Iraq and the Oil Crunch?

Iraq and the Oil Crunch?

Jim Krane of the Associate Press quotes analysts who seem to blame the high price of petroleum in part on the shambles in Iraq. Iraq could be exporting nearly 3 million barrels a day (bbd) if the guerrilla war was not resulting in massive sabotage. In 2005, Iraq did only 1.4 million bbd on average, down from 2.8 mn. bbd before the American invasion. Not only is Iraqi production way off (less than a million bbd per day on average in January of this year!), but Iraq actually imports over $4 billion a year in petroleum products, taking them off the market for other consumers.

I have to be very careful how I say this, because the oil market is a complicated subject and I am not an economist. But I can't imagine that Iraq really is much of a factor here. The world petroleum production is on the order of 86 million barrels a day. so the lost 1.4 million bbd of Iraq is about 1.6% of the total. Even if you factor in Iraq's imports (and remember it doesn't have much of an economy at the moment), I can't imagine that Iraq production issues account for very much of the current price spike.

Some economists argue that there is a lot of speculation, including a security premium, built into the current price, because you have war and rumors of war (i.e. Iran) going on in the Oil Gulf. A ten percent security premium is the difference between paying $3.00 a gallon for gas and $2.70. A 10% security premium of a speculative sort, deriving from nervousness about the future of Iraq and Iran, is actually much more consequential than the 1.6% reduction in world production because of sabotage in Iraq. The NYT implies that petroleum today, like the South Seas stocks or the tulips of the 18th century, is characterized by speculative investment bubble, just because the run-up in prices attracts investors. That really isn't an Iraq effect.

Although I am not an economist, primary commodity markets are pretty sensitive to simple things like supply and demand that most of us can grasp without greek letters. Troubles in Nigeria, Venezuela and Mexico have taken 2 million barrels a day off the market, i.e. a good 2 percent. So with Iraq, that is a 3 1/2 percent production shortfall.

The main bottleneck in supply isn't raw petroleum production but a shortfall in world refining capacity (in other words we have more crude oil than we have gasoline). And the rapid rise in demand is partially seasonal, with Americans and Europeans hitting the road in the summer (and the anticipation of it), along with an ongoing secular upward pressure on prices coming from the with heated economies in China and India.

So you know me. If I thought Iraq was a big cause of our frustration at the pump, I'd have no hesitation in saying so. I doubt it is all that important in this regard.

One of the economists seems to be arguing that over five to ten years, Iraq could have had an impact, if there hadn't been all that sabotage and if $30 bn. had been invested in the industry. This is true. But for this summer, there are other and bigger phenomena driving Americans' sticker shock at the pump.

The fact is that if Americans did some serious conservation, they could reduce consumption by 1/3. Since they use about 20 million barrels a day of petroleum, they could replace the production of both Iraq and Iran (Iran produces 4 million bbd and exports 2 of it) all by themselves, just by going on the kind of diet Europe did in the early 1980s. But the last politician who dared tell you that was Jimmy Carter and no one will ever, ever go on television and talk that way again, who aspires to hold public office.