The Oil Market Is Running Scared

Iraq's cutoff points to further anxiety about supplies

The shock hit on Apr. 8, when Iraq, the world's No. 4 oil exporter, announced it was stopping shipments for 30 days in support of beleaguered Palestinians. Crude oil rose 4%, to $27 a barrel, on the New York Mercantile Exchange. Oil gave back the gain the next day, when Saudi Oil Minister Ali Naimi reaffirmed in a press report that Saudi Arabia was "committed to guarantee stability in the international oil market"--code for pumping more oil to make up for politically motivated cuts.

Still, the Iraqi cutoff brought a painful reminder of earlier stoppages. The 1973 embargo by Arab exporters, including Saudi Arabia, caused oil prices to quadruple, leading to years of stagflation in the West and Japan. In 1979 and 1980, supply disruptions following Iran's Islamic revolution led to another traumatic price spike. This year, oil prices rose from $18 a barrel in January to $24 in mid-March, mainly on expectations of higher demand from the economic rebound. Now, the Mideast turmoil has pushed them even higher.

Does the helpful Saudi pronouncement mean no one has to worry about a replay of the bad old days? Riyadh, the betting goes, is eager to repair its image in the U.S. following the September 11 attacks--in which 15 of 19 hijackers were Saudi citizens. The Saudis have always wanted to be seen as reliable suppliers to enhance their political leverage and to dissuade importers from diversifying away from their oil. With 3 million barrels a day of unused capacity, the Saudis could easily make up for the 2 million barrels of Iraq crude taken off the market. The Saudi pledge, says John H. Lichtblau, chairman of the Petroleum Industry Research Foundation Inc. in New York, "is a very strong statement, and it's a very brave statement."

Still, a little more anxiety about world oil supplies might be in order--and not only because oil exports from major OPEC producer Venezuela are also being slashed in the wake of severe unrest. The vast bulk of the world's spare capacity is in the Middle East, notwithstanding Russia's potential to add perhaps 300,000 barrels a day and the possibility of a modest increase from Mexico. Across the Middle East, anger over American support for Israeli actions against Palestinians in the West Bank and Gaza is incandescent--and could affect policy. Moderate regimes that are seen to bend to U.S. pressure could see their legitimacy swept away overnight. "I'm nervous. This is a very, very emotive phase," says Peter Gignoux, head of the oil desk at Schroder Salomon Smith Barney.

In Saudi Arabia itself, the level of anti-American feelings is unprecedented. In early April, demonstrations against the U.S., unheard of in a country where public protests are rare, were forcibly put down by security forces. And anti-American editorials in the state-controlled Saudi press, which had abated in the months following September 11, are more virulent than ever. And they're playing to an increasingly receptive audience. "Israel is only doing what it's doing because it's backed 100% by America," says Mustafa Al Ghamdi, a computer specialist in Riyadh.

Moreover, there are signs that the Saudis may not be as forthcoming with production increases as their oil minister seems to be promising. Several major U.S. companies with contracts to take Iraqi crude requested extra oil from government-owned Saudi Aramco on Apr. 9, hours after Naimi's statement was made public. They were turned down. "Naimi basically said Saudi Arabia can make up for lost supplies. He didn't say it will. It's not automatic," one Arab oil industry official said.

The ambiguity may reflect an internal debate at the top of the Saudi royal family, say some. Crown Prince Abdullah, the day-to-day ruler, is said to be disturbed by U.S. unwillingness or inability to rein in Israel. He seems to be gaining influence at the expense of half-brothers King Fahd, ailing since a stroke in 1995, and Defense Minister Prince Sultan, who are understood to support the Bush Administration more.

A new Arab oil embargo is probably not in the cards. But as long as the slightest possibility exists that other Mideast producers will join even partially in the Iraqi protest, oil prices are likely to stay firm.

By John Rossant in Paris

    Before it's here, it's on the Bloomberg Terminal.