14 January 2003, 08:51  Iraq War May Cause Oil Price Surge, Harming Recovery

Dallas, Jan. 13 (Bloomberg) -- Gary Kelly, chief financial officer of Southwest Airlines Co., says he is trying to lock in prices for jet fuel deliveries because he fears they may surge on a sudden rise in the cost of crude oil. The combination of a U.S. attack on Iraq and a continuing halt in Venezuelan oil production could cause crude -- which closed at $32 a barrel Friday -- to soar, pushing the largest low- fare carrier's expenses up and damping demand for air travel, Kelly said. ``If crude goes to $50 a barrel, all bets are off,'' he said. Oil prices have risen 28 percent since November, and U.S. economic growth probably slowed to a 1.4 percent annual rate in the fourth quarter of 2002, a drop of almost two-thirds from the previous quarter. Higher oil prices would further sap the U.S. and weaken Europe and Japan, where growth has been slower. An Iraq war that kept oil at $40 a barrel for months would push the world toward recession, economists and analysts say.
``If oil prices rose to between $40 a barrel and $50 a barrel, both the U.S. and the world economies would probably be in a heap of trouble,'' said Paul McCulley, who oversees $110 billion as managing director of Pacific Investment Management Company, the world's biggest bond fund. The Organization of Petroleum Exporting Countries agreed yesterday at a meeting in Vienna to raise output quotas by 6.5 percent amid skepticism that member nations would be able to boost production by a targeted 1.5 million barrels a day to 24.5 million. Many analysts predicted the agreement would not cut prices by $2 per barrel as forecast by OPEC ministers.
`Dire Straits'
Brent crude oil for February delivery fell 10 cents, or 0.3 percent, to close at $29.57 a barrel on the International Petroleum Exchange in London. Brent, the benchmark for two-thirds of the world's oil, has risen 55 percent in the past year. On the New York Mercantile Exchange, crude oil for February delivery rose 58 cents, or 1.8 percent, to close at $32.26 a barrel. ``I would be surprised if the real barrels into the market would be anything more than 1 million barrels,'' said Nauman Barakat, head of the oil trading desk at Fimat International Banque SA in London. ``That gives us 1 million barrels less than before the Venezuelan strike,'' Barakat said. ``Then if you add Iraq on top of it, assuming that the U.S. does attack Iraq, and the Venezuelan strike is still on at that point, OPEC is in dire straits.'' Crude prices soared on Jan. 3 to $33 a barrel after Venezuela oil workers struck to bring down the government of President Hugo Chavez. That forced the state-owned oil company to cut petroleum exports to about 600,000 barrels a day from 2.9 million in November. Before the strike, Venezuela, the world's fifth-largest oil exporter, supplied about 9 percent of the oil consumed by the U.S.
$10 Premium
Iraq produces about 1.8 million barrels a day, according to U.S. Energy Department figures. The U.S. and Britain have threatened to attack Iraq if President Saddam Hussein doesn't disarm and disavow nuclear, chemical and biological weapons. Together, Iraq and Venezuela account for about 7 percent of the world's oil production. The strike in Venezuela and fear of military conflict in Iraq have already boosted oil by about $10 a barrel, according to James Paulsen, chief investment officer at Wells Capital Management in Minneapolis. ``To take Iraq off the market while Venezuela is still down could wreak havoc in the world oil market,'' said Adam Sieminski, an oil strategist at Deutsche Bank AG in London. While the latest OPEC move ``should balance the markets for now,'' he said, the ``overhang of political tensions and real questions over the ability of OPEC to meet demand through a Venezuelan strike and Gulf War simultaneously should keep oil prices high, with real risks of spikes above $30.'' The 30-country Organization for Economic Cooperation and Development in Paris predicts that, absent a jump in oil prices, the U.S. economy will grow by 2.6 percent this year, Europe's by 1.8 percent and Japan's by 0.8 percent. Those numbers reflect the difficulty the three largest economies are having in rebounding from a recession that began in 2001.
Sluggish Growth
The U.S. economy grew by a projected 2.4 percent in 2002, slowing from a 5 percent pace in the first quarter to a projected 1.4 percent pace in the fourth, according to Blue Chip Economic Indicators, a survey of 54 economists. Many economists say the U.S. must grow by 3.5 percent a year to create enough jobs to bring the unemployment rate down from 6 percent, its highest level since August 1994. Europe grew at a projected 0.8 percent last year, and may decline by 0.2 percent during the current quarter -- its second such dip in a decade -- the European Commission said in December. Japan's economy likely shrank by 0.5 percent in 2002, the Blue Chip consensus said, and the country is in danger of its fourth recession in a decade.
