A Barrel Of Troubles For The Oil Market

For three years, oil traders around the world have dreaded the overthrow of Iraqi dictator Saddam Hussein. His ouster would likely put an end to the embargo slapped on exports of Iraqi oil following the invasion of Kuwait. And if huge quantities started hitting already flooded international markets, the price of crude would collapse.

Saddam is hanging in there. But Iraq and the U.N. are engaged in on-again-off-again talks to forge an agreement that would permit Baghdad to sell limited amounts of oil. Small wonder oil prices are skirting their lowest levels since July, 1990: Before ticking up slightly as July drew to its close, crude slipped below $16 a barrel, down 25% from two months before (chart).

QUOTA BUSTERS. Even with that very basic motivation, though, OPEC once again has abandoned its pretense of unity. Members scheduled, then days later canceled, an emergency meeting in late July to hammer out a new production accord that would keep oil prices from dropping further.

The oil exporters likely won't meet again until September. They will have plenty to discuss. Kuwait, Nigeria, and Iran have been pumping far in excess of their allotted quotas, leaving OPEC at least 750,000 bbl. a day over its self-imposed output ceiling this quarter of 23.6 million bbl. a day. "The Iranians and the Kuwaitis are totally responsible for problems in the market," says a top Saudi official in Riyadh.

It will be an uphill battle to rein in the quota-busters. Saudi Arabia, OPEC's biggest producer at 8 million bbl. a day, is adamant about not cutting its output to make room for Iraqi exports--especially if traditional rivals like Iran continue to cheat. The standoff between Riyadh and Tehran means the downhill slide in oil prices is unlikely to be braked for long.

Energy markets are in a bearish mood even without OPEC's bickering. With a recession working its way through Europe and a sluggish recovery in the U.S., consumers simply aren't flooring the gas pedals. In a drastic downward revision, the Paris-based International Energy Agency now estimates world oil demand will rise this year by only a minute 100,000 bbl. a day.

Can this tenuous market handle a sudden gush of oil from Iraq? Not likely. With 115 billion bbl. in proven crude-oil reserves, Iraq is one of the richest patches on the planet. Until the gulf war interrupted it, Iraq's output of 3 million bbl. a day made it the largest exporter in OPEC after Saudi Arabia.

In late June, Iraqi Deputy Prime Minister Tariq Aziz met quietly in Geneva with U.N. Secretary General Boutros Boutros-Ghali to discuss the issue of a one-time sale of $1.6 billion worth of Iraqi oil--550,000 bbl. a day for six months--to pay for humanitarian supplies. Iraqi and U.N. negotiators held intense talks in New York before Iraq's chief legal official, Riyadh Al-Qaysi, returned to Bagdhad on July 12. U.N. officials now say they don't know when talks will restart.

Watching eagerly on the sidelines are some of the world's biggest oil companies. Since last year, Iraq has been quietly negotiating with France's Elf Aquitaine and Total-CFP and Italy's AGIP, among others, about potentially juicy oil production deals, the companies confirm. American producers say they're not involved in such talks.

NO COMMON GROUND. Iraq is offering the oil companies production-sharing agreements in exchange for help with getting huge southern Iraqi oil fields on stream once U.N. sanctions are lifted. Western nations likely won't lift their embargo anytime soon, until Saddam capitulates fully to the U.N.'s demands for limiting chemical and nuclear weapons. But that hasn't precluded exploratory discussions. "We've been talking with the Iraqis about possible agreements and are evaluating what they are offering," says AGIP Chairman Guglielmo Moscato. "But so far, we haven't found common ground."

Baghdad is now shipping 60,000 bbl. a day through Jordan and smuggling an additional 40,000 through Iran and Turkey, say Middle Eastern oil sources. But Iraq will need to turn to Western companies for technology, financing, and markets once it can export on a large scale.

In the near term, too, Iraq needs stability. Three years of trade sanctions have shattered the nation's economy: Galloping inflation and inadequate supplies of food and water are straining Iraqi society to its limits. A return to production by yearend, which OPEC officials now expect, will be good news for 17 million hard-pressed Iraqis. It will spell continued tumult, though, in the oil markets.

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