Is Iraq war fueling the GCC's economic boom?

Wednesday 10 August 2005, 19:29 Makka Time, 16:29 GMT

Since the US-led invasion and occupation of Iraq, the price of oil has steadily climbed upwards. A barrel of oil today costs twice as much as it did on the eve of combat, back in March 2003.

At the same time all six Gulf Cooperation Council (GCC) states - Bahrain, Kuwait, Oman, Qatar, the United Arab Emirates, and Saudi Arabia - have experienced levels of economic growth not witnessed since the 1970’s.

According to a recent Institute of International Finance report, the GCC's aggregate nominal GDP grew by 17% in 2004 and is likely to grow as impressively this year.

OPEC members Kuwait, Qatar, Saudi Arabia and the United Arab Emirates pumped 4% more oil in 2004 than in 2003, leading to a huge increase in revenues.

In the past three years, the value of Saudi oil exports has equaled the revenue generated in the 1990s.

This period of exceptional economic performance has enabled governments in the Arab Gulf to substantially increase fiscal spending, which in turn has increased private-sector confidence and stimulated strong growth in non-oil sectors.

There is little doubt that the continued occupation of Iraq contributes to the upward trajectory of oil prices, which in turn has helped fuel the GCC's economic boom. Paul Horsnell, a senior energy analyst at Barclays in London, said, "If there had been no invasion, then the current oil price would be lower."

The question is to what extent. The "Iraqi factor" is only one part of the story. The contention that we have reached, or are approaching "peak oil" – the top of a bell-shaped world oil production curve – combined with unprecedented global demand and lack of spare capacity are probably all more significant factors.

Peak oil

A former British Petroleum executive, geologist Colin Campbell, argues that the world has already consumed half of its proven oil reserves and that in effect we are close to the top of the oil production curve.

This has led some analysts to contend that the world has entered a new "oil price paradigm". Venezuelan President Hugo Chavez has said "The era of cheap oil is over," and Chevron's current advertisements state "One thing is clear: The era of easy oil is over."

The idea that we have reached peak oil is a matter of conjecture and difficult to predict due to the lack of transparent and reliable data on world oil deposits, but the idea may be fuelling speculation on the world's oil markets.

Until recently, the oil futures market remained low and stable even when the spot price shot up, but this has now changed, and the futures markets are in the unusual situation of being in contango.

This indicates that traders expect higher prices for some time. Indeed, the US Energy Information Administration (EIA) has forecast that the average price per barrel of oil will remain above $50 throughout 2005 and 2006.

Insatiable demand

High prices have so far done little to dampen demand. Since 2003 there has been a growing and seemingly greedy demand for oil. The world consumes 84 million barrels per day (bpd) but according to the International Energy Agency, this will rise to 88 million bpd by the end of 2006.

China, which is now the world's second-largest consumer of oil, has over the past few years accounted for approximately 40% of the growth in global demand. The EIA forecasts that Chinese demand will double by 2025.

India, another rapidly industrialising Asian state, is importing more oil than ever. Demand is still growing in developed economies, especially the US, where gasoline for motor vehicles accounts for most of its demand.

It is interesting to note that Ford's current range of cars achieves, on average, fewer miles per gallon than its Model-T did 80 years ago

The huge increase in demand for oil has coincided with supply constraints. This is primarily a result of limited ability to extract additional oil quickly enough but also due to factors such as lack of refining capacity.

Even though OPEC continually agrees to increase production levels – the most recent announcement was on 15 June for an extra 500,000 bpd – these have not helped reduce the price and have even led some to question whether this extra production has actually come on stream.

Indonesia recently became the first net-oil importing member of OPEC. Non-OPEC states such as Russia are widely thought to be extracting oil at full capacity. In contrast with the previous embargo and supply-driven price rises, the current oil price boom may be the first occurrence of a "demand-led shock".

The Iraqi factor

Some in Washington had hoped that by now Iraqi oil would be flooding the market, rendering OPEC obsolete and acting as a counterbalance to Saudi Arabian influence.

This has not happened, partly because Iraq's pipeline infrastructure has been sabotaged no less than 257 times since 2003 but also because its oil infrastructure is in a dilapidated state.

In the final months of the UN Oil for Food programme, Iraqi oil exports averaged at 2.5 million bpd. At peak levels, prior to sanctions, Iraq produced 3.5 million bpd. Last month Iraq managed to export only 1.6 million barrels daily.

Even if Iraq could produce significantly more oil than at present, it would not necessarily bring the price down but simply fill the gap between current OPEC quotas and forecast demand for 2006.

Although the occupation of Iraq has added to the "terrorist/instability premium" in the oil price and contributed in a small way to the lack of spare capacity, it is not the main factor for the current oil price and is therefore does not significantly contribute to the GCC's current economic boom.

The fundamental factor is the remarkable rate of growth in the world's voracious appetite and demand for oil.

Indeed, there is a danger that the situation in Iraq could adversely affect non-oil GCC economic growth.

A prolonged US occupation accompanied by present levels of violence may adversely affect foreign direct investment flows, lead to capital flight and make diversification away from dependence on hydrocarbons more difficult.

The sooner peace and stability return to the long-suffering Iraqi people the better it will be for the economies of the GCC and the world.

[Emilie Rutledge is an economist who is currently based at the Gulf Research Center in Dubai]. The opinions expressed here are the author's and do not necessarily reflect the editorial position or have the endorsement of Aljazeera.

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