialize.

Iran, which developed the shuttle concept in response to heavy Iraqi air raids on its Kharg Island terminal, is thought to have chartered three very large crude carriers that would move crude from Kharg to a transshipment point at Lavan Island about 250 miles down the coast.

The Lavan site also was used during the Iran-Iraq war and was attacked by Iraq several times. But this required long range strike aircraft with inflight fueling capabilities that are not freely available to Iraq in the current conflict.

National Iranian Oil Co. told customers Kharg Island is still open to tankers that want to load. Industry sources say tankers, including vessels owned and working for major companies, still plan to load at Kharg.

Iran also moved a number of VLCCs previously moored off Kharg that were being used to store surplus crude. There is no indication where those vessels are now.

Qatar, one of the smallest producers in the Persian Gulf, made early moves to protect its crude oil export revenues.

Qatar General Petroleum Corp. has a 3 month charter on the Sana VLCC to run a shuttle service in conjunction with the 63,132 dwt Mabrouk, also under charter.

Qatar produces about 380,000 b/d from one onshore and three offshore fields. Qatar's only refinery requires about 50,00060,000 b/d of feedstock, with the remainder exported.

The shuttle service was in place before the outbreak of unrelenting allied air attacks. Sana, a veteran of the Iran-Iraq gulf war, offloaded its first cargo off Oman Jan. 19.

Shipping sources said the Japanese ban on shipping picking up from terminals in the Persian Gulf nearest the fighting was not solely responsible for the decline in the volume of tanker traffic in the gulf.

The sharp rise in war risk insurance for tankers-now as much as 5% of hull value for vessels trading with northern gulf terminals-plus war bonuses for crews persuaded many owners to hold vessels outside the gulf until the situation becomes clearer.

MARKET RESPONSES

The international community continues to take steps to boost oil supplies and trim demand despite evidence of a glutted market.

France will meet half its requirement to release 126,000 b/d of oil onto the market through a stock drawdown, with the remainder coming from demand restraint.

Stock drawdown will involve a 3% reduction in oil companies' obligations to hold stocks. The drawdown will concentrate on heating oil and diesel fuel, where the French government considers there is the greatest need.

Demand restraint will require strict application of existing regulations on speed limits for cars and trucks and heating limits for public buildings.

Norway will implement its International Energy Agency obligations through conservation in transport and home heating fuels designed to cut oil consumption by 4-5%. Norwegian oil companies also told the government they are willing to draw on commercial stocks.

Norwegian officials said if the war leads to serious supply shortfalls, oil consumption could be reduced by as much as 15% by stricter conservation measures, including bans against driving on certain days, limiting gasoline sales, and reducing deliveries from oil companies to gasoline dealers and large scale users. Gasoline rationing also will be considered if there is a requirement to reduce consumption by 20% or more.

Japan's Ministry of Trade and Industry reduced local oil companies' requirements to hold stocks to 78 days' consumption from 82 days to meet its IEA requirement for a 350,000 b/d release of crude.

Private sector companies currently have 88 days of stocks out of a total 142 days stocks in Japan. The balance is held by the government, which said it will not release inventories unless there is a major disruption in supplies from the Persian Gulf.

MITI also asked refiners, distributors, and traders to hold down spot purchases of crudes in an effort to prevent any unexpected spikes in price.

U.S. SPR SALE

The U.S. Department of Energy proposed to sell 22,612,500 bbl of light sweet crude and 11,137,500 bbl of light sour crude, a ratio that parallels the supply to U.S. refineries, although those levels may be adjusted. The drawdown will equal 1.125 million b/d during 30 days.

Delivery is to be taken Feb. 15 through Mar. 31 via tanker, barge, or pipeline. Crude will be sold in minimum lots of 200,000 bbl if delivery is via tanker or pipeline and 120,000 bbl if by barge.

DOE said a test sale last fall "proceeded virtually flawlessly and increased industry's familiarity with the drawdown and delivery process."

Watkins said DOE did not offer heavy sour because industry did not bid for 800,000 bbl of heavy sour in that test sale.

He said, "The SPR sales and delivery process is an orderly, well thought out and tested sequence of steps that ensures large quantities of crude oil can be moved to market quickly and efficiently. As our recent test sale showed, the entire bid process from offering the oil to first contracts can be run in just over 2 weeks.

"We can begin to deliver oil to the market in less than half the time it takes for a tanker from the Persian Gulf to reach the U.S."

