Did oil overreact to the escalation of tensions in the Middle East?

Clearly, it reacted. As

noted earlier, energy prices skyrocketed Thursday on news of Israeli attacks on Palestinian targets in the West Bank and Gaza. With oil pushing $37 a barrel and open talk of $40 oil on the near horizon, some say the price moves were irrational. "We can't understand what all the fuss is about," says Leo Drollas of the

Centre for Global Energy Studies

in London.

The fuss is singularly about the risk that the tension and violence will escalate further. The first meeting of the

Arab League

since 1996 is approaching, and many observers fear a united Arab reaction to Israel's latest actions could prompt the U.S. to formally support Israel. Such a move could further strain relations between Arab-dominated

OPEC

and its largest customer.

Saudi Arabia signaled that it has stepped up aid for the Palestinian effort with medical supplies and care for the wounded Palestinians. The Saudi government also published a formal statement from Prince Abdulmajeed bin Abdulaziz, the governor of the Makkah Province, reiterating Saudi Arabia's support for the Palestinian cause.

However, Drollas says it is unlikely that OPEC member nations would react against the U.S. The reason he cites is terribly pragmatic: economics. "It is quite unlikely that one single OPEC nation would embargo oil to the United States," he says. "It would be biting the hand that feeds them. Kuwait and United Arab Emirates would never do that." He says the only two nations that might consider withholding supply are Algeria and Libya, "with their crazy leader."

Algerian Oil Minister Chakib Khelil says it is unlikely oil would be withheld. "I don't think that the oil weapon will be used," he told

Platts

, an oil trade publication, while attending a European gas summit in Paris. He also said it was likely that oil production would increase by the end of the month if prices remained above $28 a barrel.

Drollas said the perception that tensions could escalate has resulted in artificially high oil prices. "The hostility will slow down in the next several days," he said. "Oil prices will come down in step."

Still, Drollas leaves room for the possibility that tension could spread and the oil markets could react further.

Excessive aggression from Israel could clearly involve Arab nations. "The situation changes if Israel starts to throw its military weight around," he says. "They have peace agreements with Jordan and Egypt but they could attack Lebanon or Syria."

But that "isn't in anyone's interests, including Israel," Drollas says. "They will try very hard to contain the conflict within their own borders."

And Middle East experts say Arab nations' direct involvement in a conflict limited to Israeli territory is unlikely. "This is a conflict between the Israelis and the Palestinians," says Marvin Zonis, a professor at the

University of Chicago Graduate School of Business

who focuses on Middle Eastern affairs. "There may be economic support but there will be no military support

TST Recommends

for the Palestinians from other Arab nations."

And, Zonis says, comparisons to the October War and embargo in 1973 are misguided. "Arab states are much more disconnected from the Palestinian cause

now than they were then," he says.

While rage toward Israel remains strong in Arab countries, there is less willingness to sacrifice in a sure losing battle. "There are no Arab states that are in a position to challenge Israel militarily or even a coalition that could do so," says Zonis. He also notes a big difference between 1973 and now: the disintegration of the Soviet Union. "Now there isn't a superpower to stand up behind the Arab nations economically, politically, or militarily, but Israel retains its near superpower status."

What does Zonis think about the possibility of using oil as a weapon against the U.S.' support of Israel? "I think it has already happened," he says. "I think the Saudis have been much less forthcoming with petroleum because of their outrage for U.S. support of anything Israel wants."

In this case, he thinks Saudi posture and reality are purposefully incongruous. "The Saudis can't say that because they rely on the U.S. for so many things, but they have restrained production to raise prices which has put pressure on Western economies."

In the end, Drollas says current oil prices likely aren't sustainable. Despite growing tensions along the West Bank, he is sticking to his

recent forecast of lower prices into next year. "Prices should be around $30 a barrel toward the end of the year and then fall from there," he says. "Unless supplies are disrupted. If there is a disruption of oil, it's 'a whole new ballgame,' as you say in the States."

Let's hope this game comes to an end.

But Wait, There's More

Drollas seemed more surprised at the apparent bombing of the

USS Cole

just offshore Yemen and the potential response by the U.S. "It's hard to imagine how this happened. With tensions as they are, I can't imagine a U.S. destroyer refueling in port," he said. "I would wonder about the reaction."

The U.S. is investigating the explosion, and

President Clinton

vowed Thursday afternoon to seek out the perpetrators. "If, as it now appears, this was an act of terrorism, it was a despicable and cowardly act. We will find out who is responsible and hold them accountable," he said.

Yemen is located on the southern tip of the Arabian Peninsula on the Red Sea along a key petroleum transportation route.

And, in late reports Thursday afternoon, U.S. intelligence has confirmed Iraqi troop movement from Baghdad toward Jordan. While U.S. officials have dismissed the action as "show," the movement does worry Drollas. "Things change if Saddam

Hussein sends a missile at

Israel," he says.

(For more on Saddam's impact on Middle East tensions, check out the

guest column from Michael Economides.)

Christopher S. Edmonds is president of Resource Dynamics, a private financial consulting firm 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.