Jan. 2001 Vol. 222 No. 1  International Politics

A.F. Alhajji,  Contributing Editor

Middle East politics still dictate oil prices

Despite elaborate techniques used by economists and financial analysts to model world oil markets, forecasters have failed to predict oil prices. Sophisticated techniques to explain the behavior of oil prices for the last 30 years have not resulted in reasons for oil price fluctuations that economists can agree on. Some attribute oil price changes to the OPEC cartel or Saudi Arabia, while others tend to blame panic, stockpiling or low inventories. Oil companies would like to blame government regulations while officials accuse oil companies of price gouging!

Regardless of these models, laymen understand a simple fact about oil markets: politics and oil are so intertwined that politics become the main driver in the oil market. Every spike in oil prices for the last 30 years was caused by a political event, such as the Arab Embargo, the Iranian Revolution, the Iraq-Iran war, the Kuwait Invasion and the Gulf War. The reader may have already noticed that all these events took place in the Middle East, specifically, in the Persian Gulf area.

Economists who attribute high oil prices to low inventories forget that diminished stocks are the result of political events that restrict supplies. The last few weeks are no different. Despite four OPEC production increases this year, oil prices kept rising, driven by political turmoil in the West Bank, the explosion that wrecked the USS Cole and, not surprisingly, Iraq. While Middle Eastern politics are considered the main reason for recent oil price increases, political events in the rest of the world also have contributed. Such events include the loss of more than 250,000 bopd due to political turmoil in Nigeria and an unknown amount brought by farmers’ attacks on oil companies in Indonesia.

Middle Eastern violence. After OPEC’s third output increase in October, oil prices should have decreased, but violence in the Middle East and the blast on the USS Cole eroded the effect of such increases and, in turn, boosted oil prices.

The USS Cole incident created fear among traders due to its proximity to important waterways: the Straits of Hormuz and Bab Al-Mandeb. Traders feared that if terrorists could reach a sophisticated warship, they could easily destroy oil tankers. They also were apprehensive that an explosion in the straits might block one-third of world-traded oil from being transported through these waterways. In addition, traders feared that U.S. retaliation for the attack might worsen the Middle Eastern situation and lead to further oil supply disruptions.

The attack took place October 12, 2000. With renewed violence in the West Bank, oil prices increased more than $2.50/bbl that day and rose further the following day. Oil prices increased every time that peace efforts between Palestinians and Israelis collapsed. This was evident on October 23, 2000, when oil prices rose as political tension increased.

Throughout October, traders and politicians feared Arab retaliation because of the U.S. stand toward events in the West Bank. Many experts predicted another oil embargo similar to the one imposed in October 1973. Two Gulf oil ministers assured the West that such an embargo would not take place; by early November, it was clear that the Arabs could not afford another embargo.

Iraq’s politics. This has influenced oil markets for a long time. In fact, most oil price spikes, including the one in 1996, are related to political events involving Iraq. Oil prices increased virtually every time the oil-for-food agreement with the UN expired. Even recent changes in oil prices are related to Iraqi politics.

On November 7, 2000, only a few days after OPEC decided to increase output by 500,000 bopd, WTI crude for December delivery increased by 55 cents. Traders cited Iraq’s actions the previous day as the main reason for the increase. Iraq stopped pumping 900,000 bopd through the Turkish pipeline, which extends from Kirkuk to the port of Ceyhan in Turkey. Iraq was trying to force the UN to convert all of its dollar accounts to the Euro currency.

Oil prices (Brent and Arab Light) increased again on November 27, 2000, after the UN Sanctions Committee refused to accept the December pricing formula proposed by Iraq. Consequently, Iraq halted exports for a short period in the beginning of December. Surprisingly, oil prices declined. Various reasons were suggested to explain this decline, including the fact that Iraq kept exporting about 400,000 bopd illegally.

Other reasons for the decline in oil prices when Iraq stopped exporting its crude include the readiness of Saudi Arabia and its Gulf allies to increase production and a statement by the U.S. DOE that the U.S. may use its SPR if needed. Another factor was the release of 430,000 bopd from the SPR as part of the 30-million-bbl withdrawal announced in September 2000.

An additional 120,000 bpd of Iraqi oil may have been exported through Syria. Various reports show that Syria’s oil exports increased by 20% in the month of November. Experts suggest that Syria is exporting Iraqi oil, which it receives through the recently repaired pipeline that extends from Iraq to the Mediterranean. 

Dr. A. F. Alhajji is an award-winning assistant professor at Colorado School of Mines’ Division of Mineral Economics and author of the upcoming book, OPEC and the World Oil Market: an Alternative View. He is a regular contributor to this column.