Analysts see market risks of war with Iraq as serious but not immediate

Risks to world oil markets from another war with Iraq aren't likely until next year, but depend largely on whether Saudi Arabia is willing and able to make up any shortfalls in oil supplies.

Sam Fletcher
OGJ Senior Writer

HOUSTON, Sept 26 -- Risks to world oil markets from another war with Iraq aren't likely until next year, but depend largely on whether Saudi Arabia is willing and able to make up any shortfalls in oil supplies, industry analysts said in two recent reports.

"The short answer is that a war with Iraq won't begin until late next summer or in the early fall (weather creates a window of opportunity during September-October through March-April). Hence, most of the cost of the war won't begin to affect the domestic (US) economy until late in the year," said Dan Lippe at Petral Consulting Co., Houston.

"The road to war in the Middle East has been mapped out and driven down far enough to suggest that a consideration of the oil price risks is no longer premature," said Paul Horsnell, with J.P. Morgan Securities Inc. in London.

Three scenarios
Horsnell outlined three possible scenarios involving:

-- Controllable upside risks, with "some violent short-term spikes" to $40/bbl before oil prices can be brought back below $30/bbl "within a matter of days or weeks."

-- Uncontrollable upside risks, spiking $50/bbl or higher, with "nothing much to bring prices back under control within a reasonable time frame.

-- Downside risks, in which oil prices abate "reasonably quickly, or even crash" below pre-war levels.

"The difference between controllable and uncontrollable price shocks is, quite simply, Saudi Arabia," Horsnell said. "Saudi Arabia's power over determining oil prices after any attack on Iraq will be almost total. If they were to choose to sit on their hands or, worse still, faced internal pressure to go further (in restricting oil supplies), then US military action against Iraq would have some very serious consequences for prices."

With total world oil supply currently at 76 million b/d, there is only 6 million b/d of spare production capacity outside Iraq, and that is "almost entirely" within a few Middle Eastern members of the Organization of Petroleum Exporting Countries, said Horsnell. "Saudi Arabia has the most spare capacity with about 4 million b/d. The rest. . .is heavily concentrated in Iran and (Gulf Cooperation Council) members, in particular Kuwait and the UAE." So world oil markets will depend on Saudi Arabia's willingness to increase production and its ability to protect those supplies against outside disruptions.

"Sabotage or other damage to individual wells or pipelines would shake the market by the fear caused by such events being shown to be even possible," said Horsnell.

Damaged pipelines could be repaired quickly with little effect on exports, but a successful attack on the heavily guarded processing or pumping stations could disrupt supplies for months, he said. Even worse would be an attack on one or more key oil ports with radioactive or biochemical weapons that renders the facilities unusable.

Saudi oil supplies
Saudi Arabia exports oil through terminals at Ras Tanura and Juaymah, with a combined loading rate in excess of 8 million b/d, said Horsnell. In addition, Saudi oil is moved from Abqaiq and Ghawar fields through the 1,200 km Petroline pipeline, with a capacity of 4.8 million b/d, to Yanbu on the Red Sea, a terminal with a loading capacity in excess of 3 million b/d. Some of that oil also goes north through the Sumed pipeline for loading at the Egyptian port of Sidi Kerir.

"The three Saudi ports, with the addition of the Iranian port at Kharg Island, represent the major port vulnerabilities within the region," Horsnell explained. Loss of the larger Ras Tanura terminal would effectively eliminate use of Saudi Arabia's spare production capacity, "although Yanbu and Juaymah would just have enough capacity to maintain current export levels."

Loss of any one Saudi port "would be bad enough," he said, "but two would certainly take us into the realm of an uncontrollable price risk."

Even worse would be a prolonged disruption of oil tanker traffic from the Persian Gulf through the Straits of Hormuz. That, Horsnell said, "would shut in Kuwaiti, UAE, Qatari, and Iranian production, plus all Saudi exports not going through Yanbu. Export flows of about 11 million b/d of crude oil and oil products would be at risk, making Hormuz problems the worst of all possible events."

Iraq: change in regime
The far less likely chance that oil prices will sharply decline or even collapse as a result of a war is based on an illusion "within the Washington beltway" that a new democratic Iraqi government would receive huge injections of foreign capital and quickly increase its oil production to collapse OPEC's targeted price range. It "seems to imply tossing the coin several times and always getting heads," said Horsnell.

"To get to a major sustainable downside price move scenario, a lot of things have got to go right for the US," he said. "The change in regime in Iraq would have to be swift and, if not bloodless, would need to take place with a minimum of military action and be confined to Iraq. A sustainable political solution would be needed that maintained Iraq's territorial integrity, and Iraq would have to be governable. Iraq's transition to a new regime would have to be faster and more successful than Afghanistan's."

Moreover, Horsnell said, "Arab opinion (in other Middle East countries) would have to be incensed less than necessary to change (their own) governments or change policy, and the Iranians would have to be comfortable with events."

He pointed out, "The prime (Iraqi) exploration and development contracts are already in the hands of Russian and Chinese companies. Hence, either the US would have to be happy about creating conditions where the gains accrued to Russia and China, or the Russians and Chinese would have to be happy about the new regime tearing those contracts up."

Horsnell questions if it's rational to expect any Iraqi government to take actions to collapse world oil prices. "If defending oil prices is rational for democratic and pro-US governments such as Mexico and Norway," he said, "it is not clear why things would be different for an even more oil-dependent government in Baghdad."

More important, he said, Iraq simply won't be capable for years of significantly increasing its production above its current capacity of 2.6 million b/d. Earlier reports by United Nations inspectors of Iraq's oil capabilities noted decay and other problems "somewhat similar to reports on the Russian oil industry at its peak in 1988," Horsnell said. "Eight years after the fall started, Russian oil production began to recover. Iraq may not be much quicker, even in the most benign political and capital market conditions."

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