COVER

THE PRICE OF PEACE

A PROLONGED OIL EMBARGO WILL BE COSTLY

PATRICIA CHISHOLM August 20 1990
COVER

THE PRICE OF PEACE

A PROLONGED OIL EMBARGO WILL BE COSTLY

PATRICIA CHISHOLM August 20 1990

THE PRICE OF PEACE

A PROLONGED OIL EMBARGO WILL BE COSTLY

The economic weapons that ultimately may prove more successful than jet fighters in bringing Iraqi President Saddam Hussein to his knees may also hammer the economies of the West. Supported by a United Nations Security Council resolution to prevent the import or export of “all products and commodities” from or to Iraq and Kuwait last Monday, countries around the world declared a full trade embargo against Iraq, cutting off its vital oil exports and refusing to supply it with grain and other critical supplies, including weapons and machinery. So far, the impact of the economic collar placed on Iraq following its invasion of Kuwait remains unclear: late last week, Hussein remained defiant, calling the economic sanctions an act of war. And while some analysts predicted that Iraq would be severely weakened by a sustained economic squeeze, others cautioned that the desert nation has long been making preparations for such an embargo, including

stockpiling a six-month food supply.

Still, as the week progressed, the boycott gained momentum. Major oil-producing countries, such as Saudi Arabia and Venezuela, said that they will increase production to replace Iraq and Kuwait’s 4.6 million barrels a day, 8.9 per cent of world production. Even Jordan’s King Hussein, who at first supported the invasion, said that he would take part in the embargo.

Fear: Leaders of the boycotting countries clearly hope to force Iraq to withdraw without any further bloodshed, but they also fear that they may have to pay a heavy economic price for their efforts. The uncertainty over oil supplies has already caused wild gyrations in prices. In the resulting confusion, there has been, however, one clear—and potentially devastating—impact of the boycott: prices at gasoline pumps throughout the United States have gone up, in some cases dramatically. And prices in Canada are also expected to increase

in the coming months. For many countries teetering on the edge of recession, the price increases were serious setbacks. Last week, the price of benchmark West Texas Intermediate Crude rose to a four-year high of $28.31 (U.S.) on Aug. 7, compared with an average price in the first six months of this year of $19, before dropping back to $25.96 on Aug. 8 and closing the week at $26.23.

At the same time, investors, concerned that higher prices would fuel inflation and lead to higher interest rates, disrupted stock markets, sending stocks down sharply and then pushing them upward again by week’s end as an uneasy calm settled over the desert oilfields. The Canadian and U.S. dollars shot upward, indicating that nervous foreign-exchange traders were seeking out currencies that they consider safe in times of global upheaval. Said Robert Boaz, an economist with Toronto-based securities dealer Deacon Barclay: “Oil prices between $25 and $28 almost ensure a reces-

sion in this economic climate. These prices take a lot of money out of the economy.”

In the United States, the impact of the crisis on consumers was immediate. Within hours of the Kuwait invasion, U.S. drivers saw gas prices jump by as much as 15 cents per gallon, and, at the end of last week, U.S. gas prices in some areas had increased by almost 25 cents per gallon. In Canada, William Innes, president of Esso Petroleum Canada, said prices will not rise dramatically until existing supplies of oil purchased before the invasion are depleted.

In the United States, after President George Bush called on the oil companies to avoid opportunistic increases, some companies rolled back prices by up to four cents a gallon. Still, prices remained higher than they were before the crisis, and politicians accused the oil companies of price gouging and called on governments to take remedial action.

Decline: Beleaguered Canadian grain farmers, who are already suffering the aftereffects of three droughts in recent years and a decline in the world price of grain, were facing the loss of their fifth-largest customer. Canada sells almost $300 million worth of grain to Iraq annually, and there were no immediate customers for the instant surplus, some of which was sitting on docks in Vancouver. While Prime Minister Brian Mulroney has not ruled out the possibility of compensation, he declined last week to commit the federal government to a bailout of grain farmers.

While the world awaited the next move from the unpredictable Hussein, Bush’s decision to increase the U.S. military presence in Saudi Arabia had positive effects on oil supplies. Saudi Arabia is the largest oil producer of all the OPEC countries, producing 5.1 million barrels a day, and many oil traders were fearful that Iraq’s next step would be a push into the militarily weaker kingdom. But the movement of the U.S.

82nd Airborne Division and fleets of F-15 fighter jets into the Persian Gulf almost immediately helped stabilize markets. Saudi Arabia responded to the American military aid by announcing that it would increase production by two million barrels a day, making up about 44 per cent of the shortfall created by the boycott of Iraq and Kuwait. The announcement by other OPEC members that they, too, would step up production also helped to soothe concerns about insufficient supplies.

