Petroleum Markets: Crude in Full Retreat

By John Greenwald

Oil experts call it the "war premium." For the U.S., heightened global anxiety about the security of Persian Gulf crude supplies has imposed an extra cost of more than $20 billion in higher oil prices since Iraq invaded Kuwait last August. The burden, acting like a new tax, helped push the U.S. into recession and put a drag on sluggish economies around the world. With every new rumor out of the Persian Gulf, the war premium swung menacingly. The gyrations gave rise to a frightening question: How high would oil prices skyrocket if fighting actually broke out -- $50 or even $100 per bbl.?

The answer arrived with stunning force last week. At the start of hostilities, crude prices rose briefly. On news of the initial success of Operation Desert Storm, they collapsed in their sharpest drop in history. At the New York Mercantile Exchange, oil contracts for February delivery fell $10.56 per bbl. on Thursday after an avalanche of sell orders forced a one- hour halt in trading moments after the opening bell. The frantic trading slashed the oil price to near the $20-per-bbl. level that prevailed just before the gulf crisis began. "Euphoria is too weak a word," observes John Lichtblau, president of the Petroleum Industry Research Foundation. "The market assumes that the allied forces will be victorious and that Saddam Hussein will not have a chance to inflict any damage" on oil supplies. Prices stabilized for a time after Iraq's missile attack on Israel, but then closed the week at $19.25 per bbl., the lowest level since mid-July.

With every favorable turn in the war, oil prices will tend to fall because the world is awash in petroleum. The storage tanks of industrial countries are brimming with 3.5 billion bbl. of crude, a 96-day cache that is the largest in nearly a decade. The supply has built up because of slumping demand in the U.S. and other countries mired in recession, along with furious pumping by energy-rich nations to make up for the boycott of oil from Iraq and Kuwait. % Even without the two countries' combined daily output of 4.3 million bbl., the rest of the Organization of Petroleum Exporting Countries managed to produce at the rate of nearly 23.9 million bbl. a day last month, in contrast to 23.6 million in July.

The oil-price plunge was aggravated last week because industrial countries, mistakenly anticipating an outbreak of panic buying as war began, gave the go- ahead to tap their emergency petroleum supplies. President Bush authorized the month-long sale of 1.1 million bbl. a day from the 585 million-bbl. Strategic Petroleum Reserve, which is stored in salt domes along the Texas and Louisiana coasts. The drawdown will provide some 6% of the U.S.'s daily consumption of 17 million bbl.

Global oil companies also sought to help restrain prices. After being admonished by Bush last August to refrain from profiteering at the gasoline pump, Big Oil has become mindful of its image and eager to forestall congressional moves to pass a windfall-profits tax. When the gulf fighting started, such energy giants as Chevron, Mobil and Shell pledged to freeze gasoline prices at company-owned stations. (The U.S. average for regular unleaded fuel was $1.24 per gal. as the war broke out, in contrast to $1.01 last August, just before the Iraqi invasion.) Shell, Exxon and other firms later cut their wholesale prices about 5 cents per gal. when crude prices fell.

While the threat of supply disruptions could cause prices to gyrate as long as the war continues, experts say most gulf oil installations would be difficult if not impossible to knock out. Saudi Arabia, the region's largest oil producer, draws its crude from wells equipped with self-triggering shutoff valves to protect the oil in case of trouble. Even the vast Saudi port in Ras Tanura, which loads most of the country's oil exports, could be swiftly replaced by nearby facilities if it were damaged in an attack.

Yet unpredictability reigns on the trading floor as well as the battlefield. "There is plenty of oil in the world," says Barton Biggs, director of worldwide strategy at Morgan Stanley. "If it weren't for the crisis in the gulf, prices would be about $15 a bbl." While oil seemed headed in that direction, any recrudescence of the fears that have haunted the world since August could spark another run-up in oil's burdensome war premium.

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With reporting by Kathryn Jackson Fallon/New York and Ted Gup/Washington