Iraq is not a major oil producer although it has the second largest oil reserves in the world and currently exports about two million barrels a day (b/d) (of which 300,000 is smuggled) – not a sufficient amount to cause major disruption to the oil market when the war interrupts Iraqi supply. Even if, as feared, Saddam Hussein sets fire to the wells as he did in Kuwait during the First Gulf War, and the Iraqi fields do not come back on stream for some years, the effect on the oil price is unlikely to be serious or long-lasting.
There are three further reasons for optimism about the oil price in the event of war. Firstly, Saudi Arabia is expected to increase production by up to 1.5m b/d. Secondly, the oil workers strike in Venezuela appears to be coming to an end and this would restore supply to Venezuela’s pre-strike supply capacity of 2.7m b/d. Thirdly, since war is unlikely to happen before March or April, warmer spring weather in the Northern hemisphere should reduce demand for oil by about 1m b/d.
So interruption of Iraqi oil production as a result of the war should be easily offset by increases in production elsewhere. You should also remember that the recent runup in the price of oil has followed the break in supply as a result of the Venezuelan oil workers’ strike, as much as the increasing threat of war against Iraq. Another possibility is that the International Energy Agency could release supplies from its 4bn barrel reserve. It is also significant that the futures market is predicting a marked drop in benchmark crude prices by the summer.
This analysis suggests that any oil price spike as a result of the war should be small and short-lived. Prices may indeed fall as soon as military operations begin. This is what happened in the first Gulf War. All this assumes that the Middle East does not explode in a riot of Islamic extremism. This seems highly unlikely, at least in the short-term, as Arab governments are loath to risk allowing protests to get out of control or incurring the wrath of the Americans. It follows that some of the more alarmist fears about the world economy are almost certainly misplaced, as they pre-suppose a recession caused by a very large increase in the oil price.
Rebuilding Iraq will be too expensive for America
One economic consequence of the war has not been appreciated by mainstream commentators. Although the direct military costs are expected to be relatively light at between $50bn and $140bn, the occupation and nation building costs could be considerable. One estimate by an American economist, William Nordhaus, is they could amount to the massive total of over $600bn, in the worst case, spread over ten years. This total would reflect the expensive process of reconstruction, occupation and rebuilding which may be largely unavoidable. America cannot afford to allow Iraq to fall into chaos as this would seriously destabilise the Middle East. Nordhaus bases his estimate on the experience of peacekeeping in the Balkans.
Nation building at a cost of many hundreds of billions of dollars, even offset by increased Iraqi oil production, suggests that the US will prefer to save its resources for further campaigns in the war on terror. Only on one occasion since 1970 has Iraqi oil production exceeded 3m b/d. This happened in 1979 when output was boosted to 3.5m b/d to finance Saddam’s invasion of Iran. Accordingly, Iraqi production is unlikely to sustainably exceed 3.5m b/d, producing annual revenues of perhaps $30bn (assuming an oil price of $25 a barrel). But only half of the total might be available to offset America’s nation building costs.
The bottom line is that, for America, it is cheaper to buy oil in the open market than to try and take it from another country. The result is that the American occupation is likely to be short-lived and as inexpensive to the American taxpayer as possible. With the exception of the occupation of Germany and Japan, in recent times America has sought rapid exits from its military successes and if it can avoid massive nation building costs it certainly will do so. Expect the EU to be lent on to pick up the tab. Old Europe may have avoided the bar brawl, but it may still end up paying for the broken glass.
Equities and gold are likely to take their cue from oil. This was certainly the case in the first Gulf War. Equities bounced and the gold price softened as it became clear that the ground war was going to result in a quick victory for the coalition forces. America’s overwhelming firepower points to a similar result.
An additional reason why America will want to avoid a long and expensive occupation is that it would free its hands to attend to other rogue states like North Korea. Nick Louth examines the threat in more detail on page six.
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