COVER

THE HIGH PRICE OF CONQUEST

THE WEST BRACES FOR THE FALLOUT

JOHN DALY,TOM FENNELL August 13 1990
COVER

THE HIGH PRICE OF CONQUEST

THE WEST BRACES FOR THE FALLOUT

JOHN DALY,TOM FENNELL August 13 1990

THE HIGH PRICE OF CONQUEST

COVER

THE WEST BRACES FOR THE FALLOUT

The economic reverberations from last week’s Iraqi invasion of Kuwait ricocheted almost immediately around the world—from Tokyo, to Europe, to Alberta’s oilfields and beyond. As Iraqi leader Saddam Hussein’s tanks and personnel carriers rumbled between the glassand-steel skyscrapers of Kuwait City, stock markets began to slide, the prices of oil and gold soared, and the value of the U.S. dollar climbed swiftly. Then, Iraqi troops moved towards Kuwait’s border with Saudi Arabia, and economists began discussing the possibility of global, oil-price-fed inflation and a recession on a scale that could seriously damage Western economies. Said Robin Shoemaker, an oil analyst at Shearson, Lehman, Hutton Inc. in New York City: “The oil shock in its magnitude could be worse than 1973 and 1979.”

The initial economic shocks from the invasion alone were substantial. The price of oil, which dipped as low as $13.60 (U.S.) a barrel in June, shot up to $23.62 on the day after the Iraqi invasion and closed the week at $24.49

($28.16 Can.). In Japan, which is almost wholly dependent on the Middle East for its oil, the Tokyo stock market’s Nikkei index of 225 issues plunged from 30,838.18 points just before the invasion to 29,515.76 at week’s end, the first time in three months that it had closed below 30,000 points. On European and North American exchanges, trading volume exploded as investors rushed to sell shares in oil-dependent transportation companies and buy oil and gold issues. New York’s Dow Jones industrial average closed the week at 2,809.65 points, down 88.86 from the week before, while the Toronto Stock Exchange’s TSE 300 composite index closed at 3,516.95, down 24.97 points from the previous week.

Gold: In the United States, some independent gasoline-station owners took immediate advantage of the growing panic and increased their prices by as much as 15 cents a gallon within hours of the invasion. The effect on Canadian prices was unclear, but they seemed likely to follow the American trend. The U.S. increases were puzzling because, analysts said,

there is a worldwide oversupply of oil.

In currency and metals markets, the price of gold and the value of the greenback, which investors traditionally have viewed as safe assets during periods of international crisis, also gyrated wildly. Gold closed the week at $377.40 (U.S.; $434.84 Can.), up $9.90 (U.S.) from the previous week, while the U.S. dollar climbed sharply against the yen of oilimport-dependent Japan. Noted Robert Smith, president of Toronto-based American Barrick Resources Corp., one of North America’s largest gold producers: “When an event like this occurs, there is an immediate flight to gold.”

Petroleum industry executives were clearly encouraged by the rising world price of oil. Over the past four years, prices have declined steadily, largely because Kuwait and the United Arab Emirates have consistently exceeded production limits set by the 13-member Organization of Petroleum Exporting Countries (OPEC). Now, Iraq may be able to force Kuwait to keep to its quota, reducing supplies and pushing up prices. Jack Pierce, president of Calgary-based Ranger Oil Ltd., said that the invasion “will have a worldwide effect.”

If Iraq succeeds in maintaining higher prices for a long period, it could lead to a renewal of several high-cost energy megaprojects in Canada that were suspended because low prices made them uneconomical. They include Esso Resources Canada Ltd.’s proposed $4-billion expansion of its Syncrude plant at Cold Lake, Alta., and the $4.3-billion OSLO oil-sands project near Fort McMurray, Alta. Ottawa stopped financing the Fort McMurray project

in February because of low

prices. But, last week, Alberta Energy Minister Rick Orman said that the prospect of diminished Mideast supplies “underlines the shortsightedness of Ottawa’s decision to end support.”

Later this month, Ottawa and the government of Newfoundland will announce whether they will proceed with the long-delayed, $5.2-billion Hibernia offshore oil development in the Atlantic Ocean. The chances of the project getting under way seemed to improve as a result of the invasion. Said federal International Trade Minister John Cros^ bie: “It should remind everybody that we’re exsi posed to grave peril.”

