Iraq's blitzkrieg seizure of Kuwait has created chaos in world oil markets.
At a time when oil demand was relatively soft and oil stocks brimming worldwide, events following Iraq's Aug. 2 invasion of its neighbor, a former Arab ally, have sent oil futures prices rocketing to levels not seen since before the 1986 oil price collapse.
An unprecedented unity among consuming nations to embargo imports of Iraqi and Kuwaiti oil could take as much as 3-4 million b/d of supply off the market in the short term. While such an embargo is not likely to be leakproof, the shutdown of Iraq's export pipelines through Turkey and Saudi Arabia together with a U.S. led naval blockade would ensure a halt to oil shipments from Iraq and Kuwait.
Fears of protracted economic sanctions against Iraq and its new puppet regime in Kuwait and over a possible further Iraqi incursion into Saudi Arabia have sparked panic spot and futures buying on oil markets and caused motorists to top off tanks in anticipation of still higher prices.
ADEQUATE SUPPLY?
There appears to be enough spare productive capacity within the Organization of Petroleum Exporting Countries and elsewhere-in addition to high stock levels and sizable strategic stockpiles-to avoid a significant supply shortfall in the short term.
Other OPEC members have agreed to step up oil production in order to meet a shortfall of Iraqi/Kuwaiti crude caused by an embargo. At presstime last week, there were no plans by the U.S. to draw down the Strategic Petroleum Reserve to offset a shortfall. Meantime, the International Energy Agency was meeting late last week to discuss options for implementing possible emergency oil sharing agreements.
Much of the world's spare productive capacity and strategic reserve drawdown capability has not been put to the test of a long supply disruption.
The real concern is that a possible extended disruption in Saudi supplies as a result of a widening Persian Gulf conflict would overwhelm industry's ability to make up the shortfall and spark an energy crisis. That in turn probably would invite direct military intervention by the U.S. and perhaps other nations, the scope of which can only be guessed at.
Just as fears of possible Saudi supply disruptions shot oil prices up as much as $8/bbl in 5 days, the announcement of U.S. military forces heading for Saudi Arabia sliced about $2/bbl off U.S. futures prices at closing Aug. 8.
Meantime, industry and government officials last week sought to warn consumers against panicking, and industry officials sent up early warning signals against government intervention in petroleum markets in response to the emergency. To forestall that effort, U.S. refiners last week began taking measures to freeze gasoline prices in response to a call for price restraint by President Bush.
FORECASTS REVAMPED
The abrupt spike in oil prices sharply changed some industry forecasts. Until the invasion, analysts and companies generally were predicting oil prices at $18-22/bbl during the second half of 1990.
It was vocal belligerence on Iraq's part that pressured OPEC into approving an accord to seek a $21/bbl marker by slicing production, when OPEC had been unable to sustain an $18/bbl marker much of the year. That accord also allowed an overall increase of almost 400,000 b/d in the second half OPEC ceiling in a softer than expected market, raising the prospect that slumping demand or quotabreaking would quickly cause the pact to unravel (OGJ, Aug. 6, p. 36).
Now, the prospect of a widespread Persian Gulf conflict and possible threat to Saudi oil supplies has led some analysts to predict oil prices reaching $45-50/bbl by yearend.
Philip K. Verleger Jr. expects a midrange of about $28-30/bbl for West Texas intermediate futures by yearend. He is a visiting fellow with the Institute for International Economics, Washington.
Other analysts believe the situation will stabilize soon and prices will again return to roughly preinvasion levels. Steve Brown, senior economist at the Federal Reserve Bank of Dallas, contends the sharp price rises could not be sustained beyond a few weeks. He predicted WTI will settle at about $22/bbl in the longer term, leaving OPEC's marker at slightly more than $20/bbl.
Oil prices approaching $50/bbl could not be sustained for long. Even a price approaching $30/bbl probably would bring into play market forces that would undermine that price level.
As in the 1970s, such a runup in prices would force nations to implement crash conservation and fuel switching measures, dampening oil demand. It could also wreck many nations' economies, reversing the world economic and oil demand growth of the latter 1980s.
In addition, a sustained high oil price level would again render economic many marginal and shut-in oil resources, pushing supply levels up again and further crimping demand.
Industry officials and analysts in the months to come will struggle to divine some meaning from the events of early August 1990.
