Rumblings of an Arab oil embargo

Could the world be about to face a real-life sequel: Oil Embargo II?

The prospect of oil prices being driven by the deployment of Israeli tanks and the future of Yasser Arafat may be moving closer. In a development reminiscent of 1973, when Arab nations embargoed oil to the US and gas lines suddenly snaked for blocks throughout the nation, Iraq and Iran are trying to rally Gulf support for again using the denial of oil as a geopolitical weapon against the US and other industrialized nations.

The effect of a new embargo could be severe. Oil prices are already at a six-month high of $28 per barrel – rising almost $2 in just one day this week. A price of $30 per barrel might cause an "oil shock" strong enough to stall the nascent US economic recovery, some economists believe.

So far, most other members of the Organization of the Petroleum Exporting Countries (OPEC) have reacted coolly to the idea.

Still, given the volatile nature of the conflict in the Middle East, it might be premature to just assume the OPEC spigot will remain open. Aspects of the current situation are disturbingly close to those of 1973.

"Certainly the elements are similar – the great uncertainty, anger, and inability of the Arabs to do anything," says Rachel Bronson, a senior fellow at the Council on Foreign Relations in New York. "The Arab world feels considerable impotence."

Yet many other dynamics have changed since 1973 that undermine the ability of any nation to impose its will on world oil markets. For one thing, OPEC isn't as cohesive as it once was. Saudi Arabia, for example – the kingpin producer of the region – has said it would not use the oil weapon.

"The Saudis were so decimated by the embargo [in 1973]," says Ms. Bronson. "They lost considerable market share and it caused the US to take conservation efforts. In fact, to this day, they still feel the effects."

The US also now has a strategic petroleum reserve, which can be tapped to provide oil to make up for temporary disruptions. Auto-efficiency standards have improved, and there are alternative sources of energy for business, such as natural gas.

The main proponent of an oil embargo is Iraq, which currently exports about 778,000 barrels per day to the US. "The only way for it to work is if they [the Iraqis] cut back output," says Robert Crandall, a senior fellow at the Brookings Institution in Washington.

Yet Iran, too, is considering is tightening its oil valves to try to force the US into pressuring Israel to withdraw its troops from Palestinian territories. Iranian Foreign Minister Kamal Kharazi said this week the actions would depend on whether other Muslim countries go along with the move.

So far, none of the moderate Arab oil producers has shown any interest in the idea, since it hurts them as much as it hurts the US. "We're not there yet, but it could happen very quickly if the Israeli offensive gets out of hand," says Roger Diwan, managing director of the Petroleum Finance Corporation, a consulting firm in Washington. "If Arafat is killed, all bets are off."

As a general rule, embargoes won't work, energy analysts say, because there is basically one world market for oil – the New York Mercantile Exchange. That means countries that cut back on their shipments of crude to the United States can still end up having their oil arrive in US ports.

"Oil is fungible," says Adam Sieminski of Deutsche Banc Alex. Brown in Baltimore. "Once it is produced and loaded on a tanker, the buyers can change its port of call."

This is a big change from 30 years ago, when most oil companies had long-term contracts and very little oil was traded. Thus, when OPEC began its embargo, the Nixon administration tried to provide oil to refiners that lost supplies from those who had either domestic production or non-OPEC sources. This disrupted the flow of gasoline and resulted in long lines at the pump.

"We were dumb enough to shoot ourselves in the foot," recalls Mr. Crandall.

If Arab nations were to cutoff oil supplies now, it is likely to be far less disruptive. "You may have to pay $1.73 for gasoline, but there won't be the long lines," says Mr. Sieminski.

Certainly, world oil supplies have changed considerably over the past 30 years. In 1973, OPEC accounted for more than 70 percent of world output. Today other nations such as Canada, Russia, and Mexico are major energy producers. OPEC's share of output is down to 40 percent.

The US, however, has increased its dependence on foreign oil. Thirty years ago, imports represented 36 percent of US oil consumption. Today, the US imports more than 56 percent of its oil needs.

Its reliance on the Middle Eastern states has gone up – slightly. In January, according to the Energy Information Administration (EIA), a part of the US Department of Energy, the Persian Gulf accounted for about 25 percent of US imports.

Saudi Arabia alone represented 15 percent of that. In 1973, the US imported 26.5 percent of its crude from the Gulf.

EIA's Kreil says it might be difficult to offset any cutbacks from the Arab nations. He estimates non-OPEC supplies have about 500,000 barrels per day of spare capacity. Algeria, Nigeria, and Venezuela could pump an additional 1.2 million barrels of oil per day. "If there is a disruption, it may be the first one not offset by surplus production," he says.

The EIA estimates that at $30 a barrel, for every 1 million barrels taken off the market, the price will rise from $3 to $5 a barrel, if production is not increased elsewhere. Ten years ago during Operation Desert Storm, Saudi Arabia increased its output to make up for disruptions from Iraq and Kuwait.

Even with the added production, oil prices rose by $10 a barrel. Yet Morris Adelma, a professor emeritus at the Massachusetts Institute of Technology, believes any oil cut-off won't amount to much. "I think it would be very short-lived," he says, noting that such oil producers as Saudi Arabia have a large excess capacity. "It depends on how tightly they hold to the quotas."

Still, prices are likely to rise in the short term even without cutbacks in production. Just the murmur about a disruption caused the price of oil to rise on Tuesday to $28 per barrel, up from $26.60 on Monday. Although oil prices were this high last year, the driving factor was strong demand. This time oil traders have added about a $5 a barrel "war premium."

The Department of Energy had planned to raise its estimate for oil prices next week because the quotas imposed by OPEC are too tight. Now those estimates will be even higher. "We keep revising our price estimate upward," says Erik Kreil, an EIA analyst.