I In the Middle East, how| ever, Iraq shattered the z existing power structure g within OPEC, which has

PUMPING OIL

Average daily crude-oil production among OPEC’s largest producers (thousands of barrels, July, 1990)

wielded a huge influence over the world’s economy.

OPEC’s 13 members control 76 per cent of known global oil reserves and, when they succeed in lowering production, they can quickly drive up inflation and interest rates in the West. Japan gets 72.45 per cent of its oil from OPEC, West Germany 33.5 per cent and the United States 26.9 per cent. Canada is less vulnerable, buying less than 10 per cent of its total supplies from OPEC.

OPEC’s 1973 and 1979 export embargoes drove the price of oil to highs of over $40 a barrel from less than $3 a barrel within a decade, and the results were dramatic. In 1973, consumers in the United States faced long gasoline lineups and almost daily escalations in price. Homeowners, faced with rapidly climbing energy bills, pumped insulation into their houses and switched to natural gas and cheaper fuels. At the same time, governments struggled against record inflation, caused by the mushrooming energy costs. They raised interest rates and spent huge amounts of money searching for alternative energy sources.

But the cartel unwittingly sowed the seeds of its own decline. In 1982, most Western

governments, burdened with massive interest rates to fight inflation caused by the 1979 embargo, suddenly collapsed into the worst slowdown since the Great Depression. As a result, demand for OPEC oil dropped dramatically. That happened at a time when Saudia Arabia and Kuwait were convincing some of their fellow OPEC members that they had to aid the West in its economic recovery by lowering oil prices. The Saudis, who have by far the largest reserves in OPEC and who now produce 5.1 million barrels a day, threatened to flood the market if the other members refused to follow its policies.

Punish: The Iraqis, however, wanted members to adhere to strict production quotas. When some producers secretly exceeded those quotas, they created a worldwide oversupply that steadily drove prices down. This year, Kuwait and the United Arab Emirates, which had production quotas of 1.5 million and 1.1 million barrels a day, respectively, have been overproducing by more than one million barrels a day. As a result, OPEC prices tumbled to $13.60 in June from $20.50 in early January.

hat led Iraq’s Hussein to warn Kuwait that it would be punished unless it cut back on production.

Then, as Iraq’s tanks sent prices skyward, fears of oil embargoes and price shocks suddenly reemerged. Instead of being led by the moderate Saudis, Iraq may now have a much greater influence over prices because of the combined influence of the Iraqi and Kuwaiti oil outputs. Said Shoemaker: “Iraq and Kuwait together are the size of Saudi Arabia, which used to be the kingpin in terms of oil production.”

The political reaction in the West may also push up prices. Most countries seem likely to follow Washington’s lead and boycott imports of Iraqi— and Kuwaiti—oil. That would reduce OPEC sales by about 4.5 million barrels a day and, potentially, drive up prices. Analysts say that non-OPEC producers would be unable to compensate for the shortfall because reserves in such other areas as the North Sea, the United States and Canada are already being pumped at full capacity. Meanwhile, leading oil industry executives in Alberta predicted that ' oil prices will increase dramatically.

Shocks: As well, Husky Oil Ltd. president Arthur Price said that rising prices will lead to major new investments in Alberta’s oil, exploration and development industry. Added Price: “Globally, Europe and Japan will put a higher value on the oil business outside the Middle East.”

The pressures from global price increases will be felt far beyond the oil-and-gas sector. According to Michael McCracken of the private Ottawa-based economic forecasting firm Informetrica Ltd., each $5 increase in the price of oil causes a one-percentage-point rise in Canada’s inflation rate, now at 4.5 per cent. As well, while McCracken said that he does not expect that last week’s oil-price shocks alone will push Canada into a recession, he added that “this sort of thing creates a little more uncertainty.” In the United States, which imports about half of its oil, the impact will be greater, and Japan, the country most dependent on OPEC supplies, may be the biggest victim of all. In Canada, too, economic management in the coming weeks will present both governments and the private sector with a major challenge. But, in the end, it is the consumer who will feel the sharpest impact of Saddam Hussein’s lightning strike in the Gulf.

JOHN DALY

TOM FENNELL

JOHN HOWSE

MICHAEL HARRISON

RUSSELL WANGERSKY