What is certain is that the structure of OPEC has dramatically changed, just 1 month before its 30th anniversary. Whether these events lead to the organization's dissolution-perhaps resulting later in increased competition among crude exporters for market share-or to a revived emphasis on price instead of market share remains to be seen.
If OPEC survives and the crisis settles back into an uneasy stalemate with Iraq President Saddam Hussein still able to work his will on key Persian Gulf producers, the likelihood is an emphasis on production restraint and an end to quotabreaking by OPEC members with a real ability to affect markets. That, in turn, would mean oil prices a few dollars higher sooner than anyone had expected.
But that scenario also would presume an outraged world, largely unified against Iraq's aggression, would allow Saddam's daring gamble to succeed, much less go unpunished. If Saddam fails and the result is not a widening, protracted conflict in the Middle East, the underlying fundamentals of the marketplace assure that today's oil prices could again collapse as quickly as they rose.
Even a lengthy supply disruption could not sustain higher oil prices indefinitely before market forces came into play to undermine them, as was the case during the 1970s and 1980s.
CRISIS DEJA VU?
If it goes no further, Iraq's invasion of Kuwait is not likely to be a replay of the energy crises that followed the 197374 Arab oil embargo and the 1979 Iranian revolution.
Unlike those earlier crises, the world is better prepared to accommodate oil supply disruptions. Strategic reserve stockpiles, the big worldwide overhang of crude and products stocks, and spare productive capacity elsewhere, notably within OPEC, ordinarily would offset a major supply cutoff for a short time.
IEA estimated total stocks on land in Organization for Economic Cooperation and Development countries grew by 800,000 b/d at the end of the first quarter and 500,000 b/d at the end of the second quarter. Almost all of that was company stocks in North America and Europe. IEA put forward consumption of total OECD stocks as of July 1, 1990, at 99 days, up 3 days from a year ago.
IEA estimated OECD oil demand will increase by 700,000 b/d, or about 1.5%, in the third quarter and by about 400,000 b/d, or 1%, for the full year. It put world oil supplies outside the centrally planned economies at 53.4 million b/d in July, down 200,000 b/d from June, OPEC production unchanged last month vs. June at 23.2 million b/d, and CPE net exports in July at 1.8 million b/d, down 100,000 b/d.
The U.S. imported an average 610,000 b/d of oil from Iraq during January-May, about 8% of U.S. net oil imports and 3.6% of total U.S. demand. Kuwait supplied a little more than 1% of net U.S. oil imports in the period at about 120,000 b/d.
If productive capacity were hiked to maximum levels in market economies worldwide, said DOE, about 4 million b/d in added production is possible in light of the loss of Kuwaiti and Iraqi supplies.
U.S. crude and product stocks last week reached their highest level in 8 years at a combined 1.123 billion bbl. With almost 590 million bbl in the SPR, the reserve could yield maximum drawdown of 3.5 million b/d for about 170 days, DOE said. If all U.S. oil imports were cut off, SPR and commercial stocks could provide 95 days of consumption equal to a total cutoff of oil imports.
Further, IEA government stocks outside the U.S. total about 425 million bbl, or about 32 days of oil imports by IEA members.
However, even if there are ample supplies of oil to take up the slack from a loss of 34 million b/d of supplies from Iraq and Kuwait, refiners face logistical problems in securing the right kinds of crudes to replace them or reconfiguring processes to run a different crude slate. The U.S. SPR, for example, is heavily weighted with sour crude-as much as two-thirds. At least 44% of SPR stocks is Mexican sour.
Melvin Conant, president of Conant & Associates Ltd. and editor of Geopolitics of Energy, said other OPEC states will have no trouble picking up the slack.
With added production from Saudi Arabia of 2 million b/d, Venezuela 600,000 b/d, Nigeria 200,000 b/d, and the United Arab Emirates 800,000 b/d, other producers will try to grab more market share as well, he said.
"I'm sure the other OPEC members won't be shy about picking oil up everywhere they can find it," he said. "They will pump away like mad, and they will be very reluctant to give production back to Iraq when this thing calms down."
The increased flow, Conant said, will push prices back down to "somewhere between $21-25/bbl, but not immediately because the speculators are anxious to have a war start. If some Saudi production facilities were destroyed, prices would go sky high."
