By - Peter Nulty

(FORTUNE Magazine) – When the price of crude oil recently passed $40 a barrel, most people blamed panicky traders and greedy speculators. Indeed, fear of war has helped push up prices from around $20 since Iraq invaded Kuwait on August 2. But if negotiations with Iraq -- instead of fighting -- were to break out tomorrow, oil would probably not fall below $30 any time soon. That's because fear alone didn't drive up prices: A drop in the supply of crude helped. The United Nations embargo against Iraq took four million barrels a day off the market. Saudi Arabia, Venezuela, and other producers began increasing output to make up for the missing oil. But as of mid-October, they had come up with only about three million additional barrels a day. John Lichtblau, head of the nonprofit Petroleum Industry Research Foundation, says the net decline in supplies was enough to raise prices some $10 a barrel. The loss of oil from Kuwait and Iraq hurt in other ways. New oil turning up in the market is hard-to-process crude that many refiners can handle only in limited quantities. Lichtblau says Saudi Arabia is having trouble selling its lower-grade oil. So is the U.S. Strategic Petroleum Reserve, which recently tried and failed to auction off a million-barrel batch. Meanwhile, prices soared for high-quality crude, which can be more readily turned into products such as jet fuel. (The U.S. military has increased its jet fuel purchases by 40% -- 200,000 barrels a day.) Petroleum pressure will gradually ease. Tom Manning, a vice president at the Dallas engineering and consulting firm Purvin & Gertz, says that by January, Saudi Arabia and Venezuela could be producing another one million barrels a day -- enough to replace the embargoed oil. At the same time, the oil obsession could abate. Edward Murphy, an economist at the American Petroleum Institute, a Washington lobbying group, estimates that if crude stays at $40 next year, total demand could fall as much as eight million barrels a day, or 13% -- enough to send prices much lower. With supply up and prices down, says Manning, ''oil could be coming out of our ears.''