I worked as an international oil markets analyst for 17 years at the U.S. Energy Information Administration, so I feel like I know a wee bit about the major (and minor) factors determining oil prices. I also specifically did a great deal of research on oil supply disruptions, for instance in The New Global Oil Market. Which is why the latest PolitiFact “Truth-O-Meter” — “Sen. Jim Webb says Iraq war is major reason for oil price increases” — caught my eye. According to PolitiFact, Webb’s claim is “barely true.” In fact, that rating in and of itself is “barely true.” Let me explain.
According to Jim Webb, it’s simple: there’s a direct, strong, cause-and-effect relationship between the Iraq war and world oil prices. For instance, Webb says, “I recall when the Congress voted to go to war in Iraq, oil was $24 a barrel. It went up to $143. Today, it’s about $102.” Webb repeats this all the time, and has done so consistently since the 2006 campaign. And he’s been consistently wrong on that. How so?
As PolitiFact correctly points out, the spot prices of Brent and WTI crude were at around $24-$25 per barrel in late 2002, prior to the Iraq invasion but definitely during a period when many oil traders were concerned over a potential war in Iraq, and thus a potential disruption to Iraqi oil supplies. Oil prices then rose into the mid-to-upper $30s per barrel in early 2003, in part on uncertainty vis-a-vis Iraq, but far more so on oil supply disruptions and political unrest in Venezuela, where crude oil production plummeted from 3.0 million barrels per day in November 2002 to just 630,000 barrels per day in January 2003 (a short-term disruption of 2.4 million barrels per day), as turmoil and strikes gripped that country for several months. In addition, Nigeria’s oil production was disrupted by several hundred thousand barrels per day in the spring of 2003 on unrest in that country.
Note that neither Jim Webb nor PolitiFact mentions the Nigeria or Venezuela oil disruptions that took place in early 2003? Why not? Probably because, like most people, they don’t remember those events, overshadowed as they were by the invasion of Iraq during the same time frame. Yet for world oil markets, a barrel of oil is pretty much a barrel of oil, and political uncertainty is pretty much political uncertainty. One caveat to that previous statement is important: oil markets perceive any risk to oil flows from the crucial Middle East – particularly the Persian Gulf (Saudi Arabia being the most important by far) – in a significantly more dire light than potential risks to production in other areas of the world. The reason is simple: the Persian Gulf region produces enormous amounts of crude oil – around 20 million barrels per day in 2009 – and maintains almost all the world’s “spare production capacity” — mostly in Saudi Arabia. That’s absolutely crucial. In contrast, disruptions in Venezuela or Nigeria are small and limited, definitely not a major threat to the world oil markets in the grand scheme of things.
What happened in the 1991 Gulf War is illustrative of how markets perceive political risk. I was working at EIA at the time, heavily involved in analyzing the effects on world oil markets of Iraq’s invasion of Kuwait – as well as “Operation Desert Shield” and “Operation Desert Storm,” the military campaigns to protect the other Persian Gulf countries (particularly Saudi Arabia) and to expel Iraqi forces from Kuwait. Following the Iraqi invasion of Kuwait on August 2, 1990, the UN Security Council imposed an embargo on oil exports from those two countries, resulting in an oil supply disruption of 4.6 million barrels per day (2.7 MMBD from Iraq, 1.9 MMBD from Kuwait). Within a few months, Saudi Arabia and other oil exporters had increased their production sufficiently to compensate for the entire loss of Iraqi and Kuwaiti oil. Still, fears of potential attacks on Saudi or UAE oil facilities, combined with lost oil production from August through October, resulted in oil prices increasing from $16 per barrel in July to over $30 per barrel in early October. The day after the allied coalition’s bombing campaign began in mid-January 1991, the oil price spike essentially had ended, even though – and this is important – the gross oil supply disruption of 4.6 MMBD continued. In fact, Kuwaiti production didn’t achieve pre-war levels until February 1993, while Iraqi oil exports didn’t return to 1990 levels for 8 years. Despite the absence of Iraqi oil production, however, oil prices stayed extremely low throughout the 1990s, bottoming out around $11 per barrel in late 1998. So much for a disruption of Iraqi oil supplies causing an oil price spike, certainly not one that lasted more than a few months or averaged more than $10 per barrel or so. All of which makes perfect sense given the EIA “rule of thumb” that for every 1 MMBD of oil supply disrupted, prices tend to increase by about $3-$5 per barrel.
Keeping all that in mind, we come to the analysis of what happened in 2003 and beyond, when oil prices surged from around $28 per barrel (in September 2003) to as high as $133 per barrel (in June 2008). In this case, Iraqi crude oil production averaged around 2.0 MMBD in 2002, the last full year prior to the invasion. In 2003, Iraqi oil production fell to 1.3 MMBD, a disruption of 700,000 barrels per day. Using the EIA “rule of thumb,” that translates to an oil price increase of roughly $2.10-$3.50 per barrel for that year. It’s not nothing (although in the grand scheme of things, it basically is inconsequential), but it’s not even close to accounting for an oil price runup of $105 per barrel by 2008 (5 years later). In 2004, Iraqi crude oil production was back to 2.0 MMBD, and in 2009 it reached 2.4 MMBD, higher than in 2002. Using the “rule of thumb,” that would actually translate to a decrease in the price of oil, all else being equal. In other words, Jim Webb’s theory that a disruption of Iraqi oil production contributed heavily – if not totally – to the oil price spike from 2003 to 2008 is utterly, completely, factually, empirically INCORRECT. As in, not “barely true,” but “completely untrue.”
Why does any of this matter, other than as an academic exercise? Very simple: because if you don’t understand what caused oil prices to rise, you will then have absolutely no clue what to do about the situation. So, what caused oil prices to rise, you ask? Again, very simple: it’s overwhelmingly the demand, stupid. That is, rapidly rising oil demand in China, India, and around the world.
This truly isn’t rocket science; in fact, it’s as simple as can be. From 2003 to 2009, world oil demand rose from 79.7 MMBD to 84.3 MMBD, an increase of nearly 5 MMBD (almost 1 MMBD per year). That’s huge. Yes, there are other factors, like constrained OPEC spare capacity, political instability and oil supply disruptions elsewhere in the world, and oil futures trading (aka, “speculation”). But the bottom line is that overwhelmingly, the reason oil prices have risen is rising demand pushing up against limited spare production capacity. Iraq has next to nothing to do with any of that, although I suppose you could argue that, in the absence of all the wars Iraq engaged in during the 1980s (with Iran), 1990s (with Kuwait and an international coalition), and the 2000s (Bush’s invasion), Iraqi oil production might be approaching 5 MMBD, 6 MMBD, or even higher. But that’s revisionist history which could be applied to many other scenarios as well (e.g., what if Iran hadn’t had an Islamic Revolution? what if consuming countries had moved aggressively to slash demand?). The reason they’re called “revisionist” is that they didn’t happen. Which is why, like Jim Webb’s absurd “theory” about oil prices, they’re not “true” or even “barely true,” just misleading.