MARKET RESPONSE
Oil markets reacted to events in the Middle East by sending spot and futures prices to their highest levels in almost 5 years.
West Texas intermediate for September delivery on the New York Mercantile Exchange soared to $28.05/bbl on closing Aug. 6, a jump of $3.56 from the previous Friday's close and $8.27 on the week. The Nymex spurt slowed by Aug. 7 to close 26 higher, then dropped $2.35 on closing Aug. 8. The Aug. 7 closing is the highest for Nymex WTI since the December 9, 1985, close of $28.74/bbl.
Brent blend spot deliveries for August followed the same path, closing at $25.90 Aug. 7, up 5 from the day before and $6.75 on the week.
Other petroleum futures and spot prices ratcheted up in lockstep with soaring crude prices. Nymex unleaded gasoline closed Aug. 7 at 82.39/gal vs. 65.88/gal the week before, and heating oil futures jumped to 75.14/gal from 65.93/gal in a comparison of the same period. Mont Belvieu spot propane climbed to 39.13/gal on closing Aug. 7, up 9.3 on the week.
Retail prices quickly shot up in response to the crisis. The American Automobile Association reported the average U.S. price of self-serve regular unleaded gasoline jumped to $1.237/gal, up 16.2 since Aug. 1 and the highest in 5 years.
The California Farm Bureau Federation last week warned farmers against panic stockpiling of diesel fuel in the wake of a 10-15 price hike in 5 days.
The American Trucking Association last week asked Congress to urge the Interstate Commerce Commission to accept the trucking industry's request to raise freight rates because of rising fuel costs. ATA said it received reports of bulk diesel fuel price hikes of as much as 20/gal during July 2-Aug. 5, chewing up an added 1.1% of industry revenues since July 16.
Last week, American Airlines and Pan Am World Airways each raised fares 10% in response to higher fuel costs, and Northwest Airlines tacked $8 each way onto the price of U.S. tickets.
INDUSTRY BACKLASH
The U.S. petroleum industry must grapple with a growing political backlash as a result of petroleum product price spikes following the Iraqi invasion.
Higher fuel prices last week sparked outcries in Congress and among consumer groups amid charges of price-gouging by oil companies. Several congressional subcommittees began investigations into the charges.
The U.S. Justice Department said it was looking for and would prosecute any antitrust violations it finds related to the jump in petroleum product prices.
The Department of Energy, noting that oil stocks in the U.S. and elsewhere were at near record levels, said, "Uncertainties in the Middle East pose no immediate threat to the supply of petroleum products for American consumers, nor do they necessitate increases in prices for American consumers."
In fact, government actions to seize Iraqi assets and freeze Iraqi/Kuwaiti commercial transactions last week came close to creating a real shortage instead of just a perceived one and contributed to the runup in prices.
Several companies shortly after the invasion reported having crude cargoes from Iraq or Kuwait seized or prevented from offloading as part of Bush's economic sanctions against Iraq. Refiners had begun to scramble to replace supplies held captive by the action.
American Petrofina Inc. had as much as 4 million bbl of Iraqi crude on the water at the time of the embargo. Lyondell Petrochemical Co. Aug. 2 briefly cut crude runs at its Houston refinery in response to Bush's order. Lyondell resumed normal crude runs of about 290,000 b/d-well above nameplate capacity-Aug. 3, after Bush relaxed the order against selected cargoes.
The Treasury Department exempted from the embargo any Iraqi/Kuwaiti oil loaded before the morning of Aug. 2 and arriving before Oct. 1.
CONSERVATION, PRICE FREEZES
Bush and DOE called on U.S. consumers to begin conservation measures. Bush also called on U.S. oil companies to "show restraint" in gasoline pricing.
Oil companies last week moved to rein the upward spiral of products prices.
ARCO, the first to act, said it will comply with Bush's request to hold the line on prices by freezing gasoline, diesel, and jet fuel prices for 1 week beginning Aug. 8.
"We hope the market will stabilize during this time, but if at the end of the week our position is out of line with world market prices we will have to recognize that fact," ARCO said.
"We will not raise our prices even then unless we are substantially below the general market. Otherwise, if we remain below the market, we risk a run on our stations that could drain our supply and create a panic buying situation in the marketplace. While we freeze our prices, we are encouraging our dealers, who by federal law set their own prices, to also refrain from increasing their prices."
