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The $100 Barrel of Oil

Many factors weigh on $50 or $70 being next, but one factor controls whether we will go to $100.

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.

Oil at $100 would "only" be a 50% increase over today's prices, far less than the run-up caused by previous regional conflicts. So that raises the question: Could Iraq's civil war ignite a new one?

Civil War Contagion

Left unchecked, it well might. Civil wars tend to draw in the neighborhood. Concerned about border control, the security of trade routes, influxes of war refugees, the rise of transnational criminal networks and the welfare of ethnic kin, neighbors play patron to favored factions. And Iraq, lying squarely in the middle of the world's most volatile region and on the fault line of the centuries-old bloody divide between Sunnis and Shiites, represents a potential perfect storm of these concerns.

To the north lies Turkey, which has vowed to intercede if Iraq's Kurdish North tries to declare an independent Kurdistan.

To the east is Iran, which already systematically interferes in Iraqi politics and security matters in an effort to cultivate a friendly Shiite government in Baghdad.

To the south and southwest, Saudi Arabia and Jordan are deeply concerned about the emergence of an Iranian Shiite crescent of power stretching from Tehran to Beirut. Indeed, Saudi Arabia has warned that it will support Iraqi Sunnis in the event of an all-out civil war.

And to the west, Syria exploits Iraq's instability for profit and strategic advantage.

But while all are poised to join the Iraqi civil war, none actually wants to. Iraq's Sunni-Shiite divide is mirrored in adjoining states, and those populations could become radicalized by sectarian warfare and threaten to topple existing governments. Subsequent social instability fomented by refugee crises, combined with attacks on oil and transportation infrastructure, could roil economies.

However, Iraq's neighbors cannot contain a civil war alone -- they need the U.S. No major security agreement in modern Middle Eastern history has been brokered and enforced without active U.S. involvement. With over 150,000 troops in-country, effective command-and-control of ground security forces, air dominance and two carrier strike groups in the Persian Gulf, the U.S. brandishes credibility and means. For all of the ill-will its recent Middle Eastern misadventures have generated, only the U.S. can threaten and cajole the leaders of all relevant players to the table and orchestrate the array of incentives, deterrents and face-saving compromises needed to avert a region-wide descent into an Iraqi civil war.

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But will it?

One Step Behind

All signs point to "No." Since day one, U.S. perception of the facts on the ground has trailed reality. Wrong perceptions have led to wrong strategies. And wrong strategies have created worse facts. We are now at the final stage of this vicious cycle.

When the U.S. invaded Iraq, the expectation was that it would follow a "liberator strategy," focused on decapitating leadership and quickly transitioning authority to existing bureaucratic and security institutions.

Instead, it undertook an occupation. The Coalition Provisional Authority disbanded the armed forces and dismantled Iraq's civil service with its Baathist purge. By woefully underestimating the force levels needed to enforce security in a country without a functional military or government, the U.S. opened the door to the insurgency.

As the insurgency grew, the U.S. failed to recognize the strategic implications of the changed dynamics. Instead shifting to a counter-insurgency strategy, it dismissed insurgents as "a few dead-enders" and "stay

ed the course" of its occupation strategy, managing reconstruction by CPA fiat and seeking to provide security through high-kinetic combat engagements (like the U.S. assault on Fallujah). Unsurprisingly, U.S. troops won tactical engagement after engagement, only to surrender the ground to insurgents when they advanced to the next hotspot.

The result was insecurity and a loss of faith by the Iraqi people in coalition forces. Sectarian militias rushed to fill the vacuum, igniting cycles of killings that hardened ethnic allegiances. Hopes that the national government could broker peace withered in the face of impotence, corruption and the infiltration of government security services by sectarian operatives, and Iraq fell into civil war.

Once again, however, U.S. strategy was one step behind the facts on the ground. Faced with rising sectarian violence, the White House declared that "there is not a civil war going on" and announced that it would finally pursue a counter-insurgency "surge" strategy.

But the strategic challenge is no longer the fight between insurgents and coalition forces -- it is the fight between Sunni and Shiite Iraqis. A counter-insurgency solution cannot solve a civil war problem.

Rather, the U.S.' best hope is to try to contain violence within Iraq's borders and shorten its duration by working with neighbors to cut-off foreign support and broker a regional peace plan. This was precisely the strategy proposed by the Iraq Study Group and rejected by U.S. leadership.

Keep Your Eye on the Strategy

So what does this mean? Keep your eye on the strategy. Washington's heated debate about time frames and force levels is ultimately tactical. So long as the U.S. seeks to secure Iraq alone and from within, its prospects are bleak. Although failure could take many forms, it would significantly increase the risk of prolonged regional (rather than simply Iraqi) instability and much higher sustained high oil prices.

If the U.S. changes strategy and addresses the civil war directly -- engaging Iraq's neighbors and negotiating the difficult trade-offs needed to obtain their cooperation -- then the risk of Iraq's civil war engulfing the region may be diminished.

The U.S. leadership's repeated refusal to engage Iran and Syria and its dismal recent diplomatic record in the Middle East overall is reason for skepticism. However, Secretary of State Condoleeza Rice's brief meeting last week with Syria's Foreign Minister and recent ginger re-engagement in the Israeli-Palestinian peace process are notable. As the summer wears on and the public's patience with the "last best chance" surge wears thin, perhaps the administration will reconsider, if it is not too late.

If it does not, $100 oil is a frighteningly real possibility.

At the time of publication, Lieberthal had no positions in any of the stocks mentioned in this column, although positions may change at any time.

Keith Lieberthal is general counsel of Clinical Advisors, LLC, and is a term member of the Council on Foreign Relations. Lieberthal appreciates your feedback;

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