High Oil Prices Delay Economic Recovery

0 Comments | Insight on the News, Sept 30, 2003

Byline: Jamie Dettmer, INSIGHT

High Oil Prices Delay Economic Recovery

The difficulty in repairing Iraq's ramshackle oil facilities quickly has undermined the argument made quietly before the Iraq war by some Bush administration hawks that ousting Saddam Hussein would ensure cheaper oil. At the end of the 1991 Persian Gulf War oil prices collapsed to $16 a barrel. But, at almost $30 a barrel, Brent crude now is 25 percent more expensive than four months ago. Oil prices are of crucial importance for the world economy and high prices are not helping economic recovery.

Instead of breaking the stranglehold of the Organization of the Petroleum Exporting Countries (OPEC), the Saudi-dominated oil producers' cartel, the aftermath of the war so far has seen that stranglehold tightened. "Prices were expected to fall," says Steven Bell, Deutsche Bank's chief economist. "But oil is now a major limiting factor to global recovery."

Of course, it always was going to take some time to repair Iraqi oil facilities.

The deep northern wells long have been neglected. Experts now calculate that even the shallower southern fields will need half-a-decade of investment before oil will flow abundantly.

But sabotage is the main culprit delaying the Iraq oil industry's comeback. The sabotaging of the Ceyhan pipeline in August was a major setback. That pipeline links the giant oil fields of Kirkuk (which account for 40 percent of the Iraqi output) to world markets via Turkey. Prior to the war, Iraq's export capacity stood at 2.5 million barrels per day. This month, the average daily figure is unlikely to reach 300,000.

The problems in Iraq, though, are only part of the story behind the persistently high oil prices. Supply disruptions in Venezuela and Nigeria also are playing a significant role. And strong demand from oil-hungry countries such as India and China is forcing prices ever upward.

Then there is OPEC, which is refusing to agree to a price-softening rise in quotas unlike 1991, when the Saudis opened the taps.

Russia Experiencing An Economic Boom

While the United States and Europe remain mired in economic doldrums, Russia continues to enjoy its longest economic boom since the breakup of the Soviet Union. As it does so, the big boys of Wall Street are flocking back Merrill Lynch, Goldman Sachs and Citigroup lost billions of dollars in 1998 when Russia defaulted but seem happy to enter the Russian market again. "A lot of banks that left Russia are now coming back," said Bruce Misamore, chief financial officer of Yukos, Russia's biggest oil producer.

Earlier this year Yukos' $11 billion purchase of billionaire Roman Abramovich's oil company, Sibneft, helped lift Russian acquisitions to a record $19.2 billion, almost twice the total of the two previous years combined.

Bond sales this year reached an all-time high of $4.7 billion, following February's $1.75 billion sale of 10-year debt by Gazprom, the world's biggest gas producer. Russia's economy is growing for a fifth straight year, helped by 45 consecutive monthly increases in consumer spending on products ranging from mobile phones to appliances. Russia's RTS index of stocks has soared, up 51 percent this year.

And Russian companies have raised $5.6 billion in the capital markets so far this year. Growth in Russia, Europe's seventh-biggest economy, is forecast to reach 6 percent this year, compared with 0.75 percent for the European Union.

Iraq's Reconstruction and the U.S. Deficit

President George W. Bush's earmarking of $87 billion for pacification and reconstruction of Iraq could pose problems for America's economic recovery. The fresh request substantially will increase the record budget deficit of $480 billion that already had been forecast for the coming fiscal year. But Bush likely will get his request through Congress, where Democrats as well as Republicans will be reluctant to withdraw support from U.S. troops serving overseas.

The administration clearly underestimated the cost of continuing U.S. military operations in Iraq, now running at nearly $4 billion per month not much less than during the "combat phase." Washington failed to plan for a worst-case scenario in post-Saddam Iraq and, given the deteriorating security situation, few countries are willing to step in to assist.

Administration officials hoped to draw on revenue from the Iraqi oil industry to offset U.S. reconstruction and policing costs. But oil has been slow to come on line with the industry subjected to sabotage. Oil revenue is unlikely to be more than $10 billion to $15 billion this year, and much of that will go to the cost of civil administration.

In terms of the U.S. economy and politics the amount that will have to be devoted to Iraq will make it much harder for compromises to be reached on future spending plans, including the high-profile, $300 billion bill to expand prescription-drug benefits to seniors. And the huge deficit well could force the Federal Reserve to raise interest rates, slowing economic recovery. Even more worrisome, say experts, is that the White House may have to ask for yet more money for Iraq as reconstruction costs are likely to mount.