The Bush administration also is waiving Jones Act provisions that require use of U.S. flag vessels to move crude between U.S. ports if they are moving SPR crude.

Bob Gentile, DOE assistant secretary for international affairs, explained that was done because 60% of U.S. refineries do not have access to pipeline systems serving SPR sites.

The deadline for bids to be delivered to DOE's SPR project management office in New Orleans was 4 p.m. CST Jan. 25.

DOE said any firm, organization, or individual can submit an offer, but it will consider only reasonably priced offers from responsible bidders. The crude will be sold to the highest bidders that meet DOE's sale terms.

Bidders were required to submit an offer guarantee in the form of a certified or cashier's check, a wire cash deposit, or a letter of credit amounting to 5% of the total offer or $10 million, whichever is less. The sale will be governed by regulations published in the June 3, 1988, Federal Register.

DOE said the first SPR oil could begin moving to U.S. markets within 2 weeks, but because industry normally schedules shipments on or about the 25th of the month, DOE expects most sale contracts to call for delivery in late February and throughout March.

The sale is offering:

  • 3 million bbl of sweet crude and 8.25 million bbl of sour from the Bryan Mound storage site near Texas City, Tex.

  • 6 million bbl of sweet and 5.25 million bbl of sour from the West Hackberry site near Lake Charles, La.

  • 2.25 million bbl of sweet and 2.25 million bbl of sour from the Bayou Choctaw site near Baton Rouge.

  • 6.75 million bbl of sour from the Weeks Island site southwest of New Orleans.

DOE said the Big Hill site near Beaumont, Tex., is just beginning to be filled and will not be used.

DOE may sell sour crude from the Sulphur Mines site near Lake Charles, La., as part of the sour crude stream from West Hackberry.

Sulphur Mines holds 25 million bbl, but it can be drawn down only once, so DOE has been planning to decommission it next year (OGJ, Oct. 8, 1990, p. 25).

REACTIONS

The Petroleum Marketers Association of America said the sale of SPR oil will have an "extremely positive effect" on the nation's economy.

Phillip Chisholm, PMAA executive vice-president, said, "This strong, forceful action by President Bush will send a clear signal to the nation's oil markets and to consumers. That message, quite simply, is 'Don't panic.' Our oil supplies are adequate, and there is absolutely no need for overreaction."

PMAA also urged oil companies "to treat all their customers responsibly, with fairness and equity throughout the duration of the crisis."

Chisholm said in the months following Iraq's invasion of Kuwait there were instances of some refiners favoring their own direct operated outlets at the expense of independent petroleum marketers.

"We sincerely hope that we do not see a repeat of those types of practices."

Rep. Silvio Conte (R-Mass.) said, "The possibility of flooding the market at this time with our stockpiles should keep the market stable in this time of crisis and protect our economy from damaging high prices.

"Big Oil has even taken steps to keep oil prices down. Some oil companies decided to freeze prices. But they just do not know how to do something without hurting the American consumer. Big Oil announced their price freeze when the price of crude oil was dropping like a stone."

Chevron Corp., in announcing it was cutting wholesale prices Jan. 18 after freezing them 2 days earlier, took issue with renewed claims of profiteering by oil companies freezing products prices at the beginning of war.

"Our freeze was intended to protect our customers from expected price spikes," said Chevron Corp. Chairman Ken Derr. "If we had foreseen a price drop, we would have said 'cap' or 'ceiling.' The suggestion by some that we froze prices to keep them higher than the market is the most ludicrous, irresponsible thing I've heard in a long time."

Chevron lifted its freeze Jan. 24.

SUPPLY SITUATION

Watkins said despite the outbreak of war, there is no shortage of oil on the horizon. He said world stocks are 195 million bbl higher than average.

He added, "We have 6 weeks of oil on the seas today to keep everything going."

Watkins praised oil companies for restraining prices on the outbreak of war and said their actions were not due to DOE jawboning.

"They are very sincere in trying to do their best for American consumers," he said.

"They know they will be severely criticized (when fourth quarter profits are released soon), and they are trying to be fair as well."

Asked if oil companies would maintain the products price freeze if oil prices drop rather than increase, he said, "I don't think the oil industry is going to play games on that. "

He said the federal government should not interfere with markets through price or allocation controls.

Watkins told a National Petroleum Council meeting in Washington, D.C., last week the government will proceed with the planned SPR drawdown despite a relatively calm, well supplied world oil market.

