Shrinking Reserves to Keep Oil Price High

NEW YORK -- On the second day that allied forces bombed Iraq during the Gulf War of 1991, oil futures plummeted from about $30 per barrel to $20 per barrel, the biggest one-day drop in history.

But consumers shouldn't expect a repeat if the United States leads an attack on Iraq in the coming weeks, economists said this week. The reason? Threadbare U.S. oil inventories.

Since early December, an anti-government strike in the world's No. 5 exporter, Venezuela, has removed more than 100 million barrels from global markets, or about as much oil consumed globally in 32 hours. The crimp comes during a bitter U.S. winter season, particularly in the U.S. Northeast, the world's largest heating oil market.

"We are going to war on empty," said Phillip Verleger, an independent energy economist and consultant.

Even in the event of a war that ended as quickly as the last one, oil prices could bubble at levels that could keep major economies mired in the doldrums for months to come, economists said.

"It is hard to be sanguine about the risks to the U.S. economy from higher oil prices," Jim O'Neil, economist at Goldman Sachs, said in a recent report.

Just like before the Gulf War, fears of conflict in the Middle East, which controls some 40 percent of the world's oil, have sent prices spiraling upward.

Oil prices began rising in August 1990 when Iraq invaded Kuwait, peaking above $40 per barrel in October and dropping to about $30 just before the U.S.-led bombing in early 1991.

This winter, prices have risen 35 percent since November to hit two-year highs of more than $35 per barrel on war fears, the Venezuelan strike and bitter cold in the United States -- which consumes a quarter of the world's oil.

But unlike in 1990-91, the world oil supply system has far less on hand. U.S. crude stocks fell below 273 million barrels last week according to the U.S. Department of Energy. That level was 55 million barrels, or 17 percent, less than the United States had before bombing started in 1991. Low supplies of oil products have also helped to spike prices. Heating oil futures in New York have rocketed to 23-year highs while gasoline pump prices climbed 8 percent over the last two weeks and are expected to rise further ahead of the summer driving season.

Only Saudi Arabia and the United Arab Emirates now have idle capacity. Such a thin margin could magnify the impact of potential disruptions in producer countries, like a threatened Nigerian oil workers' strike.

"The nightmare scenario is one where Venezuela's slow production ramp-up is not complete, where there is war in Iraq and where something else goes wrong. Nigeria is high on the list of potential candidates for something else," said Paul Horsnell, analyst at J.P. Morgan bank.

While the expected release of strategic stocks, as in 1991, should blunt the current price surge, the currently more fragile geopolitical situation will prevent prices from falling very far, economists said.

"The dynamic of the last Iraq war was that it was going to lead to a considerable improvement in conditions in the Gulf and lower oil prices here," said Cary Leahey, an economist with Deutsche Bank in New York.

"But [if the U.S. invades in coming weeks] you could certainly put together a scenario where you could have greater rather than less instability" in the Middle East, he said.

Investment bank Goldman Sachs forecasts oil prices to average $36 in the first quarter of 2003, and to drop to around $28 per barrel by the end of the year.

But sustained high oil prices have already hurt the consumer, economists said. U.S. economic growth was 0.7 percent in the fourth quarter last year, down from 4 percent in the third quarter.

High oil prices translate to "a lack of purchasing power because households are spending money on higher energy bills that they could spend elsewhere," said Thorsen Fischer, an economist at Pennsylvania-based