The impact of the First Gulf War (1991) on oil prices
The First Gulf War started when US attacked Iraq on 17th January 1991. But the real war had started when Iraq invaded Kuwait on 2nd August 1990 and proclaimed it as Iraq’s province. Tension was already simmering between the two countries.
Iraq had just finished its decade old war with Iran and had taken huge debt from Arabian countries, including Kuwait, to finance the war. Saddam Hussein, Iraq’s president wanted Arabian countries, particularly Kuwait and Saudi Arabia, to write off their debts to Iraq.
Also, Iraq had only oil to sell to reduce its debt and finance its development. It wanted OPEC to implement production cuts to increase crude oil prices. But the crude oil prices declined in the first half of 1990. Iraq laid the blame of that mainly on Kuwait by pointing out the excess crude oil being produced by it over its sanctioned quota. In the second quarter of 1990, Kuwait produced 0.38 m barrels a day more than its authorized quota and was responsible for 18 percent of estimated OPEC overproduction of 2.1 m barrels a day (Yamini, 1991). Iraq reasoned that this was the main reason of drop in crude oil prices from around $21 per barrel in January 1991 to about $15 per barrel in June 1990. It also blamed Kuwait for stealing Iraq’s oil from disputed territory between the two countries. When Kuwait refused to comply with Iraq’s above requests of writing off debt and reducing crude oil production, Iraq invaded Kuwait. So this analysis of impact of the First Gulf War on oil prices starts from the time when Iraq invaded Kuwait.
Crude oil is undoubtedly one of the most important commodities in the world. Middle East is the oil producing and exporting hub of the world. Around 65 percent of proven global oil reserves are situated in Middle East (Carvalho and Suni, 2003) The normal production and export of crude oil from Middle East is very crucial for the maintenance of world wide oil supplies and prices. Oil prices rise if the supply in Middle East is actually or expected to be disrupted.
This paper analyses the impact of the First Gulf War, starting from Iraq’s invasion of Kuwait, on movement of crude oil prices. We analyse the initial movement in crude oil prices at the beginning of hostilities against Kuwait. The analysis covers short term movement in prices through spot prices and future prices. Future prices reflect the market expectations over time and are a good indication of likely course of events. They also throw light on the probability of different outcomes. We also analyse the impact of the First Gulf War, if any, on the medium to long term prices of crude oil. In the medium to long term, we will analyse whether the First Gulf War has resulted in any permanent shift in oil prices or was the price change only a temporary phenomenon.
Oil prices were gradually declining in 1990 till the month of June. The news of Iraq’s attack on Kuwait caused panic in the oil markets. Crude oil prices rose sharply to $40 per barrel (Yamini, 1991) There was panic buying by traders and uncertainty around the future availability of oil. The invasion resulted in shortage of 4 million barrels per day and this was about 7 percent of consumption in OECD countries. But the fall in oil prices was also as rapid as the rise. This was after US sent its armed forces in the region. This gave expectation to the market that the crisis will not last long and it won’t affect oil production and export from other Middle East countries. When US armed forces finally attacked Iraq in January 1990, prices dropped down sharply in anticipation of quick resolution of the crisis. The First Gulf War ended when Iraq accepted all US and UN terms of conditions at the beginning of February 1991.
Like any crisis about availability of crude oil, the First Gulf War did have an upward impact on the prices of crude oil. But the rise in crude oil prices was only for the short duration. We found that there was no sustainable long term upward impact on the crude oil prices.
After a decline in oil prices in late 1980s, oil prices again moved upwards in the late 1989 before touching a high of $21 a barrel in January 1990 (Yamani, 1991). But thereafter oil prices dropped to $15 a barrel in June 1990 owing to slack demand season and higher production by OPEC countries. So the chances of rise in oil prices in later half of 1990 shouldn’t be neglected and price rise after Iraq’s invasion should not be attributed to military attack alone. At the same time, the scale and speed of rise is mostly and undeniably due to Iraq’s invasion of Kuwait.
The future prices started rising in July 1990 when Iraq’s intention about Kuwait were causing concern about the stability in Middle East. Iraq wanted to keep oil prices high to repay its debt. It was even trying to pressurize Kuwait in to writing off its debt. Towards the end of July, it became clear that Kuwait would not write off Iraq’s debt. So the chances of rise in oil prices in later half of 1990 shouldn’t be neglected and price rise after Iraq’s invasion should not be attributed to military attack alone. At the same time, the scale and speed of rise is mostly and undeniably due to Iraq’s invasion of Kuwait.
Iraq also blamed Kuwait for siphoning off oil from the disputed territory shared by the two countries. As Iraq assembled its armed forces near Kuwait, oil traders increased price in anticipation of growing chances of hostility and disruption in oil supplies.
Before we analyse the movement in crude oil prices, it is useful to check the impact of the First Gulf War on the total worldwide crude oil production to form a better perspective of what caused the change in crude oil prices. Table I shows the oil production in 1989. Total oil production in 1989 was 64.15 million barrels per day and OPEC contributed 36 percent of it.
Iraq and Kuwait produced 2.8 and 1.6 million barrels per day respectively in 1989. Iraq’s invasion and subsequent UN embargo led to loss of oil production from both Iraq and Kuwait. The total loss was about 4.4 million barrels per day. This represents 6.9 percent of total world oil production.
We analyse the short term movement in crude oil prices through changes in both spot prices and future prices to reflect the oil prices around the invasion and expectation of oil prices over the next one year.
Tags: crude oil prices, crude oil production, first gulf war, iraq invaded kuwait, saddam hussein