Cutting Growth Rate
John Felmy, chief economist at the American Petroleum Institute in Washington, estimates that every $5-a-barrel increase reduces real growth in the U.S. by three-tenths of a percentage point if the price increase remains in effect for three to six months. By that measure, oil's $5-a-barrel jump since November could shave the 2.7 percent annual rate of growth projected for the U.S. in the current quarter to 2.4 percent, while a surge to $50 a barrel would trim projected growth to a 1.2 percent annual rate. That would be the slowest since the economy stopped shrinking in the third quarter of 2001. The outlook for oil prices depends on whether the U.S. attacks Iraq, how long the conflict lasts and whether Hussein destroys his country's oil wells and facilities, said John Lichtblau, chairman of the Petroleum Industry Research Foundation in New York, an industry research group. Even in the case that oil-producing countries boost production to help cover such contingencies, ``crude oil prices could be bid up because of higher demand, speculation and hoarding,'' the World Bank said in a report last month. ``Buyers might have to pay a substantial premium for prompt supplies, and prices could rise to 1990 levels'' of $35 to $40 a barrel, the bank said. ``You have the possibility of price spikes that are very high and the possibility that prices could crash, depending on the scenario,'' Lichtblau said.
Recession Threat
In the four months leading up to the 1990-91 Persian Gulf War, oil prices surged to $40.42 a barrel on Oct. 11, 1990 -- from a low of $15.30 the previous June 20. After the U.S. launched its first air attacks, on Oct. 17, oil prices began to decline, reaching the low $30s by the following November. By then, the U.S. had fallen into recession. The economy began to shrink in the third quarter of 1990 and didn't start to recover until the second quarter of 1991. ``Every recession in the last three decades has been associated directly or indirectly with turmoil in the oil market, terrorism or war,'' said William Nordhaus, a White House economist during the Jimmy Carter administration who is now a Yale University economics professor. ``Concerns about oil markets in the context of war in the Middle East are not idle.'' The Center for Strategic and International Studies, a non- partisan research group in Washington, has three forecasts. In the event that Iraqi forces collapse within a few weeks and Hussein is overthrown, oil prices would rise to around $36 a barrel then quickly fall to the low $20s, the center says. Should U.S. forces meet stiff resistance and Hussein hang on for months, inflicting heavy casualties and sabotaging Iraq's oil production, the center says prices might jump to $42 a barrel and then settle toward the end of the year at around $30.
Worst Case
In a worst-case scenario, in which Hussein would attack Israel with Scud missiles, set Iraqi oil wells on fire and sabotage other Middle Eastern oil facilities, the center predicts that prices may soar to $80 a barrel, then edge down to $60 and $50. In 2004 under these assumptions, prices may average $40 a barrel. Even $30-a-barrel prices would squeeze the major economies if they remained in effect very long, raising costs for businesses and consumers and leaving less for profits and disposable income. ``Our company would be hurting if prices at $30 a barrel continue for six months to a year,'' said Toshiyuki Kasahara, general manager of finance and accounting for Shin-Etsu Chemical Co., Japan's largest chemical maker. ``There is a possibility that we would have to raise prices if the cost of oil remains at these levels.''
Europe Shielded
So far, two forces have helped shield Europe from much of the impact of rising oil prices. First, the value of the euro has risen 8 percent against the dollar since mid-October, at $32 on Friday. With oil prices denominated in dollars worldwide, European oil importers have been able to absorb part of the oil-price increase without having to spend more of their local currencies. Second, the U.S. and Europe use different varieties of oil, and oil prices in Europe have risen less rapidly over the past 12 months than those in the U.S. Prices of Brent crude oil, which dominates the European market, have risen 41.3 percent to $29.67 a barrel during the period, while those of West Texas Intermediate, a proxy for U.S. oil prices, have gone up 55.4 percent to $31.68 a barrel.
Consumer Confidence
The specter of higher gasoline and home heating oil costs is already making consumers in Europe and North America apprehensive. ``There aren't any signs of an economic recovery, and all consumers can see before them is war,'' said Carlo Mochi, head of research at Italy's largest retailers' association, Confcommercio. ``Families are setting aside extra savings.'' Christmas sales in Italy were down 3 percent from their levels of a year before, Mochi said, and Italian consumer confidence fell to a six-year low in December, according to the Ifo Institute. Italy's economy barely grew in the third quarter, expanding by 0.3 percent. The European Union predicted Nov. 13 that Italy would grow by 1.8 percent in 2003 after edging up by 0.4 percent in 2002. In the U.S., gasoline prices have risen 29 percent in the past year -- to an average $1.41 a gallon for regular unleaded gasoline, according to the U.S. Department of Energy. ``If it hits $2 a gallon, I'm staying home,'' said Amy Brooks, an unemployed Chesterton, Indiana, warehouse worker who was pumping $1.36-a-gallon gasoline into a 1988 Honda Civic hatchback at a suburban Chicago gas station. ``I can't afford to drive around burning $2 bills.'' //www.quote.bloomberg.com

© 1999-2024 Forex EuroClub
All rights reserved