IMPLICATIONS OF THE IRAN-IRAQ WAR FOR PERSIAN GULF OIL SUPPLIES AND PRICING

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP83M00171R001500060001-5
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 7
• Document Creation Date: December 20, 2016
• Document Release Date: January 17, 2008
• Sequence Number: 1
• Publication Date: January 1, 2000
• Content Type: STUDY

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IMPLICATIONS OF THE IRAN-IRAQ WAR FOR
PERSIAN GULF OIL SUPPLIES AND PRICING
The at ched study, prepared by the Office of
Str gic Assessments, International Affairs
(DOej, evaluates the impact of the Iran-Iraq
War on current and future international oil
supply and pricing.
DOE review completed.
Any questions should be directed to John Del;pres,
Director, Office of Strategic Assessments, on
252-8355.
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A CURREN'T' ASSESSMENT
IMPLICATIONS OF THE IRAN-IRAQ WAR FOR
PERSIAN GULF OIL SUPPLIES AND PRICING
The Iran-Iraq war has lasted longer, caused greater damage to oil
facilities, and stimulated greater uncertainty about oil prices than
most initial estimates suggested.
CM-UM CkTTLWK
For the duration of the war, oil output in the Persian Gulf will be
reduced by about 3 MMB/D for most of one quarter, probably two quarters,
and possibly much longer. After the war, losses of 1-2 MNB/D for another
quarter or two are likely to derive from delays in the repair of facili-
ties and restoration of export capacity. Several outcomes are possible:
Best Case
- Even if the war ends within a few weeks, exports would remain severely
depressed in Ira
d
q an
Iran for another few months
Most Likely Case
- If military operations continue through the winter, as now seems
likely, oil exports from the Persian Gulf could probably not achieve
re-war l
l
p
eve
s until mid-1981.
Worst Case
- Longer, wider, or more damaging military operations (e.g air strikes
against Kuwaiti oil facilities) might reduce Persian Gulf exports by
greater amounts.
We estimate that cumulative losses of oil supply to the world market are
virtually certain to exceed 300 MM, are likely to exceed 500 1M, and
could even reach 900 MM within a year. Spot market traders, as well
as major producers and consumers, are beginning to anticipate larger
supply losses as the war continues. Average world oil prices (including
official prices, premiums, and spot market margins) will accordingly rise
by at least 10%, probably 15%, and possibly over 20% by the middle of
next year, if not sooner. The pace of price increases will depend on
US policy choices and OPEC decisionmaking, as well as the following
factors:
- duration of the war, damage to oil facilites, and other constraints
on exports;
- offsetting supply increases and demand restraint measures;
- seasonal and cyclical demands that could be unusually heavy this
winter and spring in OECD countries; and
- rising expectations of future price increases, which could strengthen
incentives to hold stocks.
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W :4i fULENIIAL
IMPACT OF THE WAR
The war between Iraq and Iran will probably continue at least until either Iraq
can deny Iran access to Khuzestan's oil or there are leadership changes in
Baghdad or Teheran. Both sides are preparing for several more months of war;
while the fighting could wind down this winter, it is unlikely to end before
next spring or even later. Wet winter weather could impede Iraqi advances more
than Iranian defenses. As long as the war continues, total oil output and exports
from Iraq and Iran will be constrained by severe damage to loading facilities,
active interference with normal operations, and passive security precautions.
Gross losses are likely to vary between 3.5 and 4 MMB/D, depending on the scale
of both countries' wartime exports. A net loss to the international market of
about 3 MMB/D is thus likely to persist, since other Gulf producers will probably
not increase output more than 0.8 MMB/D. Unless major repairs are undertaken
before the war ends, they could take an additional three to six months. During
this time exports through the Gulf, by Iraq in particular, will be far. below pre-
war levels. Iran could more readily restore its crude oil exports to their low
pre-war level, much as Iraq has already resumed exporting through Turkey to the
Mediterranean. Assuming alternative dates for the war's end, we have estimated
cumulative oduction losses and their effects on stocks and prices in the Appen-
dices.
PRICING TRENDS
Although spot prices are rising steadily, thus far most buyers have remained
publicly calm and refrained from large-scale purchases. The importance of
escalating spot market prices has been largely discounted by officials and
industry experts, who note that they have comprised less than 2% of total
volumes of oil traded. Aggregate supply and demand, rather than limited trading
on the spot market, will determine the prices that generally prevail. Moreover,
if Iraq can export 0.5-1.0 MMB/D though pipelines to the Mediterranean, upward
pressure on these prices could be largely relieved. 25X1
However, with heavier demands for winter heating supplies and a recent warning.
by Saudi Oil Minister Yamani that the world may be on the verge of a new round
of panic oil buying which could drive up contract prices even before mid-December,
desperate buyers may attempt to secure available supplies at higher prices. Spot
prices, notwithstanding limited volumes, have repeatedly been used by producers
to justify contract price increases. Kuwait recently sold contract oil to a
Japanese company with a premium that closely followed spot market trends. Japanese
companies could well be the first to abandon the restraint generally exercised thus
far. One trader has suggested that in, a few weeks MITI will succumb to growing
restiveness on the part of Japanese industry and allow much higher purchase prices.
Persistent expectations of excess demand, uncertainty about the duration and extent
of the war, and a reluctance to deplete existing stocks could compound demand and
restrict supply to the world oil market. Particularly if buyers panic, producers
may seek to impose higher contract prices and premiums on their long-term customers.
