Ten strange days for oil prices

Oil prices have not obeyed the pattern expected with the onset of hostilities in Iraq. There has been no immediate spike in prices to $40 a barrel. Indeed prices fell on the news of the invasion.

What is going on? And where does this leave the outlook for oil prices? After all, oil revenues are by far the most important part of many key Middle East economies.

It has to be said that history does not always repeat itself, especially when lessons of the past have been learnt and acted upon.

In the case of the Third Gulf War, Saudi Arabia knew what was likely to happen and took very decisive evasive action. That meant flooding the oil markets with new supply in the run-up to the attack on Iraq, so that when the attack actually happened the global oil market was amply supplied.

Then the relief rally in global stocks that greeted the end of the uncertainty surrounding the start of hostilities was complemented by a fall in oil prices, and there was no release of emergency oil stocks. Markets quickly reasoned that the conflict would be confined to Iraq, probably quick and that only Iraqi oil supplies would be halted.

So far that sentiment has been partially justified. Certainly Kuwaiti oil supplies continued to flow throughout the invasion, and tanker movements in Gulf waters - with the exception of Japanese VLCCs - have been unaffected (and they are being supplied by feeder vessels at sea).

But there is now a realization that not only is the war likely to be rather longer than first expected - possibly months rather than weeks - but the reconstruction of Iraqi oil installations will not be easy to achieve if security problems persist.

Thus it increasingly looks likely that GCC oil states will have to stay pumping oil at higher levels of production for longer than expected at much higher prices than earlier expected. Oil revenues for 2003 will therefore be the best for 20 years by a wide margin.

It will take just a little deft maneuvering by Opec to keep oil prices comfortably within the $22-28 oil price band in these circumstances. And the idea that oil prices might slump to $10 or even to the high teens is now ludicrous.

So while the oil states may now experience unwelcome disruption in the form of anti-war protests, and lower tourism, trade exhibition and conference earnings, there will be no sudden slump in oil revenues. Far from it, this is a cash bonanza.

Indeed, governments should now be dusting off their spending plans and be preparing to invest in schemes which will both compensate for weaknesses in some areas of the economy and promote economic diversification.

This is a great opportunity for oil states to find a new sense of direction, and to pursue economic modernization which is the only way to deliver a sustained higher standard of living to their growing populations and to secure the economic future of the region.