ARCO also urged motorists to begin conserving fuel in support of Bush's conservation push. Amoco Oil Co., Phillips Petroleum Co., Chevron Corp., BP America, Unocal, and Getty Petroleum Corp. quickly followed suit with similar products price freezes.
API VIEW
American Petroleum Institute Pres. Charles J. DiBona told Congress last week a competitive market is the main reason oil and gasoline prices have risen sharply since the Iraqi invasion.
Many of the same criticisms of the petroleum industry heard last winter when extreme cold weather drove up heating oil prices are being leveled again, DiBona pointed out. He also noted much of the recent rises in the price of crude and gasoline came before the invasion-a $4.50/bbl jump in average spot crude prices by the end of July.
"While the Iraqi invasion of Kuwait has had a substantial impact on world oil markets, we are in a much better position to handle this than we were 10 years ago," DiBona said. "There is no reason for panic.
"The impact of a reduction of 3 million b/d in world supply, with the U.S. absorbing perhaps 1 million b/d of that, would depend crucially upon how long it lasted and how we adjusted to the situation.
"First, the price increase which already has occurred will help reduce demand, just as it did in the 1970s and 1980s. Second, private stocks of crude are currently ample, and we have an asset we did not have in the 1970s-a large government held strategic reserve.
"Given its present size, if we chose to utilize only 1-2 million b/d from this stockpile, we could sustain that rate for many months. If other countries similarly released stocks and if we did not panic or take clearly counterproductive steps, we probably could sustain the loss of Iraqi and Kuwaiti oil without serious damage for an extended period of time."
DiBona warned against government intervention in response to oil market shortfalls.
"In the 1970s, the U.S. government responded to oil market shortfalls in the worst ways possible, by slapping on price and allocation controls and later a special excise tax on domestic crude oil production.
"The results were long gasoline lines ... reduced domestic production, increased domestic demand, and growing oil imports."
DiBona recommended as short term supply boosting measures, in addition to using the SPR, start-up of Point Arguello oil field off California, blocked for more than 2 years. Point Arguello could contribute about 100,000 b/d to U.S. oil supply. He also called for temporary relaxation of federal gasoline volatility standards that have jumped U.S. oil demand by 150,000 b/d.
Longer term, the U.S. should press for opening Alaska's Arctic National Wildlife Refuge and more of the Outer Continental Shelf to exploration and development, support tax incentives for domestic production, and reassess the energy implications of environmental rules such as the push to reformulate fuels, DiBona said.
CONOCO'S VIEW
John Sauer, chief energy economist for Conoco Inc., said a 3-4 million b/d shortfall represents about 7% of world demand. On a pro rata basis, that means the U.S. would have to trim gasoline consumption by about 500,000 b/d, he said.
"If we are short 3-4 million b/d of crude supply for quite some time, I don't think we have the stocks to get us over that shortage," Sauer said. "We will have to reduce consumption."
If higher oil prices persist, Conoco will funnel resulting higher revenues into increased capital outlays downstream as well as upstream. The company will emphasize accelerated spending on efforts to expand its refining capability to meet more stringent air quality standards for petroleum products and to solve environmental problems at refineries.
Conoco is changing plans for marginal properties, including additional well workovers and secondary recovery projects, as higher oil prices improve their economics.
"But I don't think we should translate that into a big, immediate increase of supply," he said.
Higher oil prices will provide adequate incentive to bring natural gas to market more quickly, he said. Higher prices also will help increase E&P activity, but only to the extent that qualified personnel are available, he said. Equipment availability will not constrain activity as much as finding enough personnel.
SPARE CAPACITY CONCERNS
The Iraqi invasion highlighted the sharply decreased spare productive capacity within OPEC compared with the mid-1980s.
Earlier this year, First Boston put OPEC production at 89% of its capacity of 25 million b/d. Even with potential OPEC capacity additions totaling almost 5 million b/d during 1990-94, First Boston estimated OPEC capacity utilization rates at 85-90% during that period.
First Boston estimated OPEC's maximum sustainable capacity at 24.7-25.7 million b/d, putting current output close to 90% of capacity, a higher utilization than at any time in the 1980s.
That spare OPEC capacity represents only about 4% of total world consumption, estimated First Boston, which added, "There is no significant spare producing capacity in the world today outside of OPEC."