He said, "These issues were raised after the first day's dramatic drop in oil prices, which defied the predictions of pundits. Well, I do not believe a couple of days of market activity should be the sole criteria for decision making regarding SPR drawdowns.

"In fact, a steady hand on the tiller in this juncture of the campaign seems to me to be very prudent."

He noted IEA's governing board will meet Jan. 28 to assess the situation.

"The potential for a shortfall of oil, not the fact that the price has dropped, will determine the IEA response. I don't envision any change in course by IEA nations unless circumstances dramatically change."

However, Watkins thinks further stock drawdowns are unlikely.

"With the facts we have in hand and without any change in the situation, I do not see the governors coming out with a second draw.

"I don't think that's necessary at all, because we've now proven the ability of our military forces in combination with all the other multinational forces in the region to do the job (of protecting Saudi production)."

CRISIS MANAGEMENT

DOE has selected an energy emergency management team to help cope with any severe supply disruption.

Watkins expressed concern about protecting the trans-Alaska crude oil pipeline from sabotage and said additional efforts are being made (OGJ, Jan. 21, p. 20).

Watkins also is using a direct communications link with the Saudi petroleum ministry to head off false reports in U.S. oil markets.

He noted that in November there was a rumor terrorists burned the Ras Tanura export terminal.

DOE checked and found that a normal industrial accident had sparked a fire that damaged the refinery's distillation tower. Watkins said the new system has been used to check two dozen such rumors. DOE has relayed the correct information to Nymex for display on members' computer screens.

He also noted Iraqi threats to set large oil fires in Kuwait to prevent coalition forces from retaking the country could be "a very severe environmental problem for the region."

ENVIRONMENTAL CONCERNS

War in the Persian Gulf could result in major oil spills damaging the environment and slowing industry operations there, contends Richard Golob, publisher of Golob's Oil Pollution Bulletin, Cambridge, Mass.

He warns that Saddam Hussein's threats to attack regional oil facilities could result in massive amounts of oil being spilled into the gulf and causing extensive contamination of water intakes to desalination plants, power plants, and other industrial facilities along the coast.

Likely targets are pipelines, storage facilities, refineries, oil terminals, tankers, and offshore platforms. Iraq inflicted serious damage to all such targets through missile attacks and sabotage, Golob noted.

Golob said Iraq hit 218 merchant vessels representing 41.4 million dwt during the 1984-88 "tanker war" with Iran. Most of those attacks occurred during the day within 80 miles of Kharg Island and within 10-65 miles of Iran's coast.

Iraq's Exocet missiles caused less damage to tankers than first expected. No tanker exploded when struck by an Exocet, although some were ablaze for several days.

"The risk of explosion on the tankers was reduced because the crude oil acted effectively as a sponge for the missile impact, as did the inert gas in the cargo tanks when the ships traveled in ballast," Golob said.

Mines proved more effective in damaging a tanker's hull and causing a major oil spill during the tanker war.

In August 1987, the fully laden Texaco Caribbean struck a mine while approaching the anchorage area at Fujairah, Golob pointed out. The tanker took damage to its No. 3 port tank about 1 m below the waterline and eventually spilled more than 3 million gal of light Iranian crude oil into the Gulf of Oman.

The spilled oil dissipated in the Gulf of Oman without causing serious environmental damage.

Golob contends the biggest threat of major oil spills if Saddam mounts a tanker war would come from problems tankers would encounter with restricted navigation in the Persian Gulf.

"For example," he said, "during the Iran-Iraq war, the largest tanker spill, which involved the loss of more than 21 million gal of crude oil, took place Dec. 6, 1985, when the tanker Nova collided with the tanker Magnum as both vessels were traveling off the Iranian coast under the cover of darkness."

The environmental damage from that spill remains unknown because it mostly remained in Iranian waters, and Iran did not disclose information about it, Golob said.

Overall, the worst case scenario for a major oil spill would come from a well blowout resulting from a Iraqi attack on an offshore platform.

"During the Iran-Iraq war, Iraq repeatedly attacked Iranian offshore wells in the Nowruz, Ardeshir, and Cyrus fields, and missile attacks during the first half of 1983 resulted in the second largest oil spill in world history. Between February and September 1983, multiple wells in the Nowruz and Ardeshir oil fields lost over 80 million gal of oil."

