- The Washington Times - Thursday, March 20, 2003

As war with Iraq has become more imminent, the price of oil, which hit its recent peak of $39.99 per barrel in intra-day trading late last month, has begun to decline precipitously. Falling Wednesday for the seventh time in the last eight sessions, the New York Mercantile Exchange (Nymex) price for its benchmark sweet, light crude oil for next-month delivery closed at $29.88.

In recent years, oil prices have become increasingly volatile. Average world oil prices bottomed out in the summer of 1998 at about $10 per barrel. Since February 2002, by which time the price of oil had recovered to nearly $20, the cost of the world's arguably most indispensable commodity had soared by another 100 percent to nearly $40 before beginning its recent decline. Rising oil prices over the past year sent the average U.S. nominal gasoline price to a record $1.73 per gallon recently, reflecting an increase of more than 50 cents per gallon from a year ago.

These price run-ups have had their impact. Over the past year, higher energy costs have amounted to about 0.5 percent of gross domestic product (GDP), or more than $50 billion. The increase in gasoline prices, which acts like a tax increase, has diverted billions of consumer dollars away from other spending. Meanwhile, many industrial businesses, unable to pass on their higher energy costs because of weak pricing power, have seen their profits fall. That, in turn, has reduced their ability to make new investments and delayed the arrival of a robust economic recovery.

Indisputably, these oil-related cost increases have been steep, and the price levels reached in recent days have been high. Still, some serious perspective is in order. After Iraq had invaded Iran in September 1980, following Iran's oil-market-destabilizing 1979 revolution, some OPEC nations commanded a price of $41 per barrel in late 1980. That price would exceed $85 in today's dollars (after adjusting for inflation). And the $41.15 peak oil price in October 1990, following Iraq's August invasion of Kuwait, would be $56 per barrel measured in today's dollars. Adjusted for inflation, the price of gasoline peaked in 1981, when it would have cost about $2.50 per gallon measure in current dollars. That's nearly 50 percent higher than today's price of $1.73 per gallon.

What is certain about future crude prices is their unpredictability and volatility. Equally certain is this fact: Whichever direction the price of oil moves will have a profound impact on the sluggish U.S. and global economies. The International Monetary Fund estimates that each $10 per barrel price increase sustained for a year chops 0.6 percent off global GDP a year later. That rule of thumb essentially works in reverse as well.

History provides one possible outcome. On Jan. 17, 1991, the first day of trading following the U.S.-led coalition attack on Iraq, the price of oil plunged a record $10.56 per barrel on Nymex, falling below $21.50 a price less than the pre-invasion oil price. Shortly, the price fell to $18.

For numerous reasons, however, such a positive scenario may not be repeated. In the first place, today's market has much less spare-oil capacity. In 1990, unused OPEC capacity exceeded 5 million barrels, more than enough to replace the 4.5 million barrels lost when sanctions closed down Iraqi and Kuwaiti exports. Other suppliers also had unused capacity then. Today, non-OPEC sources are producing at their maximum levels. In OPEC, only Saudi Arabia has any meaningful excess capacity, although how much is open to considerable debate. The Saudis are as secretive about their production levels as they are about their Swiss bank accounts, but it is believed they can increase immediate production by only 500,000 barrels. Perhaps another million barrels per day can come on stream in a few months. That's still below the 2 million barrels per day that Iraq has recently been exporting. When war starts, Kuwait may have to shut down output from its wells near Iraq, removing as much as 800,000 barrels from the market.

In addition to strained capacity, oil inventories at refineries are at their lowest levels since 1975. And Japan has shut down 14 of its 17 nuclear plants for safety reasons and has begun using oil to generate electricity in their place. Meanwhile, violence has broken out in Nigeria as its presidential election approaches. And Venezuela remains a wild card. The U.S. Strategic Petroleum Reserve has nearly 600 million barrels (less than 60 days worth of U.S. imports), which can be tapped at the rate of 4.3 million barrels per day.

In short, there remains little margin for error this time around. In a worst-case scenario, a terrorist attack could conceivably take out the 5 million barrels Saudi Arabia can export each day from its Ras Taura port. Then, all bets would be off.

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