Assessing the economic impact of another Gulf War

For 2003 the great economic conundrum is what impact a highly probable war in Iraq will have on the regional economy.

In fact, the Middle East probably divides into two camps: the Oil States and Non-Oil States. For the six GCC nations high oil prices in the first half of 2003 look a certainty, and that can only be good news. For the other countries a disruption of trade will be bad news.

But a lot depends on how a potential conflict pans out, with January 27 now seen as the most probable date for the commencement of hostilities. Anthony Cordesman of Washington's Centre for Strategic and International Studies has laid out three war scenarios.

In the first, benign, case an allied coalition is victorious in six weeks, Saudi Arabia plugs any gap in oil production and oil production facilities in the region are not damaged. Mr. Cordesman sees this as a 40-60% possibility.

The second scenario, with a 30-40% probability, is that war lasts six to 12 weeks, Saudi Arabia offers only passive support and there is some limited damage to regional oil production capacity. A third, Armageddon scenario includes an attack on Israel by Iraq with weapons of mass destruction and serious damage to oil installations in the region. This gets a 5-10% probability.

On the first benign scenario oil prices spike to $36 and then fall back to pre-war levels. In the second the oil price passes $40 and then remains above $30 for the remainder of the year. The third scenario results in $80 per barrel and only falls back to $35 by the end of 2004.

However, in all three scenarios the Oil States will receive a substantial boost to oil revenues in 2003, though scenario one is not much of an increase on 2002's already very good revenues. For the basic impact of rising oil prices is to squeeze wealth in the consumer nations and transfer it to the producer nations.

The non-oil nations of the Middle East would certainly feel a trickle down effect from the affluence of their oil-owning cousins. But countries like Syria, Lebanon, Jordan and Egypt would also have to cope with the disruption of their trading patterns with Iraq, although if Iraq were freed from UN sanctions this would release more spending power to compensate.

With oil prices touching $30 at the end of December the imminence of another Gulf conflict, whether or not it happens, is already being felt. These are great times for oil companies and oil supply firms in the Middle East who are digging development plans out of their draws and looking at new investments.

In previous oil price explosions prices soared. In today's dollars the oil price was near to $40 per barrel in 1974 and 1990, and hit $95 in 1979.

These years are all remembered with warmth in the Gulf Oil States - as an oil price driven investment boom followed - whereas in the Western world there was a severe downturn in economic activity.

Is history about to repeat itself? On the face of it this looks pretty inevitable and that is what Western stock markets are telling investors.

The most likely scenario is that a swift war would stimulate Western economic activity by the end of the year and leave the Oil States with high incomes for 2003. But unless a war goes horribly wrong, things look good for the Oil States in 2003 and difficult for just about everyone else.