Oil Runs Deep in U.S. Stance on Iraq

By James Flanigan

Aug. 25, 2002 12 AM PT

Oil plays a role in the U.S. determination to end Saddam Hussein’s rule in Iraq--a role that goes far beyond the concerns that convulsed commodity markets last week.

The price of crude oil rose to more than $30 a barrel last week, a very high level, because of financial market concerns about a possible U.S. invasion of Iraq.

Prices fell back by Friday after President Bush threw cold water on the idea of an imminent invasion, even though he clearly indicated that a “regime change” in Iraq was what his administration wants. It’s “in the interests of the world,” Bush said.

Oil is one reason for wanting to displace the Iraqi regime, although the more important reason is the need for political and economic reform in the Middle East. But oil is part of that equation.

Bluntly put, the world will need Iraq’s oil as the solution to a looming energy shortage. Iraq has the second-largest oil reserves in the world--after Saudi Arabia-- and many experts put its potential as equal to that of the Saudi kingdom.

Yet because of a decade of sanctions and rules, OPEC member Iraq is producing far below its capacity and even below its 2-million-barrels-a-day production rate of recent years.

That’s why oil prices are unusually high, even without the “war premium” of $4 to $5 a barrel that nervous markets added on last week. These current high prices haven’t yet shown up at gasoline pumps in the United States, but they will over the next six weeks, analysts say.

Persistent high oil prices, despite slow economic growth around the world, “tells me that oil is in tighter supply than most people believe,” says Mark Raskir, an energy fund portfolio manager for Milwaukee-based Strong Financial Corp.

In fact, because of sanctions against Iraq that cut development of new wells, and continued growth of oil consumption in Asia and elsewhere, OPEC countries’ surplus of production capacity is down to 2 million barrels a day, from a surplus of 5 million barrels a day at the time of the Persian Gulf War 11 years ago, estimates Amy Jaffe in studies done for the James A. Baker III Institute for Public Policy at Rice University.

A smaller surplus makes for nervous markets, with traders pushing up prices at any hint of disruption of supplies. The International Energy Agency, the Paris-based organization of petroleum-consuming countries, Thursday requested that OPEC raise its production quotas next month as a way of easing tensions in the markets.

Accelerating economic development in China, India, Russia and Central Asia will surely strain the capacity of OPEC and other oil-producing nations, which already have little spare capacity, say the Baker Institute studies. New oil development in Central Asia and Russia itself would not be enough to alleviate a potential shortage--and oil from those regions is projected to be very high-cost compared with the oil of Iraq, Saudi Arabia and other Middle Eastern countries.

Iraq’s reserves total 112 billion barrels, compared with Saudi Arabia’s 262 billion, and experts agree that more reserves remain to be discovered in both countries. But development of Iraq’s oil potential is impossible while Saddam’s regime, with its threats and weapons of mass destruction, remains in power, Washington experts say. A new Iraqi regime would launch aggressive development and use oil revenue to pay for the country’s rebuilding, says Patrick Clawson, deputy director of the Washington Institute for Near East Policy, a research organization.

Factors Complicating the Oil Situation

Two factors are complicating the oil situation and the outlook for the Middle East. One is an increasingly public quarrel between the United States and Saudi Arabia.

In recent weeks, a high-level Defense Department advisory panel heard a report from a Rand Corp. analyst calling Saudi Arabia “the most dangerous opponent” in the Middle East. And Saudi private investors were reported last week to have shifted $100 billion in investments out of the U.S.

However, Treasury securities traders at Payden & Rygel in Los Angeles and other firms discount the investment reports because no evidence of such massive shifts have shown up in the bond markets. At the end of the week, Saudi officials took pains to say that their country would hike oil production to prevent any supply disruption if the U.S. attacked Iraq.

The other factor that will continue to affect prices for oil is that oil companies in general, and particularly independent refining companies such as Valero Energy Corp., Tesoro Petroleum Corp., Premcor Inc., are holding low inventories of oil these days. They are doing so because credit is less available to energy companies in the wake of Enron Corp.’s collapse and the widespread troubles of other energy firms, and because oil prices are volatile and refining profit margins thin. What that means for consumers, analysts say, is that gasoline, heating oil and jet fuel prices will go up.

What lies ahead? Oil probably will be in relatively short supply no matter what happens. Energy economist Philip Verleger warns against counting on significant additional supplies from a future Iraq. After Iran’s wells were shut by sanctions in the 1980s, “they never came back to previous production levels,” Verleger notes. Iran produces 3.4 million barrels a day, down from 5 million barrels a day historically.

Outlook Depends on Mideast Peace

But all economic projections hinge on the emergence of a peaceful and progressive Middle East. Dangers are obvious, experts note. Saddam, reacting to invasion or moves to oust him, could destroy Iraqi oil fields as he did a decade ago when he set fire to Kuwait’s fields.

On the other hand, the replacement of Saddam’s regime would spur development of Iraq, a country with a large middle class and an educated population that--with U.S. help--could reform its country and benefit the whole region.

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Oil in Reserve

Iraq has the world’s second-largest oil reserves, but its oil production lags behind that of many of the leading producers.

Estimated oil reserves as of January 2002, in billions of barrels:

Saudi Arabia --- 259.2

Iraq --- 112.5

United Arab Emirates --- 97.8

Kuwait --- 94.0

Iran --- 89.7

Venezuela --- 77.7

Former Soviet Union --- 57.0

Libya --- 29.5