Iraq and the oil market

To understand the deplorable state of the oil market, consider how well things are going for Saddam Hussein.

The Iraqi president wants, first, an end to United Nations sanctions on his oil exports and, second, a position of power in the Middle East. Since a regional bully needs bombs and bullets, Saddam's second objective requires successful achievement of the first. Bombs and bullets cost money. Saddam will have very little money with which to buy bombs and bullets until he exports all the oil his country can produce and is free to do with proceeds as he wishes. That's why he craves the end of sanctions.

To this end, Saddam now behaves himself with the UN weapons inspectors still snooping around his country. And he pressures fearful neighbors into supporting his goal by indirectly squeezing their oil revenues. As crude prices last week showed when they fell to their lowest level since 1986, the strategy is working nicely.

Market wrecker

Doubters of this reading of events argue that falling crude prices hurt Saddam as they do other producers. They miss an important point. Saddam cares nothing about revenues he can't control, such as those now generated by oil the UN allows Iraq to export to pay for food, medicine, and war reparations. Because the UN foolishly based the ceiling on revenue instead of volume, the program is a market wrecker. The lower prices go, the more Iraq produces in pursuit of the revenue cap, feeding a surplus and weakening prices. In the first quarter, according to the International Energy Agency, Iraq produced an average of 1.58 million b/d. By May output had climbed to 2.1 million b/d.

With prices at recent levels, Iraqi production isn't sufficient to achieve the UN dollar targets. For Saddam, that's no problem. They're not his revenues. He's getting what he wants. His neighbors are frantically slashing production in defense of crude values. Their revenues are plummeting. Their populations are getting restive.

No one should doubt that Saddam is cunning enough to have pulled this off. He was on the receiving end of a similar strategy in early 1990 when Kuwait, convinced of Iraq's intention to attack, tried to glut the oil market in a last-ditch attempt to keep money away from the Iraqi military.

In his own use of the beggar-thy-neighbor gambit, Saddam enjoys an advantage that Kuwait lacked: help from the UN. After maneuvering U.S. President Bill Clinton into a mortifying military bluff early this year, Saddam extracted from UN Sec.-Gen. Kofi Annan an unbelievable increase in the semiannual UN revenue ceiling for Iraqi exports to $5.26 billion from $2 billion. It was a gesture of friendship from Annan to Saddam designed to ensure smooth going in their peace negotiations.

Annan's benevolence amounts to 2 million b/d of crude oil pouring into the market without regard to price. To producers for whom price matters, the effect is a barrel-for-barrel reduction in demand. The IEA projects worldwide oil demand in the third quarter, after adjustment for Asia's economic problems, at 74.6 million b/d. But price-sensitive producers-everyone in the world but Iraq-now essentially compete in a 72.6 million b/d market. By this measure, balancing the market with production cuts looks especially challenging.

Asian economies weakened the oil market; a joint venture of Iraq and the UN wrecked it.

Bombs and bullets

The perversity of these outcomes is breathtaking. Oil-producing nations not run by murderous tyrants face difficult political challenges as their national treasuries shrink. Saddam's relative power in the Middle East, meanwhile, grows. When he appeals to the UN for an end to sanctions-as he's sure to do within months-he'll have plenty of support from economically beleaguered and politically threatened neighbors.

And when Saddam begins buying bombs and bullets again, no one should forget that it all happened in the name of internationally negotiated peace.