That spill contaminated the coasts of Saudi Arabia, Bahrain, and Qatar as well as U.A.E. waters, resulting in widespread environmental damage and shutdown of desalination plants and other industrial facilities, Golob said.

Golob also noted Saddam refused to allow safe passage to blowout containment specialists unless Iran agreed to a limited ceasefire in the blowout area.

"if Iran had agreed, Hussein would have used the threat of future military strikes on other wells in Iranian waters as a way to expand the limited ceasefire into a general truce between the two countries," Golob said.

"Hussein's strategy failed, and eventually Iran succeeded in capping the wells, but only after the spillage had created a gulfwide crisis."

Golob contends an attack on offshore fields in the Persian Gulf could result in a blowout of as much as 40,000 b/d, resulting in a spill perhaps surpassing the June 1979-March 1980 1 Ixtoc that spilled 3.3 million bbl of crude into the Gulf of Mexico.

He believes Saddam could use massive oil spills in diplomatic maneuvering to win his political objectives.

PRICE COLLAPSE

Market fundamentals strongly suggest downward pressure on oil prices in the months ahead even if Iraqi and Kuwaiti crude exports remain off the market.

According to the latest IEA data, OPEC fourth quarter 1990 production averaged 23 million b/d. With demand slipping, that meant a net stock build of 600,000 b/d for the quarter.

Yearend 1990 stocks on land in Organization for Economic Cooperation and Development countries are the highest since yearend 1982 at about 3.5 billion bbl, equal to 96 days of consumption, near the 1981 peak, and 122 million bbl higher than a year ago. Company stocks are the highest since yearend 1985.

Some additional stocks will be retained as insurance against any supply disruptions. However, with a drop in demand likely in 1991, companies will have little need to carry additional stocks for very long.

Assuming OPEC production is sustained at 23 million b/d in the first quarter, balancing supply and demand will require a net stockdraw of about 700,000 b/d.

The second quarter could get dicey for oil prices, especially if Iraqi and Kuwaiti crude supplies are returned to market-in which case an oil price plunge would be almost impossible to avoid.

Assuming no change in stock levels, demand for OPEC crude will fall to 20.3 million b/d, a drop of 2.7 million b/d, in the second quarter. To sustain prices, Saudi Arabia would have to slash production, given the likelihood of little cooperation from other exporters, from yearend 1990 levels of about 8.2 million b/d. That probably would entail a Saudi production cut to about 5 million b/d. But the Saudis have sharply hiked their productive capacity and probably will reject assuming again the role of OPEC swing producer.

Given the strong possibility of Iraqi and Kuwaiti supplies returned to market by then, that strengthens the likelihood of surplus crude on the market.

OGJ also estimates that a fourth quarter surge in products demand expected in Europe and non-OECD countries, offsetting a drop in North American demand, will boost the call on OPEC oil to 23.7 million b/d.

That should tighten markets and possibly buoy oil prices.

But when the war is over, OPEC will have more production capacity than at its start.

SAUDI PRODUCTION CUT

The surplus of crude oil on the market apparently is forcing the Saudis to cut production.

Since the war's outset, the Saudis have cut crude flow by 2.5 million b/d to 6 million b/d.

Storage facilities at Ras Tanura and Juaymah on the gulf coast and Yanbu on the Red Sea coast are full, forcing Saudi Aramco to throttle back production.

Fewer tanker liftings are also a factor.

Tanker traffic in the Persian Gulf is noticeably lighter since the war began. Japanese tankers are keeping clear of terminals in the northern gulf, while others have been deterred by higher operating costs caused by war risk insurance and war bonuses for crews.

Demand for Saudi crude is unlikely to increase until the huge volume of surplus crude overhanging the market is reduced.

Further, prospects for exporters have not been improved by IEA's plan to release 2 million b/d of stocks and reduce demand by another 500,000 b/d.

MILITARY PRODUCTS DEMAND

Despite a surplus of crude oil on the market, the big spurt in demand for military fuel associated with the allied forces attacks could tighten some products markets, especially with a major refinery outage.

Energy Market Consultants, London, said any potential disruption to the 1 million b/d of Saudi refinery capacity near the war zone could be offset by spare capacity elsewhere because of the weakening trend in world consumption and approach of the seasonally weak second quarter.

With the air war in full swing, however, the supply of jet fuel is crucial. EMC said production of jet fuels in Saudi Arabia is not clear. In 1988, it averaged 100,000 b/d out of total products output of 1.3 million b/d.

