Oil markets in the first half of this year continued to be characterized by oversupply, and oil prices fell to their lowest real price in a decade. OPEC struggled to drive up prices by imposing quotas that would reduce production and minimize member countries "cheating." In particular, Iran and Iraq-struggling to rebuild their economies under a mountain of war-induced debt and destruction-were desperate to raise oil revenues through a price increase. On July 17, Saddam Hussein of Iraq accused neighboring states (specifically, Kuwait and the UAE) of exceeding OPEC oil-production quotas and threatened retaliatory action. Four days later, Iraq moved tens of thousands of troops to the Kuwaiti border. On August 2, Iraq overwhelmed Kuwait.

Days after Iraq invaded Kuwait, the UN Security Council unanimously voted to impose an economic embargo against Iraq which prohibited export of Iraqi and Kuwaiti oil, as well as imports of consumer and military goods. As a result, 4 mbd of oil was withdrawn from the world oil market. The most significant customers of Iraqi oil were the U.S. (620,000 barrels/day), Japan (230,000 barrels/day) and Turkey (335,000 barrels/day). Prior to the embargo, the US imported 8% of its oil from Iraq and Kuwait and Japan imported 13.5% of its oil from the two countries.

In addition, there are sizeable government stocks: the U.S. Strategic Petroleum Reserve (SPR) holds almost 600 million barrels, West Germany has 190 million barrels and Japan has 175 million barrels. In addition, other IEA countries hold 90 days of imports in government-controlled company stocks. Together, these stocks would cover the major oil consuming nations' total oil imports for 5 months; government stockpiles alone could cover Iraqi and Kuwaiti oil production for over six months.

The IEA estimates world demand for oil in the fourth quarter of 1990 will be 55.3 mbd, an increase of 2.7 mbd over third quarter demand due to seasonal factors. We believe that this is a conservative estimate. The ultimate level could be higher if public and private sector oil consumers seek to build excess stocks in light of market uncertainties.

Other oil producers have stepped up production to meet the shortfall from Iraqi and Kuwaiti production. The IEA estimates Saudi Arabia can increase its production by 2.5 mbd to 8.0 mbd, while Venezuela and UAE the only two other countries with significant surplus capacity, can increase production for a total of 6.2 mbd. In addition to production capacity, the security of Gulf oil supplies, which could be threatened by military or terrorist action, and consumer demand for oil that has risen in response to concern over future availability of oil, are also critical factors to consider when predicting future oil flows.

A Framework for Action: Making up for Iraqi & Kuwaiti Production

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Tailoring a short term international energy response to the Gulf Crisis.

Meeting the present crisis requires that we be respectful of the mistakes and progress of the past; at the same time we must recognize that each crisis in the market requires a tailor-made response. The present situation, in my view, is comparable to the setting of 1979. There is uncertainty as to how and when the situation in the Middle East will be resolved. If we are into a period of drawn-out stalemate, then we can expect oil prices to rise gradually based on speculation. In times of market unrest past experience suggests that private companies will hold or build their stocks with the expectation that prices will rise further. This is not unlike consumer behavior when confronted with uncertainty, consumers will tend to fill up more regularly -- thereby keeping their own personal stocks high. In the past we also have learned that markets can be influenced by speculation and rumors. The challenge of governments is to resist undue intervention into the markets; at the same time OECD nations should seek coordinated measures to ensure that price rises or losses are market influenced, not generated by speculation and/or profiteering.

A major policy question is whether to draw down government strategic stocks in the U.S., Germany and Japan. There are two contrasting views. The first is that stocks should be drawn early in a crisis, thereby reducing the potential for oil price spikes. This strategy seeks to protect the world economy early in a crisis but has the downside that stocks can be used only once and then must be replenished. Also, there might be less incentive for producing countries with available surplus to put their is prolonged these stocks would be available in potentially desperate situations (such as, for example, restriction of oil flow from Saudi Arabia). added production on the market, if the OECD countries are lowering their stocks. Another view is that stocks should be used as a last resort. If the military confrontation

Our first defense is a coordinated draw of strategic stocks. An OECD stock draw of 2 million barrels a day should be adequate to send the appropriate signals t to the market, but at the same time not deplete the reserves at an alarming rate. The U.S. should only consider drawing down its strategic reserves in coordination with other IEA countries. Considering the contribution already provided by the U.S. military-and the U.S.' relatively minimal dependence on Kuwaiti and Iraqi oil—an equitable coordinated drawdown policy could call for Germany, Japan and the international effort commensurate with their interest in the region. U.S. to draw equal amounts, for example 600,000-700,000 barrels per day. Since the U.S. has a larger SPR than either Japan or Germany, this plan would in effect proportionally reduce the U.S. burden, and provide Japan and Germany the opportunity to make a sizeable contribution to the

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remained relatively stable.
Second, IEA countries should agree to discourage abnormal purchases on the spot market. This strategy was successfully implemented at the
beginning of the Iran-Iraq war in 1980. Nations gave their oil traders notice that abnormally high purchases of oil would not be tolerated and prices

switching that yield comparable oil supply savings (1.5-2.0 mbd overall).
Third, countries that do not have stocks to provide to the world market should be called upon to do their part through demand restraint measures and fuel

nations that higher oil prices, brought about primarily by speculation, would not be tolerated.
Stock draw and demand restraint would reduce demands on world oil supplies by at least 3 million barrels per day which, combined with increased production by
OPEC suppliers, would more than adequately cover the most likely oil supply disruptions. Agreement to avoid abnormal purchases would be a strong signal by OECD

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