Failing this, producers could divert larger volumes to the more profitable spot
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MULTILATERAL OPTIONS
Attempts to spread shortages more evenly through sharing arrangements in the IEA,
domestic oil reallocation, or other mechanisms could temporarily dampen competitive
bidding for limited suppilies on the spot market. Without any action, in the
best plausible case, world oil prices are likely to rise by at least $3 per barrel
by the middle of 1981. But prices are more likely to rise by $5 per barrel unless
the war ends soon or a strong program of countermeasures is undertaken. Prices
might rise as much as $8, $10, or by even larger increments per barrel if a more
widely destructive war, a harsh winter, or other adverse developments were not
offset by new multilateral restraints on oil demand. 25X1
Barring the rapid restoration of normal export operations in Iran, Iraq, and the
Persian Gulf, a multilateral program would be needed to prevent most of the price
increase due to a much more damaging war. The United States would have to lead
the way by adopting a variety of moderately stimulating energy supply-enhancement,
fuel-switching, and oil demand-restraint measures. This could provide the basis
for a coordinated contingency plan to impose import fees, quotas, or other restraints
on demand to pre-enpt producer price increases and minimize the economic losses of
consumer economies.
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3er the formula that OPEC's Long-Tenn Strategy Co.- nittee Chairman Yamani has
roposed and begun to implement unilaterally in Saudi pricing policy, price
increases of $1-2/b would be due each quarter. So, benchmark and average crude
prices are almost certain to increase $3/b within the next six months unless
OECD growth and inflation rates abate. By the middle of 1981, the Iran-Iraq
war could raise world oil prices by another $2-5/b. The size of this additional
incease will depend on the actual course. and effects of the war as well as other
strategic, economic, and psychological factors. Several possible outcomes can
25X1 be distinguished:
- Best Case - Aggregate production loss will be 300-500 million barrels. Average
prices (FOB) will rise about 10% above the current $32/b OPEC price to around $35/b.
- Most Likely Outcome - Aggregate production loss will be 500-750 million barrels.
Average prices will rise about 15% to around $37/b.
- Worst Case - Aggregate production loss will be 750 million to 1 billion barrels.
Average prices will rise 25-30% to $40-42/b.
The assumptions underlying these outcomes are as follows:
- Best Case - Presumes that winter weather in OECD countries will not be severe;
that the war ends by the turn of the year; that the conflict is at least
apparently settled and there is a vigorous recovery and reconstruction program
for damaged Iraqi facilities; that Iraqi pipeline exports return irrnediately to
about 1 mmb/d; that special loading devices are installed within two or three
months as an interim substitute for the damaged sea island terminals; that these
terminals are repaired so that exports are back to normal within 6-9 months;
that security is restored within Iran and Iranian exports pick up within a month
or two; and finally that these developments are well known by late January 1981.
(This last condition is critical because final decisions on contract prices
for the first quarter of 1981 cannot be deferred beyond mid-February. These
prices will be determined by the parties' current expectations of future supply
and demand.)
- Most Likely Outcome - Presumes that the war continues at least through January;
that there is additional damage to both sides' export capacity; that the recovery
period takes longer than in the Best Case; and that the end of the war and restora-
tion of production will not not be clearly foreseeable prior to first quarter
contract decisions and. perhaps not until after mid May when prices for the second
quarter will be finally fixed.
- Worst Case - Presumes the same facts as in the second case plus additional con-
straints on Kuwait's exports, an exterrnely harsh winter, rapid economic expansion,
and other developments which cut supply or raise demand more than expected.
In all cases, other Persian Gulf producers are presumed to keep their output about
0.7 tt',3/d above pre-war levels until Iran and Iraq approach their pre-war levels.
(Contrary to published information, Kuwait has not sustained production increases
and has imposed security constraints on its oil export operations. Also contrary
to presumably well-infor ed opinion, Saudi Arabia has been unable, for technical
reasons, to sustain production increases above 10
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Erri i Ur inn, LruU1-1rtt%V wt1LC ULV v1L olv%,IJ tUVU rLl1VL'J
Average Consump-
Alternative Out- Projected Cumulative "Excess" tion Cut Needed
come of the Month of Oil Output Draw- to Re-stock by
Iran-Iraq War War's End Losses (MMB) down 1/ (MMB) mid-1982 2/(MBD)
--------- ------ -------- ------------
------------- --------- -------
Nominal (Real)
Price Increase
% Official
Project
Needed by mid-1981
Price Increase
Officia
to Restore Norma
Implied
Price o
Stacks in 1982 3
7/1/814
---------------------
--------------
-------
Best
Dec. 1980
300
0
0
$2
($0)
6/
$34
Better
Jan. 1981
450
150
400
$4
($2)
13
$36
Likely
Mar. 1981
600
300
800
$6
($4)
19
$38
Worse
May 1981
750
450
1200
$8
($6)
25
$40
Worst
July 1981
900
600
1600
$10
($8)
31
$42
1/ Assumes that current "excess" stocks worldwide are 300 MMB and that an additional 600 t
of "normal" stocks could also be drawn down.
2/ Re-stocking is assumed to take place within about a year of war termination.
3/ Assumes the short-term price. elasticity of world demand for oil is -.15.
4/ Official price for Arab Light, which'is assumed to approximate the average price for
all oils.
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