According to industry reports, military stocks of transportation fuels are extremely high.

About 20-25 million bbl of all grades of land and aviation fuels and lubricants were imported into Saudi Arabia to mid-December in addition to an inventory build based on local processing.

The Defense Fuel Supply Center in Washington could not comment on volumes of petroleum products used in the war effort other than to note the Saudis were supplying the fuel.

The New York Times, quoted western diplomats and Saudi analysts, reported Saudi Arabia has become a major importer of petroleum products because of the war.

In the last 6 weeks, the country has imported about 8 million bbl of diesel fuel for vehicles and jet fuel to enable its fighter planes and those of the U.S. led multinational coalition to fly an average 2,000 sorties/day, the Times reported.

The coalition had flown more than 15,000 sorties, mainly with Saudi jet fuel, as of OGJ presstime last week.

In addition, Saudi Arabia has stopped exporting jet fuel and heavy diesel fuel, the Times reported.

The newspaper quoted one Saudi oil official as saying that until the crisis in the gulf, Saudi Arabia was exporting about 150,000 b/d of jet fuel and 200,000 b/d of diesel fuel.

The fire that took out almost half of Ras Tanura's capacity also crimped Saudi ability to produce military fuels.

MARKET OUTLOOK

More analysts are pointing to the growing prospect of an oil price drop in 1991, and none seems to be advocating the likelihood of $50/bbl.

"The oil market has now discounted its worst fears of the war impacting on Middle East oil supplies," said Joseph Stanislaw, managing director of Cambridge Energy Research Associates. "If the allied forces continue to dominate militarily in the gulf, prices will hover around their current levels with the possibility of further weakening if no major cold snap appears before spring-still a real possibility. The market, however, is still subject to a high degree of volatility, especially if the allied forces suffer any military setbacks.

"If there is the perception that Iraq-through terrorism, sabotage, or military maneuvering-appears to have gained some ground, prices will react. We see the limit on any price jump being in the $26-29 range, which we also consider to be unsustainable. As soon as it reaches that point, the market will pause to stop and catch its breath and begin falling when market fundamentals once again become the key focus."

However, Stanislaw sees the rate of decline in world demand slowing as secondary and tertiary stocks of gas oil and gasoline are rebuilt following recent drawdowns, particularly in Europe and the Far East. Lower prices could give this stockbuild an added impetus, he noted.

"In an effort to curb the extent of any possible increase in demand, some Asian nations have taken the unusual step-for them-of implementing oil and energy conservation measures," Stanislaw said. "South Korea has ordered 10% of all cars to stay off the road using a system based on license plate numbers. In this way, the South Koreans expect to save 7,000 b/d of gasoline and diesel. Thailand, Philippines, India, and Japan also have introduced some form of compulsory or voluntary system of energy conservation.

"Jet fuel demand in the gulf has more than doubled since the air raids on Iraq and Kuwait began. Jet fuel, which did constitute 60% of military oil demand in the gulf, now accounts for 80%. Nonetheless, jet fuel inventories on a worldwide basis remain high and a reduction in commercial jet traffic to the gulf area as well as to some European destinations is helping to balance the increased military demand."

Crude oil prices could slump to $12/bbl if OPEC supplies remain high, former Saudi Oil Minister Ahmed Zaki Yamani told a BBC television interviewer.

He said OPEC production of 23.5 million b/d could soon swamp the market, adding that finding an agreement within OPEC to tackle the problem could be difficult because such countries as Saudi Arabia, which previously had exercised production restraint, face heavy financial demands resulting from the fighting.

Royal Dutch/Shell Group Managing Director Peter Holmes said the IEA decision to draw down stocks would support the move to lower prices. He said major companies were looking for stable prices, and lower prices tend to be more stable prices.

The current price of a little more than $20/bbl for North Sea Brent blend is justified, given the ample amount of world supplies, Holmes said, noting there remains about 130 million bbl of oil in offshore storage around Europe. With current market conditions, a Brent price exceeding $15-16/bbl represents a war premium, Holmes said.

Fundamentals for the industry are good, said Holmes, and will remain favorable absent something unexpected such as a successful attack on Ras Tanura refining/shipping facilities.

Recession slicing oil demand is another factor in the equation for oil prices, contends Salomon Bros.

"We believe the world recession may push oil prices into a $20-25/bbl range, although geopolitical risks could still keep oil price volatility high."

Copyright 1991 Oil & Gas Journal. All Rights Reserved.