A senior Saudi Aramco official last month said the five major Persian Gulf producers have more than 6 million b/d of surplus productive capacity (OGJ, July 23, Newsletter). However, a big share of that surplus is in Kuwait and Iraq.
CANADIAN SITUATION
Canada is already producing crude oil at capacity and could not increase volumes if the Middle East crisis worsens, says the Canadian Petroleum Association.
CPA Pres. Ian Smyth said production of light and medium crude is about 1.5 million b/d. Canada imports only about 100,000 b/d from Middle East suppliers with a fraction of that from Iraq and Kuwait. Overall, Canada imports about 500,000 b/d of oil and exports about 600,000 b/d to the U.S., leaving it marginally a net exporter.
"That will change in a couple of years because our conventional oil reserves are declining," Smyth said.
"The crossover to net importer could come earlier if, for example, opponents of tanker traffic were successful in closing the port of Vancouver on the West Coast to shipments."
Smyth said it is too soon to tell whether Middle East developments will encourage Ottawa to provide more support for domestic projects such as the OSLO oil sands project in Alberta to reduce dependence on oil imports.
VENEZUELA, MEXICO
Venezuela can attest to its ability to ramp up production quickly, having conducted recent tests of that capability.
State owned Petroleos de Venezuela SA estimates crude production potential at 2.75 million b/d. It could boost sustained production to about 2.45-2.5 million b/d from the current level of 2 million b/d.
Reports from Venezuela last week showed that Pdvsa was increasing oil production in response to the shortfall in the Middle East.
Mexico, however, would be hard pressed to help offset any oil shortage. Recent austerity measures crimping E&D by state owned Petroleos Mexicanos have sliced Mexican productive capacity by about 500,000 b/d since 1982, says George Baker, a Berkeley, Calif., consultant.
Mexico currently produces a little less than 2.5 million b/d and may become a net oil importer by the mid-1990s without increased spending for E&D, Baker said.
"Mexico essentially has been producing at total capacity for about a year now," Baker said. "It would take 4-6 months to substantially change that situation, even say 50,000 b/d.
"In terms of productive capacity, Pemex is really hurting. Can it get that 500,000 b/d of capacity back? Perhaps, but not for maybe 18 months or so. And Pemex does not have authority to set spending levels."
CRISIS FALLOUT
Even if the latest oil crisis settles down in the weeks or months ahead, the oil industry will continue to feel the repercussions in 1991.
The crisis has sharply jolted the world's complacency about energy security and refocused arguments on developing indigenous supplies. But it hardly translates into carte blanche support for industry's efforts, especially in the U.S., to win access for drilling in sensitive areas.
Environmentalism, the industry's dominant issue until a few weeks ago, has taken a back seat to newly pressing concerns over energy security. But it has not disappeared and could return with a vengeance later.
Despite suddenly heightened emphasis on energy security, Conoco's Sauer said, it is unlikely U.S. consumers would be willing to forego environmental concerns for lower energy prices.
"As prices rise at the consumer levels, some of the more extreme suggestions might go by the wayside," he said. "But there will be no end to consumers wanting a cleaner environment."
The major concern for industry watchers now is to see where oil prices settle in the months to come. Beyond immediate inventory revenue gains, refiners are likely to suffer if higher crude costs cannot be passed through to consumers.
Oil and gas producers, especially independents, are likely to benefit from higher oil prices. But the long term effects of high oil prices can remind the industry of repercussions from the two previous energy crises: fuel switching, a rise in conservation, and a boom in marginal oil supplies that helped set the trap of the 1986 price collapse.
Too high a level will gut world economies that mostly were limping along before the price spike.
That in turn will depress demand for OPEC oil, eroding the price gains, and perhaps fueling a fresh battle for market share in an OPEC possibly dominated by a belligerent Iraq.
Soaring oil prices resulting from a supply shortfall also could invite a new round of government price and allocation controls and new energy taxes, as was the case in the 1970s.
In the U.S., industry officials are scrambling to deflect any such moves and at the same time chide government for contributing to industry's weakened state.
More importantly, this latest flareup in the Middle East threatening to crimp the world's oil lifeline may act in tandem with heightened concern over industry's effects on the environment-notably the recent rash of oil spills by tankers-to create a fresh impetus among consuming nations to wean themselves from oil.
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