Another Oil Shock?

The Middle East conflict - Palestine versus Israel now, Iraq to come - creates serious risks for growth and financial stability. To understand the severity of these risks, let's work backwards from what is unlikely to happen.

All grandstanding notwithstanding, neither Iraq nor Iran will mount an effective oil embargo on the US. First, their commitment to oppose America does not include a pre-emptive sacrificing of essential oil sales that keep their run-down economies churning. Both countries recognize that if they refuse to sell America oil, other countries (Russia and Mexico) will take up the slack. So an Iran/Iraq oil embargo is bound to be ineffective. All that will happen is that they will lose money.

Even Saddam is smart enough to avoid this trap, so he and Iran's ayatollahs will posture and grandstand and thus move oil prices up a bit. Nothing more serious than that. To their Arab spectators, grandstanding is almost as good a proof of leadership as actually doing something.

But the real risk to oil is open hostilities or sabotage of oil installations. What matters here are not oilfields, but pipelines, refineries, and oil ports - they influence spot price because they govern the immediate availability of oil. As we saw in the Gulf War, the risk of damage to oil refineries raised spot prices dramatically: $40 back then. This time around the price would certainly go higher because the risks including sabotage are much more widespread.