War will have us all over a barrel

WAR in the Gulf seems unavoidable. The only remaining doubts are over its timing, nature and duration. From a stock market perspective, a swift and definitive outcome is essential to restore confidence and reignite the global economy. The oil markets have other worries.

Some point to the last Gulf War and predict a lasting collapse in the cost of crude once the tanks roll into Baghdad. That looks like wishful thinking. Major issues for oil prices have been piling up since the last conflict.

It may be that the Western economies will face the burden of expensive oil for years to come.

The bears argue otherwise. Despite four years of high oil prices, their consensus remains that prices will fall back rapidly to $18 a barrel. In reality, this decade will be remembered for seemingly endless periods of oil at $30 a barrel and petrol at almost 80p a litre.

Saddam Hussein has the ability to change the price of oil for decades. Should Iraq choose to destroy its wells and damage its vast underground reservoirs, the rest of the oil producing world would face a major challenge. In spite of soothing words from Saudi Arabia, even a temporary loss of Iraqi output and capacity would be disastrous.

Under UN control, Iraq has been pumping some 2.6m barrels a day, pretty close to its sustainable capacity. Almost 2m barrels have been exported daily to Western markets.

During any Gulf conflict, this flow is likely to stop. If allied troops move quickly, the taps can be turned back on under UN/US supervision. But world stocks are low, so even a short-lived disruption might trigger a price hike. Stocks should then start to recover and prices could drop.

But if Baghdad sabotages its oil infrastructure, there are big problems. We are already being short-changed by Venezuela thanks to its strikes.

Peak global oil demand is 77m barrels a day. Maximum supply capacity, in spite of billions spent every year by the industry, is stuck below 80m barrels. All the surplus capacity is in the hands of Opec.

That surplus is now less than normal due to quota busting. On a sustainable basis, there may be little more than 3m barrels a day of unused supply. Prolonged loss of Iraqi oil would leave the world pumping virtually every available barrel.

No system can operate for long near 100% of capacity, particularly when it is largely in the hands of unstable suppliers. One more producer glitch would leave the world physically short of oil at a time of low stocks and rising seasonal demand.

The likelihood is that Iraq's oilfields will survive unscathed. A new, benign regime in Baghdad could eventually see sanctions lifted. Iraq has the capability over several years to boost significantly its capacity and exports. But this will not happen overnight, so it is foolhardy to assume that oil prices will decline immediately.

Opec's January agreement to boost supplies is little more than a placebo for a gullible patient. Most producers are already pumping out as much as they can. The deal legitimises recent cheating, but will add little new oil to top up empty tanks.

The US market is gearing up for its summer driving season with low stocks and scant chance of weaker demand. Once again, US motorists can expect to pay $3 a gallon.

A rapid end to war could stimulate stronger economic growth and lift oil demand. Oil prices have been firm for four consecutive years without meaningful demand growth. Supply is expanding too slowly, as evidenced by the failure of the world's major quoted oil companies to increase their output.

The myriad uncertainties plaguing the world's key oil producers will not vanish overnight. Poor handling of Iraq, coupled with the unresolved situation in Israel/Palestine, could mean heightened tensions among the Arab states.

Extra supplies are coming largely from Angola, Kazakhstan, Brazil and Russia. The days of predominantly secure supplies from the US and Europe are ending. Risk to supply has arguably never been greater, so the belief that cheap oil will return is dangerously complacent.

AFTER 15 years in the City researching the oil industry, Alan Marshall is now a freelance writer and consultant.