The OPEC decision is critical to maintaining worldwide economic stability. Nearly every major country imports some of the cartel’s oil, and a few, like the United States, are highly dependent on its output. Indeed, U.S. OPEC

imports amount to 26.9 per cent of its consumption. By comparison, West Germany imports 33.5 per cent of its oil from OPEC countries, and Japan roughly 72.34 per cent of its needs. In contrast, Canada, a net exporter of oil, imports only 550,000 barrels a day of OPEC oil, which prior to the embargo included 16,000 barrels a day from Iraq. Federal officials said that Iraqi oil supplies, required to serve eastern Canadian markets, which are not connected to the pipelines that ship western Canadian oil, could be easily replaced from other OPEC sources.

Even without Iraq and Kuwait’s production, most analysts say that other OPEC countries have enough unpumped capacity to make up the shortfall. Total world oil demand outside of the centrally planned economies is about 51.9 million barrels per day, and, of that amount, OPEC supplies about 43 per cent. Analysts say that the 4.6 million barrels a day produced by Iraq and Kuwait could be almost fully replaced, for the short term at least, by Saudi Arabia and OPEC countries outside the Persian Gulf, including Venezuela, Nigeria and Libya. Said Michael Canes, vice-president and chief economist at the American Petroleum Institute in Washington: “Potentially, all the other OPEC producers

can make up almost all the shortfall if they produce at full capacity. If that happens, the impact on world markets will be relatively slight.”

Some countries have also calmed oil markets by announcing that, if the crisis deepens, they would draw on their government-owned supplies of crude. Although Canada does not maintain such a strategic reserve because it is a net exporter, Canes said that there are about one billion barrels available in government-controlled stockpiles around the world. That in-

cludes the 600 million barrels in the U.S. strategic petroleum reserve that can be released into the market for only a few months at the rate of three million barrels a day, about 18 per cent of daily consumption.

Still, oil prices could surge this winter when cold weather pushes world demand for OPEC crude oil up to an estimated 24.4 million barrels per day, well above expected production levels if the boycott continues. As a result, Richard Carl, senior oil-and-gas analyst with Toronto-based Loewen Ondaatje McCutcheon & Co. Ltd., predicts that the last three months of the year could be the most difficult for consumers. Said Carl: “If Hussein has not been toppled by then, there could be serious price increases.” According to Carl, however, rationing of crude-oil supplies is possible but unlikely in Canada. He added: “Production will be made up from other sources, and there are at least 75 days of inventories. Unless Saudi Arabia is bombed, there is no real need for rationing.”

And Maurice Ruel, director general of the oil-and-gas branch at the federal department of energy, mines and resources in Ottawa, says that the government has been assured by the oil industry that supplies are secure for the next three to six months. As a result, the government is not contemplating rationing. Indeed, Ruel says members of the International Energy Program, meeting in Paris last week, announced that no emergency was imminent and that the Iraq and Kuwait shortfall could be made up with other sources. Said Ruel: “We’re monitoring supply and price on an ongoing basis.” Through informal talks with oil company executives, Ruel has been assured that the industry will only make justified increases in prices.

Hikes: But consumers in s Ontario and the Maritimes I could see gasoline price hikes = before other parts of the 1 country. Gasoline stations in 5 the East Coast region receive I supplies from refineries using 5 imported oil, which has become more expensive. As well, Robert Allen, vice-president of Cango Petroleum Inc., Ontario’s largest independent gasoline retailer—with 300 outlets in the province— said that he received notice last week from major refiners that his wholesale purchase price for oil will go up two cents per litre. And Allen expects costs will escalate again when more expensive, $28-a-barrel crude is processed through the system in about a month’s time. While major gasoline retailers, such as Petro-Canada, have yet to raise their prices, smaller independents such as Cango have no choice but to pass on the higher prices. Said

Allen: “The two-cent increase has to be passed on—or you eat it. You cannot take 4.6 million barrels of oil off the market without paying higher prices.”

Meanwhile, Ontario Energy Minister Lyn McLeod summoned the presidents and vicepresidents of Petro-Canada, Suncor Inc., Esso Petroleum Canada and Shell Canada Ltd. to her Toronto offices at week’s end, where she voiced the province’s concerns that prices remain stable. The major oil producers assured McLeod that there was no supply problem in Ontario, and the energy minister says that she is satisfied that oil companies are not using the Mideast crisis as an excuse to hike gasoline prices. And in Ottawa, Mulroney told reporters: “We’re very concerned that nobody take advantage of the present situation to artificially and unfairly escalate the price of petroleum products. That is being monitored very carefully by the government.”

Even in oil-rich Alberta, there are only cautious signs of optimism. A decade of up-anddown economic fortunes has made many oilmen cautious, and most are waiting to see if the price of oil remains at $26 or more before initiating spending on new oil wells or on megaprojects. Said Norman Gish, president of North Canadian Oils Ltd. of Calgary: “It will be three months at least, and probably closer to six, before anybody changes spending plans.”

