Putting Oil Prices in a Wartime Context

With the recent, rapid deceleration in crude prices, that move may no longer be imminent, if needed at all. More likely, the Bush administration and the IEA will now take a wait-and-see approach to reserves, using them more to balance short-term emotional price spikes, rather than to flood the market with supply.

"If the conflict spreads to Kuwait, the Iraqi oil fields are torched or chemical weapons are used, the reserves may be drawn down to soften psychological bullishness," the ESAI report also stated.

Caution in the Gulf and Elsewhere

If the war is executed as planned, the military conflict should be contained within Iraq's borders. However, conflict is fraught with surprises and unintended consequences, and many Persian Gulf oil producers are preparing for the worst.

Iraqi exports have been curtailed, and production in Iran and Kuwait is also experiencing cutbacks. On Wednesday, Royal Dutch Shell (RD - commentary - Cramer's Take) curtailed 60,000 barrels per day of production in Iraq. In an informal survey of Persian Gulf producers, many others seem ready to slow production and temporarily abandon facilities if the threat of war -- or residual terrorism -- intensifies. Although most OPEC members are publicly saying that a war wouldn't impact production, quietly there are concerns that well operators will head for the hills when war breaks out.

Of course, Saddam Hussein might attempt to interrupt production through military strikes in Kuwait, Iran and even Saudi Arabia. If that happens -- even if such strikes are not successful in damaging production facilities -- oil prices could temporarily surge and a significant amount of production may be temporarily shut in.

Away from the Persian Gulf, civil strife in Nigeria, which isn't making the front pages, is also threatening a meaningful amount of production. Nearly 100,000 bpd of production is offline due to violence around production facilities. Nigeria remains a powder keg that could create challenges for OPEC as the cartel attempts to manage production through the Iraqi conflict.

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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.