A Shocker from the Oil Patch

Opposition to Venezuela's strongman--more than a looming Iraq war--is driving up oil prices

Blindsided again. While the U.S. has focused on the threat to oil supplies from war with Iraq, crude prices jumped 13% in the first half of December, to $30 a barrel, largely because of a struggle involving an oil-rich strongman in America's own backyard--Venezuelan President Hugo Chavez. Managers and workers alike at Petróleos de Venezuela, the national oil company, have joined a strike to oppose the authoritarian Chavez, causing the nation's oil output to fall from 3 million barrels a day to around 400,000.

At first, the markets shrugged off Venezuela's general strike, which began on Dec. 2. But with no resolution in sight, oil economists suddenly grew more worried that Venezuela's troubles, if they drag on, could hamper the U.S. economic recovery. Signs that the U.S. was moving closer to war with Iraq also contributed to the price rise. But in terms of oil-supply disruptions, "Venezuela now overshadows the threat from Iraq," said Phil Flynn, a senior energy trader for Alaron Trading Corp. in Chicago.

Venezuela matters because it supplies about nine times as much crude oil to the U.S. as Iraq does, and it has been--until now--a more reliable supplier. In September, before the latest crisis broke, it accounted for 14% of U.S. imports, close behind Saudi Arabia, Mexico, and Canada. Since oil accounts for half the Venezuelan government's revenue, it's the prize in a protracted struggle for power. The small amount of oil still dribbling out of Venezuela is coming mostly from wells controlled by foreign multinationals.

How bad could things get? Hard to say, because no one has a handle on when--or how--the Venezuelan crisis will end. But for now, things look dire. The U.S. State Dept. warned on Dec. 17 that the situation is "deteriorating rapidly." The next day, police used tear gas and rubber bullets to disperse protesters who blocked highways. In a televised address, Chavez, who was deposed for two days in a coup earlier this year, seemed to pave the way for a declaration that would permit him to use the army to break the strike. But such a move would probably encounter violent opposition. "Every day now becomes a bigger and bigger problem," says Roger Diwan, a senior analyst at Petroleum Finance Co., a Washington-based energy consultant.

The impact on the U.S., though, may be comparatively mild. Saudi Arabia and other big oil producers have spare capacity and could step up production--or delay planned cutbacks--to make up for the shortfall from Venezuela. Although it takes several weeks for oil from the gulf to reach the U.S., President George W. Bush could tide U.S. refiners over by releasing oil from the Strategic Petroleum Reserve. Several refiners, including Amerada Hess Corp. (AHC ) and Citgo Petroleum Corp., have already asked to be allowed to "borrow" such reserves. For now, the Administration is saying no.

There's still breathing room for the U.S.: The drop-off in Venezuelan imports hasn't lasted long enough yet to make a big dent in U.S. supplies. On Dec. 17, the American Petroleum Institute announced that inventories had fallen a modest 1.1% in the latest week. Inventories could keep shrinking if Venezuela's wells remain shut, but traders are betting that more oil will be found either overseas or from the strategic reserve. On the New York Mercantile Exchange on Dec. 18, oil closed at $30.44 for January delivery and $30.43 for February, but only $29.63 for March and $28.59 for April--a sign that traders think the pressure will ease.

For an oil-price rise to have a big impact on the U.S. economy, it generally takes at least a $10-per-barrel price increase that's sustained over many months. While today's prices are well above the low of $20 per barrel that oil sank to a year ago, they aren't far above the mid-$20s average of the last few years. The national average price of gasoline on Dec. 16 was just under $1.38, down from the $1.46 it reached in late October on fears of an Iraq war, according to Opis Energy Group of Lakewood, N.J.

That's not to say there is nothing to worry about. There's no guarantee that the big Mideast producers will supply enough oil to compensate for the Venezuelan strike if it endures. OPEC has been trying to reduce output. The oil states fear that, if the strike ends abruptly after they've increased production, there will be an oversupply that causes prices to crash. "This is really a difficult situation," says a gulf oil official. "If it's going to create a shortage, we have to do something. Right now, we don't think there's going to be a shortage."

Likewise, President Bush might not release oil from the Strategic Petroleum Reserve unless the situation gets desperate. That oil is supposed to be for emergencies, not to smooth out price fluctuations. For now, the Energy Dept. has allowed oil companies to suspend their contributions to the Strategic Petroleum Reserve, freeing up more oil for sale to the public. But it's hoping to avoid allowing the reserves to be tapped. As a result, Alaron's Flynn says that if the Venezuelan strike drags on for a few more weeks, oil could hit $35 or even $40 a barrel--although it would have to stay at that level for several months to damage the economy.

The oil threat from an Iraqi war is less immediate but potentially more severe. Lehman Brothers Inc. global chief economist John Llewellyn in London figures there's a 70% chance that there will be no war or an easy war with Iraq, causing oil prices to fall to $20 a barrel. But he estimates that there is a 5% chance that the conflict could spread to other parts of the gulf, potentially driving oil prices to $75 a barrel or more. Impossible? He regards the $3 price increase resulting from Venezuela's troubles as a warning: "It shows what even a modest supply disruption can do in a tight market."

The latest spurt in oil prices will probably recede without harming the U.S. But who knows? After all, it was not obvious at the beginning of December that the oil-exporting strongman who roiled the markets would be named Chavez.

By Peter Coy in New York, with Stanley Reed in London and Geri Smith in Mexico City

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