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Oil: Is the damage done?
Pre-war surge ends, and prices aren't likely to rise again, though hurt could already be baked in.
March 21, 2003: 5:05 PM EST
By Mark Gongloff, CNN/Money Staff Writer

NEW YORK (CNN/Money) - So much for the oil crisis. Contrary to the fears of some experts, the start of a U.S.-led war in Iraq, rather than sending oil prices through the roof, has abruptly punctured a mini-bubble in oil.

That sounds like good news for the struggling U.S. economy, but some analysts worry that enough damage has already been done by the recent spike in oil prices to require some help from the Federal Reserve or Congress later this year.

A barrel of U.S. crude oil for delivery in about a month was going for nearly $38 on the New York Mercantile Exchange on March 12. In the nine days since, the price has plummeted nearly 30 percent, closing at $26.91 in U.S. trading Friday.

Prices rose briefly on Thursday, the first full day of hostilities, when reports of burning oil wells in southern Iraq raised memories of the first Gulf War, when Iraqi troops set fire to more than 700 Kuwaiti oil wells as they retreated from U.S.-led forces.

But prices quickly fell again when traders realized very few oil fields were actually burning -- only about 7, according to the latest report from the British military -- and U.S.-led forces had secured many other fields. [For the latest developments in the war, go to CNN.com.]

And many oil analysts doubt that even a repeat of the Gulf War I oil conflagration would send prices back up near $40, where they peaked briefly this year, capping a jump of about 20 percent since the start of the year.

Only major, unexpected disruptions to supply, such as terrorist attacks on oil fields in Saudi Arabia, could send oil prices back to that level, many analysts believe. As long as the damage is limited to Iraq, the Organization of the Petroleum Exporting Countries (OPEC), the group of nations that supplies about half of all U.S. oil imports, should be able to take up the slack.

"It's clear to us that the overproduction of OPEC members at the moment is more than sufficient to compensate for the loss of Iraqi volumes as they currently stand," UBS Warburg oil analyst Matthew Warburton said.

If for some reason OPEC can't fill the gap, Warburton said, the U.S. Strategic Petroleum Reserve (SPR) and the International Energy Agency, which has its own oil reserve for use by a group of 26 Western nations, could easily open their spigots and keep oil flowing.

At the moment, however, the IEA has said it sees no need to release any oil, and the U.S. government seems highly unlikely to tap the approximately 600 million barrels of oil in the SPR.

"World energy supplies are more than adequate to compensate for any disruption," Energy Secretary Spencer Abraham told the Senate Armed Services Committee Thursday. "The response by OPEC and major producers like Saudi Arabia, and if needed, our large strategic stockpiles, will ensure that our economy will have the ample supply of energy it needs."

Inventories keep floor under prices

But it also seems unlikely that oil will drop back below $20 a barrel, where prices stood in early 2002, before talk about regime change in Baghdad began in earnest.

Tight world and U.S. inventories of oil and gasoline, the result of an unusually cold winter in parts of the United States, and the long strike in Venezuela, the world's fifth-largest oil producer, should keep a floor under prices, most analysts say.

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"The U.S. inventory situation remains extremely tight, with total inventories still falling and gaining no ground on the five-year average," J.P. Morgan oil analyst Paul Horsnell said in a research report Wednesday.

Though OPEC is publicly fretting that prices will keep falling, Horsnell and other analysts suspect prices have actually found their floor and will continue to trade between $25 and $30 a barrel for some time.

And prices may yet move somewhat higher even absent disasters in Saudi Arabia. For one thing, if the latest price drop is driven by a belief among commodity traders that Iraqi oil will be flowing freely soon, the disappointment if that doesn't happen could boost prices.

"The market seems to have pushed far too far, far too fast and on the basis of far too little hard information," Horsnell said in the note.

How much economic damage has been done?

High oil and gasoline prices are of great concern to economists, since they weaken consumers' ability to spend on other things and raise costs for businesses. All the big oil spikes in the past 25 years or so have resulted in recessions, and some economists have worried that the recent spike could result in another one.

The recent drop in prices, then, should be something of a relief. But the spike already may have contributed to a dramatic slowdown in growth early this year, helping to drive consumer confidence to lows not seen in about a decade.

"If everything happens just like it did 12 years ago, [oil prices] would continue on a quite rapid decreasing trend, and the worst would be behind us," said BNP Paribas U.S. economist Alexandra Estriot. "However, even if it develops in this positive way, there will be a cost."

Federal Reserve policy-makers decided earlier this week to hold short-term interest rates steady and said they couldn't be sure how much of the recent weakness in the economy will disappear after the war ends.

If longer-term damage has been done by war fears, by the spike up in oil prices, or by more substantive underlying problems, the Fed might have to step in and cut rates further sometime later this year. Congress is also debating tax cuts and spending measures that could be enacted in an effort to help the economy.  Top of page




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