For The Moment, the Shock Is Limited

By Barry Hillenbrand

Oil and war do not mix. In 1973, when the Middle East erupted in the October War, the world was hit with Oil Shock No. 1. Then in 1979-80, after revolution broke out in Iran and the country was invaded by Iraq, came Oil Shock No. 2. In both cases petroleum prices soared, energy shortages developed, inflation took off, and the world's economies sank into recession. Last week fears of Oil Shock No. 3 could be felt from New York City to Tokyo.

The price of West Texas Intermediate crude, the benchmark for trends in the U.S. oil market, ended the week at $24.49, an increase of $3.51 in two days. In Tokyo the Nikkei stock index plummeted 729.42 yen, closing the week at | 29,515.76 yen. The market drop reflected concern that Japan, which depends on imported oil for 57.9% of its energy needs, might face tougher economic times. In Europe, which also relies heavily on Middle East oil, stock and currency markets gyrated nervously.

Despite the anxiety in the markets and a surge of price gouging at the pumps, experts agree that Shock No. 3 is not imminent -- unless there is further military action in the gulf. The Iraqi invasion of Kuwait should not have an appreciable impact on the world's oil supply. While there was some temporary disruption of the loading of Kuwaiti tankers last week, oil continued to flow out of the region. More important, world supply far exceeds demand.

Fully loaded supertankers are anchored offshore awaiting space to unload their cargo. Even if Iraq's daily production of 3.1 million bbl. or Kuwait's 1.9 million bbl. were cut off, either by military action or by a U.S.-led embargo, a serious shortage would take time to develop. Countries like Saudi Arabia and Venezuela, which are producing below their capacity, could quickly fill the gap.

In the event of a true oil emergency, the industrialized nations are far better prepared than they were in the 1970s. The U.S. now has 590 million bbl. of crude squirreled away in salt domes in Texas and Louisiana. That is enough to satisfy America's gas-guzzling habit for about 34 days. Japan has a similar reserve that would last 142 days.

Still, a tightening of the market could cause price increases, which would send debilitating ripple effects through the world's economies. According to Laurence H. Meyer & Associates, an economic forecasting firm in St. Louis, a rise to $30 in the price of crude would produce a 3% drop in the American GNP by the first quarter of next year and an increase in unemployment from the current 5.5% to 7.5%. The threat would not be so great if the economy were not already teetering on the edge of recession. Says Barry Bosworth, a senior fellow at the Brookings Institution: "We could not absorb a big price shock given the fragility of the economy."

After the first two oil shocks, the U.S. lowered its dependence on Middle East oil by reducing consumption and increasing its own production. That trend was quietly reversed in the past few years, but no one in Washington seemed to care. As a result, the U.S. is unnecessarily hostage to instability halfway around the world.

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CREDIT: TIME Chart by Joe Lertola

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Imports of crude oil from Arab OPEC countries in thousands of bbl. per day

With reporting by Anne Constable/London and Richard Hornik/Washington