The $100 Barrel of Oil

Will oil go up or down $10 per barrel in the next few years?

No one can answer that with any certainty as dozens of interrelated political and economic forces can each move prices several dollars per barrel, and divining the collective effect is impossible.

Will oil hit $100 per barrel?

That, surprisingly, is an easier question because there is one indicator that may give you a pretty good idea: the U.S. response to Iraq's civil war.

To date, the U.S.' Iraq strategy has lagged fatefully behind conditions on the ground. If we continue on our current path, the risk is high that the present civil war will pull in neighboring countries and drive oil prices to record levels. If we change course and adapt our strategy to the facts on the ground, that risk may be reduced. But that would require serious change of perspective in the White House.

The Cost of Regional War

If history is any guide, regional war could send oil prices soaring. The Yom Kippur War of 1973 and ensuing Arab Oil Embargo sent world crude prices up nearly 400% in less than a year. Four years later, the Iran-Iraq War more than doubled crude prices between 1978 and 1981, and that phenomenon was repeated in 1989 when Saddam invaded Kuwait.

A glance at the numbers explains why. Two-thirds of the world's proven petroleum reserves lie in the Middle East, and two-fifths of its traded oil sails through the Straits of Hormuz each year. Moreover, nearly 100% of spare production capacity lies in the Persian Gulf. Disproportionate reliance creates disproportionate effect -- for example, the record oil price run-up during the Arab Oil Embargo was the result of just a 7% reduction in free world oil production.

Today's oil market is already tight and edgy. The U.S. standoff with Iran over its nuclear program, Nigeria's failed elections, deteriorating security in East African producers and nationalization of foreign oil outfits in Venezuela and Bolivia have tested the nerves of oil markets already frayed by razor-thin excess capacity.

The degree of supply anxiety can be seen in the rare "contango" curve of futures contracts. Whereas prices for oil deliveries typically grow cheaper in the future (on the assumption that supply will be increased to meet predicted demand), contracts for oil deliveries through 2015 are trading several dollars a barrel higher than current spot prices. In other words, the markets are less confident about future supply than present.