Running for Cover: The US, World Oil Markets and Iraq

by Chris Toensing | published September 28, 2000

Last week's panic within the Clinton Administration over a potential winter spike in heating oil prices has greatly eased, as oil prices have begun to fall. The Democrats' political planners feared that Republican candidate George W. Bush and voters would blame Clinton and Vice President Al Gore for failing to forestall the price rise that dominated the news for the last two weeks. Hence Clinton's acquiescence in Gore's September 21 call for the US to dip into its Strategic Petroleum Reserve (SPR) despite the counsels of Administration technocrats, like Treasury Secretary Larry Summers, that tapping the reserve would not significantly lower oil prices over the long term.

The SPR release was only one of several Administration strategies behind the scenes to find political cover as oil prices rose. One strategy that briefly surfaced in the media was to blame the turbulent oil markets on planned "disruptions" in Iraqi oil production. The Iraqi regime obliged last week by voicing harsh criticism of Kuwait and Saudi Arabia -- accusing those countries of stealing Iraqi oil -- and apparently sending an Iraqi plane into Saudi airspace. US officials appear to believe that the shrill Iraqi rhetoric mirrors Iraq's threats against Kuwait in 1990. Iraq, they argue, is looking for ways to increase its leverage in the ongoing debate over economic sanctions and how to implement the Oil-for-Food program. Will the Iraqis -- still the sixth-largest supplier of crude oil to Western markets despite sanctions -- cut back production to drive up prices?

The Real Iraqi Calculus

Iraq's belligerence was about more than Oil-for-Food. Rather, Iraq was greatly concerned about today's UN Compensation Commission (UNCC) meeting. At this meeting, the UNCC accepted a huge $15.9 billion Kuwaiti claim for oil field damage caused by the Iraqis in 1990-1991. Baghdad not only sees this compensation demand as excessive, but also fears that the claim could open the floodgates for more large claims against Iraq by various other countries and companies. The regime can ill afford this danger to its revenue base.

Faced two weeks ago with this prospect, Baghdad signaled that it was prepared to take drastic action, maybe even temporarily suspending its oil exports under the Oil-for-Food program. On September 20, the five permanent members of the Security Council concocted a diplomatic face-saving formula. With Russia, France, China and two temporary members of the committee, Tunisia and Malaysia, calling for delay on the Kuwaiti compensation decision, US and UK officials at the UN suddenly began to emphasize the need for consensus among all UNCC members before moving ahead with the claim.

September 27, the five permanent Security Council members reduced the amount of oil export revenue to be used for Iraq's reparations payment from 30 percent to 25 percent effective in December, probably assuaging Iraq's anger at the scale of the Kuwaiti claim for now. Given the recent signs that Iraq's international isolation is lessening -- with Venezuelan President Hugo Chavez visiting Iraq and French and Russian planes landing in Baghdad -- the UN allies of the Iraqi regime are pressing Iraq to claim a political victory and rest easy that Iraqi concerns are being taken seriously by the council. Iraq's deputy foreign minister, Riyad al-Qaisi, scoffed today at the five percent decrease in the oil sales contribution to reparations. But cooler heads will likely prevail: Iraq has no immediate cause to suspend exports.

US Politicking in the G-7 and OPEC

To magnify the effect of the SPR release on the market, the US is pushing a coordinated release of reserves by the entire G-7 group, or a subset thereof, on September 29. The US wants broad cooperation from the G-7, both because world prices would be much more likely to fall and because coordinated action would insulate the Administration from Republican charges -- voiced last week by Bush -- that the SPR release holds long-term energy security hostage to US electoral politics. The Europeans need the coordinated release because French and UK Prime Ministers Lionel Jospin and Tony Blair, and even German Chancellor Gerhard Schroeder, are feeling threatened by deepening fuel protests. US officials are investigating the impact of a release among large oil companies. France and Spain have long favored a release of petroleum reserves, and now the last holdout, Germany, appears to be wavering. It is likely that a coordinated G-7 action for a period of three months would cause prices to fall by $3-4 per barrel, diminishing even further the political pressure on governments on both sides of the Atlantic.

Meanwhile, the US called on OPEC to hike production at its September 25 meeting. The OPEC meeting was mostly uneventful, stressing "stability and cooperation" as usual. Only Saudi Arabia has the spare capacity to cover the extra production, and the Saudis would prefer not to tap it. Hence the Saudis welcomed news of a possible G-7 SPR release. The threatening statements emanating from Caracas probably only reflected Venezuela's position, and do not signal that OPEC will cut production.

Oil Markets, December Surprises

Falling oil prices have lightened the tense atmosphere of the last two weeks, when Iraqi threats to cut production and US saber-rattling fueled increased speculation about an "October surprise" -- intensified US bombing of Iraq. But the latest round of UN compromises doesn't alter the fundamental irritants to Iraqi-Western relations: sanctions remain in place and Washington will keep them there as long as Saddam Hussein rules Iraq. Ironically, the cooling of tensions now may presage sharper tensions over oil in the coming months.

Iraq is not especially eager to wield its oil weapon. Key European states -- France, Germany, the Netherlands -- are reeling from the social impact of high oil prices, and Iraq wants to avoid alienating them so that the erosion of international consensus on sanctions may continue. The oil weapon might not be so effective in any case, since the resulting oil output gap could be partially filled by a Saudi production increase.

But the UN compromise on the Iraq reparations payment issue does not preempt the possibility that Baghdad will suspend oil supply in the coming months. At the end of the current eighth phase of Oil-for-Food program in early December, Iraq may be tempted to halt exports. Baghdad certainly paid attention when the US and UK quieted their clamoring for the Kuwaiti claim in the UNCC because they feared the consequences for Iraqi supply. A looming Iraqi export suspension will keep nagging pressure on the Security Council to soften the terms of the Oil-for-Food deal, especially the contract approval process that allows the US and UK to hold up otherwise approved transfers of goods to Iraq. As early as December, the lame duck Clinton Administration may once again be running for political cover as Iraqi threats, rising global consumption and winter weather cause oil prices to rise anew.

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