The Oils of War (Iraq)

THE MARKETS ARE treating the fall of Saddam and the extraordinary history we've been watching this past week as a non-event. In my view, they couldn't be more short-sighted.

Let's sidestep for a moment the admittedly fascinating, complex and profound geopolitical implications of the stunning coalition military victory and focus on the one thing that will mean the most to markets world-wide: oil.

Relatively little is being written on this vitally important aspect of the conflict, which is surprising given that many accused the U.S. of fostering a war in Iraq for the primary if not sole purpose of getting its hands on some of the world's largest proven reserves.

The reason, I suspect, is that the subject touches too many raw nerve endings now that U.S. and British military forces actually occupy the Iraqi oil fields. Washington and London don't want to talk about it openly for fear of alienating people with a vested interest in the oil wealth — which is to say just about everybody, from giant oil companies to American consumers and, of course, the Iraqi people. France and Russia dare not openly tip their hands. But you can bet oil was the No. 1 topic at last weekend's meeting of France, Russia and Germany — the so-called coalition of the unwilling — in St. Petersburg.

The real prize here isn't the oil itself. Surely no one seriously disputes that the oil belongs to the Iraqi people and that proceeds from the sale of that oil should go to their benefit. What's important is who controls the rate of production — whose hand is on the spigot. For whoever controls Iraqi production is a de facto member of OPEC and effectively determines the world supply. This is a role recently occupied by Saudi Arabia as the one country that, by withholding or stepping up production, could unilaterally cause gluts or shortages and the accompanying enormous shifts in oil prices. This has given Saudi Arabia enormous influence both in the global economy and in world affairs. Saudi Arabia will retain tremendous influence, but now Iraq can be the spoiler. You can be assured that this hasn't gone unnoticed in Riyadh — where ambivalence about the coalition's military success has been only too obvious.

Of secondary importance to the world economy is who gets to develop, extract and market the Iraqi oil — ChevronTexaco and BP, on the one hand, or TotalFinaElf or Gazprom, to cite a few obvious examples from the opposing camps. Billions are at stake, no doubt, but this issue pales next to the global macroeconomic issues.

Let's hypothesize for a moment that the U.S. and Britain, at least in the interim, assume the dominant role overseeing what remains of the Iraqi state oil company. I strongly suspect that Washington and London have already pretty much figured out an optimal price for oil that both stimulates the global economy and generates enough revenue to feed Iraq's population and to rebuild its infrastructure. I've heard some economists put this price at about $22 a barrel. Imagine an Iraq with state-of-the-art highways, airports, fiber-optic communications systems, schools and hospitals, all paid for by vast oil wealth that, finally, may be managed for the benefit of its people. The resulting stimulus to Iraq's economic activity could be such that most Iraqis won't have to depend on the government for food and other necessities, but will be able to pay for it themselves.

At the moment, this is nothing but conjecture, because under the sanctions imposed by the United Nations (news - web sites) after the Gulf War, the U.N. Security Council controls the sale of Iraqi oil under the so-called oil-for-food program. These sanctions, of course, make no sense now that Saddam and his neo-fascist regime no longer exist — indeed, they're perverse. Yet France, a permanent member of the Security Council (backed by Russia), is threatening to veto any resolution to lift the sanctions unless it plays a significant role in the Iraqi oil industry and the rebuilding of Iraq. This is little more than extortion.

If there's any justice, unfettered management of the oil should pass as quickly as possible to a new Iraqi government. But that will take some time. And it begs the question: What kind of government? The U.S. and Britain want a democracy and would no doubt hope to see at least the beginnings of a market economy. But if you think most of the rest of the world shares this vision, think again. Iraq's totalitarian, theocratic and monarchist neighbors aside, this won't satisfy even other democracies that are primarily interested in preserving oil contracts already entered into with the Saddam regime, or recouping massive outstanding loans to Saddam's government — i.e., France and Russia.

So if you think the build-up to war was ugly at the U.N., then watch this play out.

Ultimately, I believe that reason will prevail, either because the U.S. and Britain throw some bones to France, Russia and the U.N., or because, like the war itself, they simply act unilaterally. In either case, this is bullish for the U.S. and global stock markets because it will keep oil prices low, stimulate demand related to the rebuilding of Iraq and unleash economic activity world-wide. More parochially, it's also good for oil stocks, which are priced as though $10-a-barrel oil were just around the corner. (For more on oil stocks, see my column in the May issue of SmartMoney magazine.)

The U.S. can also score diplomatic gains by managing Iraq's oil for the best interest of the Iraqis, a policy that has the added benefit of being in our interest as well. This means setting an example for government's role in a free economy by opening up the bidding process for the vast rebuilding of Iraq and avoiding even the appearance of cronyism (cronyism being an endemic problem in much of the Middle East, as well as many other parts of the world.) Henceforth Halliburton (NYSE:HAL - News), a company with close ties to the Bush administration, should compete for contracts on an open and level playing field, as should other U.S. companies. Foreign companies should be welcome to bid. If a company like Alcatel (NYSE:ALA - News) of France, which built the Iraqi phone system, makes the best bid to repair it, then Alcatel should get the contract.

I know it's tempting to insist that the "spoils" of war should be reserved for those who fought it. But given its great military power and recent success, the U.S. can afford to put principle ahead of short-term expedience. There's plenty of work to go around. And in any event, a great power need not sink to the level of blatant self-interest recently exhibited by erstwhile allies France and Russia. America should lead by example.

__________________ This article was originally published on SmartMoney Select on 4/15/03.

Henceforth Halliburton (NYSE:HAL - News), a company with close ties to the Bush administration, should compete for contracts on an open and level playing field, as should other U.S. companies.

Halliburton is competing. Under US law, they had to compete against a number of other companies, as did Bechtel. This job is big enough that other companies will be brought in, either subcontracted to these two or in their own right. And you can bet that foreign companies will be invited to compete. There is a list of about 40 countries whose offers will be entertained sympathetically.

France will probably not be on that list while Chirac remains in office.

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