How Global Growth Could Skid on Oil

Even a quick end to an Iraq war might not be enough to pull prices back down to the $23-per-barrel range. That could be disastrous

The prospect of war with Iraq weighs heavily on the minds of many business leaders at the World Economic Forum meeting in Davos, Switzerland. The Europeans, in particular, are worried that an assault on Baghdad will sap already feeble consumer confidence, thus undermining demand, hurting corporate profits, and slowing the sluggish global economy. They also fear that conflict in the Gulf will drive oil prices higher and keep them there for at least the rest of the year.

Most business strategists have drawn up their forecasts for this year assuming that the price of oil would average about $23 a barrel. But it's already up to $30 -- partly because of the general strike in Venezuela, partly because of fears about Iraq. Although oil prices may dip slightly when the Venezuelan situation eases, analysts doubt that they'll fall sustainably below $30 until the Iraq crisis is esolved.

"Some commentators predict the U.S. will win a quick war and that Iraqi oil will then flood onto the world markets driving prices down," says William F. Browder, chief executive of Hermitage Capital Management in Moscow. "But that's wishful thinking. The market could be disrupted for a year or more."


  That could be disastrous for the world economy. Kenneth Rogoff, economic counseler and director of research at the International Monetary Fund in Washington, D.C., estimates that a sustained increase of $5 a barrel knocks between 0.25% to 0.50% off global growth. Stephen S. Roach, chief economist at Morgan Stanley, warns that "an oil shock" could "easily push the U.S. economy into recession." American output was hardly growing at all by the end of last year, he points out. So higher oil prices is the last thing it needs. Adds Daniel Yergin, chairman of Cambridge Energy Research Associates: "Every U.S. recession since the 1970s has ultimately been caused by rising oil prices."

The Europeans are worried because -- even if the U.S. does win a quick war -- Iraq won't be able to pump more than 1.8 million barrels of oil a day above its current daily output of from 1.7 million to 2.8 million. That's only 2.4% of global output and isn't enough to drive prices down significantly. And that's an optimistic scenario. "Saddam Hussein could destroy a lot of Iraq's oil capacity if he loses a war," points out Browder. So it may be unable to increase production at all after the conflict is over.

Abdallah S. Jum'ah, president and chief executive officer of Saudi Aramco, says Saudi Arabia will do its bit to nudge prices down by pumping more oil. "We want a price in the $23 to $24 range," he says. And OPEC Secretary-General Alvaro Silva-Calderón says the cartel is committed to creating stability in the markets. OPEC countries have been pumping up to 1.5 million more oil a day than usual in recent weeks, he points out, in an attempt to neutralize the impact of Venezuela's problems. "I think the oil price spike is a transitory rather than permanent phenomonen," he says.


  But how much additional oil OPEC, including Saudi Arabia, can produce over the longer term is limited. And Silva-Calderón warns, in a reference to Iraq, that "developments outside our control" could yet disrupt the markets and drive prices higher. "The market is volatile and is getting more volatile," adds Andrei Illarionov, Russian President Vladimir Putin's personal representative to the G-8 gourp of countries. He doubts prices will come down to the mid-$20s level in the short term.

That's good news for Russia, which makes billions of dollars from oil exports. But it's bad news for business, whose costs will rise, and for the world economy, which will end up growing even less than expected.

By David Fairlamb at the World Economic Forum in Davos

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