If negotiations that began last week at the United Nations succeed, the world will not suddenly have 700,000-800,000 b/d of new oil from Iraq. A grasp of the subtle points of this proposition is essential to understanding why resumption of Iraqi exports need not wreck the oil market-but might anyway.
Iraq probably cannot produce 700,000 b/d of crude the minute it and the UN come to terms on exports to fund humanitarian needs. It will take weeks, perhaps months, for the Iraqis to restart idle production equipment, pipelines, and pump stations. Mechanical comebacks have a way of happening faster than anyone expects, and disrepair of Iraqi production and export capacity may not be as bad as outsiders imagine. On the other hand, it may be worse. And repairs require capital, Iraq's shortage of which the UN does not attempt to address.
No surprise
More important is the fact that this will not be new oil. The restart of legal Iraqi exports would only partly make real the potential supply that has hung over the market for 51/2 years. The potential has not been a secret. The market has known that, one day, Iraqi flow would resume. The only question has been when.
Whether the answer to that question is soon remains to be seen. If it is, the Iraqi volumes will not come as any surprise. The market will adjust, and the adjustment will involve a price decline. Falling prices will: 1) encourage non-Iraqi producers to lower output, and 2) stimulate consumption, which will reduce the amount by which production must be cut.
This adjustment will not occur without hardship, but the market can make it without wrecking if nothing distorts the process. Unfortunately, something might.
Limits on Iraqi oil exported under UN Resolution 986, the subject of the negotiations begun last week, have to do with revenues instead of volume or price. The resolution allows Iraq to earn $2 billion in revenue from oil sales every 6 months for humanitarian needs, as long as the country can produce crude fast enough to earn that many dollars. The only other economic constraint is production cost, which in Iraq is low.
The price-blind nature of Iraqi oil sold under Resolution 986 could create problems in the market. The longer the market takes to adjust to oil from Iraq, the longer oil prices will be depressed, which means Iraq will have to increase its exports to meet revenue levels of Resolution 986. More oil, lower prices.
And once exports start they will not stop. This is oil funding humanitarian goods and services, the adequacy of which the UN secretary-general must review every 6 months along with Iraqi behavior. Unless Pres. Saddam Hussein steps seriously out of line, no secretary-general will halt exports designed to help struggling Iraqis. Once begun, the exports will be regularly renewed and, if anything, increased.
As quickly as possible, therefore, the UN should set limits on Iraqi export volumes. There will be protests that limiting volumes might make less than $4 billion/year available for humanitarian uses. But $4 billion is itself an arbitrary limit in a world where there can never be enough money for humanitarian uses. The UN must consider the type, and not just the level, of its export limit.
Volume vs. price
A revenue limit on Iraqi exports allows Saddam Hussein to weaken his oil-producing neighbors and competitors to the extent that his country's humanitarian allowance comes from volume instead of price. Under Resolution 986, Iraq earns $2 billion in 6 months producing 730,000 b/d with the crude price at $15/bbl, or 916,000 b/d with the price at $12/bbl.
The UN should ask which option creates the most difficulty for Kuwait, Saudi Arabia, and-for that matter-Texas and Oklahoma. At this writing, no one knew whether Saddam seriously hoped to sell oil under Resolution 986. But it was a sure bet that he had performed the volume-vs.-price arithmetic and considered the strategic implications of the numbers.
Copyright 1996 Oil & Gas Journal. All Rights Reserved.
