Putting Oil Prices in a Wartime Context

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As the U.S. launches attacks against Iraq, oil prices hang in the balance. In the past week, as war became increasingly certain, oil prices declined, leaving some pundits wondering what would happen to commodity prices once war begins.

Although history is somewhat instructive, it's difficult to compare today to the 1991 Gulf War, when barrels were plentiful and new supply was burgeoning. Now, however, supply is much tighter, and finding new barrels is more challenging. Prices may still decline -- in fact, I believe they will -- but commodity prices probably have much less chance of simply collapsing.

It's difficult to predict oil prices in wartime, but you can assess probable outcomes and understand how commodity prices are likely to react as the conflict develops.

Supply Tight, but Manageable

Crude and gasoline supplies are tight, but inventories are not at crisis levels. After reaching multidecade lows earlier this year, crude inventories appear to be stabilizing. After a crippling strike, Venezuelan crude should begin to return to market, further helping to dampen any supply shock from the loss of Iraqi oil or shut-in production elsewhere around the Persian Gulf.

In addition, inventories will get some help, as demand tends to slip when winter ends. Combined with a still-anemic domestic economy, the demand profile may actually be weakening.

"Crude oil fundamentals are weakening significantly as OPEC output rises," noted a recent comment from ESAI, a Boston-based energy consulting firm. "Even though crude demand is currently high on the back of strong refining margins, we expect crude demand to taper off, especially with the end of the heating season and as Asian refiners slow crude purchases late next month."

There's been talk that at the outset of war, President Bush could order as much as 4 million barrels per day (bpd) of crude to be released from the Strategic Petroleum Reserve to stabilize oil prices. Some also have speculated that the International Energy Agency might call upon members to release reserves in case of war.

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Christopher S. Edmonds is vice president and director of research at Pritchard Capital Partners, a New Orleans energy investment firm. He is based in Atlanta. At time of publication, neither Edmonds nor his firm held positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send it to Chris Edmonds.