Severe: Still, if severe shortages should develop, Canada would have to share its oil resources with the United States and other Western nations under two different treaties. Under the International Energy Agency agreement, for one, signed by Canada and 21 other Western countries in 1974, all signatories pledged to share and ration oil supplies during periods of prolonged shortages. But, at an emergency agency meeting in Paris last week, delegates decided that the current situation is not serious enough to trigger the treaty provisions. And under the Free Trade Agreement with the United States, Canada is prohibited from cutting oil exports to that country—now about one million barrels a day, or over 10 per cent of U.S. consumption—to meet domestic needs unless it cuts domestic consumption by the same proportion.

Beyond the immediate crisis, the Middle Eastern conflict illuminated with frightening clarity how interdependent many world economies have become. For such countries as Canada and the United States, which are already fighting rising unemployment and slowing growth, the increases in oil prices are a direct, two-pronged assault on their failing economic health. Rising oil prices spark inflation by pushing up the cost of commodities made from crude oil. Those include not only gasoline, home-heating oil and jet fuel, but plastics, synthetic fibres and rubber products as well.

THE OIL CRISIS COULD MAKE A WESTERN RECESSION UNAVOIDABLE

Indeed, there are few products not affected by an increase in the price of a barrel of oil. At the same time, higher oil prices take billions of dollars out of the economy, reducing spending by consumers and business, and increasing the chance of a severe economic slowdown. The Petroleum Institute’s Canes estimates that, if oil prices climb $8 over a one-year period, and the United States continues to import about three billion barrels of oil annually, the result will be equivalent to a $24-billion tax increase.

OIL’S VOLATILE PRICE

West Texas Intermediate Crude benchmark, $U.S.

SOURCE: U.S. ENERGY INFORMATON ASSOCIATION

The same situation would cost the Canadian economy between $2 billion and $3 billion, partly because Canada imports only about 550,000 barrels of oil per day. But according to Deacon Barclay’s Boaz, the amount is significant because of Canada’s weakening economy. He said that if oil prices remain between $25 and $27 a barrel for five to six months, the consumer price index in Canada could jump by 1.5 percentage points, to just under six per cent. In addition, he says that growth could fall by one full percentage point, to just under two per cent in 1991. Added Boaz: “The impact is much worse now for the average person than it would have been two years

ago, when the economy was robust.”

In addition, a recession in the United States could greatly accelerate the pace of Canada’s downward spiral: 70 per cent of Canada’s exports are sold to the United States and, in 1989, oil exports accounted for $1.8 billion of Canada’s $651-billion gross domestic product. Said Douglas Peters, chief economist for the Toronto-Dominion Bank: “They buy our goods, and if they fall, we could follow.” Canada’s soaring dollar is making it even more difficult to export to the United States. The dollar, already high because of attractive Canadian interest rates, is being pushed even higher by foreigners investing in Canada because its economy is more protected than others thanks to its vast domestic oil supplies. Indeed, the dollar’s new status as a so-called petrodollar pushed the currency to a 10-year high last week of 87.22 cents (U.S.). It is likely to move even higher because of the added threat of increased inflation. Said Boaz: “With high oil prices, high interest rates and a high dollar, its a triple whammy for the Canadian economy.”

Critical: For the Canadian airline industry especially, the oil price increases are critically important. Fuel costs account for between 12 per cent and 15 per cent of the airlines’ total expenditures. But Canadian carriers, which have already announced cumulative price increases of about eight per cent this year, have little room to raise fares further. A faltering economy has already resulted in lower passenger levels, and higher prices could lead to even greater declines. Said Ella Brown, an airline industry analyst at Toronto securities dealer Richardson Greenshields Ltd.: “The rise in oil prices is not good news at a time when traffic is falling.” And airlines in the highly competitive U.S. airline sector could face a more difficult future. Indeed, some analysts suggest that continued hikes in jet-fuel prices could push a number of airlines into bankruptcy. /

Despite the mounting costs—and recessionary fears—caused by the embargo, world leaders such as Bush and Mulroney say that the goal of defeating Saddam Hussein is well worth the price. And in the long term, added Judith Kipper of the Washington-based Brookings Institution, the negative consequences of allowing Hussein to remain in Kuwait far outweigh the cost of the embargo to other countries. Other analysts, however, warn that Hussein’s determination is likely to prolong the economic and military standoff for as long as a year. If that occurs, the embargo of Iraq may become an even more severe test of the world’s willingness to pay for the nonviolent resolution of global conflict.

PATRICIA CHISHOLM

TOM FENNELL

MICHAEL HARRISON