[A-List] US Imperialism: Iraqi Oil

["annewilliamson" <annewilliamson@xxxxxxx>]

UNWARRANTED OPTIMISM
By Marshall Auerback

"The combined effect of Venezuelan and Iraqi disruptions
has the potential to be the biggest shock in oil market
history, even allowing for offsetting supply increases by
other players."

- Jim O'Neill, Goldman Sachs


Today's oil market is tighter and more geopolitically
threatened than ever...and the markets are incredibly
complacent about it. Somehow, investors still believe that
supply is ample, that a potential war with Iraq will be won
as easily as in the first Gulf War or Afghanistan, that
foreign oil companies will invest after it's all over, and
that Iraqi oil production will soar after the 101st
Airborne sorts out Saddam Hussein.

But in fact, capacity utilization in global oil is almost
as high as it has ever been. Crude oil supply is lower
relative to consumption than at any time in recent decades.
And in three of the six largest oil-producing countries,
oil supplies are at risk due to geopolitical factors.

Iraq's case is obvious. There is also ongoing political
instability in Saudi Arabia, the world's largest producer.
Venezuela's oil-dependent economy is staggering under the
weight of a labor dispute, which has disrupted oil exports.
In this context, a war in Iraq could tip the balance in
favor of a sharply rising oil price, which in turn could be
the nail in the coffin of a teetering global economy.

The prospects of an oil shock are as high as they have been
in decades. According to a recent report by Goldman Sachs,
"More Perfect Storm than Desert Storm", low global oil
stocks and reduced exports from strike-torn Venezuela have
boosted prices by more than 30% since late November. The
Venezuelan 'outage' has cost 125 million barrels of
production, already the fifth biggest supply shock in
history, which the study cites as 'almost entirely explains
the current high level of prices'. If the strike continues
for a further two months, and an Iraq war lasts a similar
time, the cumulative outage will be 600 million barrels -
far more than the 400 million taken off the market in the
Arab-Israeli war.

Since the Goldman report was completed, the strike
affecting the Venezuelan oil industry has begun to
dissipate. But tightness in the global oil markets remains
much as Goldman described. The Venezuelan government has
sacked almost 10,000 striking workers, and its efforts to
reactivate oil wells and refineries are achieving only
limited success.

In addition to Venezuela's problems, the increasingly
tenuous position of the ruling House of Saud also weighs on
the oil market. The ruling royal family of Saudi Arabia,
which has enjoyed the lion's share of oil wealth, is
perceived as corrupt - and domestic discontent is high.
Saudi oil production is at risk because social conflict
over oil, such as has materialized in Venezuela, is
possible...and also because a global Islamic extremist
movement currently threatening terrorist action calls Saudi
Arabia home.

The belief in an amply supplied crude market - whose
current price just happens to be artificially propped up by
a "war premium" - smacks of unwarranted optimism.
Proponents see the impending war itself as the cause of the
trouble...even though most stock markets peaked almost 3
years ago, well before Saddam became an issue. Many even
seem to welcome the prospect of war's outbreak, as they
believe it would rid the markets of bearish uncertainty.

This is not to suggest that today's market practitioners
are all blood-thirsty warmongers. Instead, what appears to
be "priced" into the markets is an image of conflict
(largely inspired by the television images of Gulf War I or
Afghanistan) that now bears almost no resemblance to the
bloody, chaotic experience that has historically been war's
gory reality.

Of course, if the first Gulf war conflict or the more
recent Afghan experience has inspired such tremendous
complacency, it becomes harder to argue that concerns over
Iraq have been a major factor in discouraging investment.
This paradox inspires us to sympathy with the view
expressed by market commentator Richard Russell: that Iraq
has become a "hook" inducing the public to hang on to its
shares...despite the increasingly ominous
political/economic backdrop and the catastrophic losses of
individual investors over the past 3 years. The belief in
an easy, relatively inexpensive war and the corresponding
fear of missing a "war rally", maintains Russell, are the
factors preventing a major sell-off...not fears of a
bloody, messy, economically disruptive conflict.

But the more one draws comparisons to the period preceding
Gulf War I, the less comforting appears the precedent.
Consider the political context today: As the U.S.
contemplates a second Gulf war, it faces unprecedented
terrorist threats, a fraying transatlantic alliance
(including perhaps the biggest split in NATO's 50 year
history), and antagonistic relations with virtually the
entire Islamic world. None of these conditions pertained in
1990/91. Nor is the economic backdrop remotely comparable:
consumers in the U.S., Europe and Japan still have record
levels of debt, accumulated long before any prospect of war
with Iraq became a reality

The likelihood of a sharp price spike in oil being followed
by a big decline (as was the case in 1991) is also much
less likely this time around. Were the work stoppages in
Venezuela conclusively ended, AND should all go well in the
Iraqi conflict (i.e. no major supply disruptions occur),
then much of the existing shortfall could be made up out of
the world's Strategic Petroleum Reserves. Iraqi oil
production will probably stabilize for a year and then rise
by perhaps 1.0 to 1.5 million barrels a day over a two-year
period.

But over the longer term, it is unrealistic to expect huge
amounts of additional Iraqi oil to come flooding onto the
market. As a recent working paper co-sponsored by the
Council on Foreign Relations and the James A. Baker III
Institute for Public Policy maintains:

"Iraq's oil industry is unlikely to be able to immediately
deliver recovery in oil production and, depending on damage
sustained during hostilities, may find its ability to
export oil reduced. It is in dire straits with existing
production levels declining at a rate of 100,000 bpd
annually...Notwithstanding the value of Iraq's vast oil
reserves, there are severe limits on them both as a source
of funding for post-conflict reconstruction efforts and as
the key driver of future economic development. Put simply,
we do not anticipate a bonanza."

In short, there is no quick fix to the problem of high oil
prices, even if an oil shock is avoided. A best-case
scenario allows for stabilization and perhaps a modest
decline in the price of crude, but an imminent return to
sub-$20 oil, as was the case in 1991, appears unlikely.
Venezuela adds to the severe problems of a market on the
knife's edge of a price explosion. To many, Iraq remains a
relatively untouched jewel in the crown of the Middle East.
But this 'jewel' could yet prove no better than a crown of
thorns, if invasion plans do not adhere to the optimistic
outcome now assumed by the markets.

Today's markets view war as something akin to a machine.
Armchair strategists squeeze out the human element in a
clash between independent wills to a point where it is
almost invisible...or at least, until something goes wrong.
Only the most deluded optimist would expect certainty and
good times to return to the markets once the first cruise
missiles are launched.


Regards,

Marshall Auerback,
for the Daily Reckoning

Editor's Note: International equities strategist Marshall
Auerback is a frequent contributor to The Daily Reckoning.
Specializing in international markets, Mr. Auerback derives
his expertise from 9 years 'on the job' with GT Management
in Hong Kong and Japan, during which time he covered the
stock markets of Hong Kong, Korea, South East Asia
(Thailand, Indonesia, the Philippines, Singapore, and
Malaysia), Australia, and New Zealand, Japan.