Markets braced for expensive Iraq war

Date: 03/10/02

By Khaled Diab

WHETHER or not Iraq, after more than a decade of 'containment' and sanctions, poses a threat to the United States and its allies, any military action would most likely have serious economic and political ramifications for Europe

Although the US would be expected to foot the bulk of the bill for a strike against Saddam Hussein - White House estimates put this as high as $200 billion - a war would still carry an inevitable price for Europe.

More worryingly perhaps, experts warn that military action could speed up the continental drift between Washington and European capitals, destabilise the already volatile Middle East, and test relations within the Union.

Although the EU has a less than clear-cut stance towards the unfolding crisis, an understanding is emerging among member states. 'We're moving towards a common position in which all EU states support going through the UN,' says Fraser Cameron, director of studies at the European Policy Centre, a Brussels-based think-tank.

He believes that this diminishes the possibility of an attack, particularly before the end of the year.

However, Washington's reaction to Tuesday's meeting between Iraqi and UN officials in Vienna has opened up the prospect of a rift in the EU.

Colin Powell, the US secretary of state, made it clear that the arrangement reached for the return of weapons inspectors was not acceptable.

Backed by the UK, Washington is calling for a tough new Security Council resolution that would specifically mention the threat of military intervention should the inspectors be unable to complete their work. It does not want inspectors to return until this is passed.

There is widespread concern that the Anglo-American drive for a tough new resolution is just a bid to cloak their intentions to fight with a sheen of international legitimacy.

'The worst-case scenario for EU cohesion is Britain backing the US alone,' Cameron admits.

As the political debate rages on, energy and financial markets are bracing themselves for a conflict.

'Markets don't wait for a war to happen,' says Daniel Gros, director of the Centre for European Policy Studies in Brussels. 'They've already factored in a war premium.'

Crude oil already carries a premium of $8 per barrel, according to some estimates. Europe's beleaguered stock exchanges, along with other major markets, have been shaken by war jitters in recent weeks with European blue chip shares slumping to near five-and-a-half year lows.

Whether this will prove, in the event of war, to be just a foretaste of the economic poison to come - or a case of temporary nerves - is yet to be seen.

It will depend largely on the nature and duration of any eventual military campaign, how much international backing it has, and how destabilising it is on the Middle East, which produces 40 of the world's oil.

A relatively short campaign is the most likely scenario and this would have a transitory economic effect. 'This may delay the recovery of the economy. But it will not change European fundamentals. It will be one factor among many,' forecasts one analyst.

But, with Germany, Europe's economic powerhouse, stagnating, even a transitory downturn could be the final straw that plunges EU economies into recession.

The International Monetary Fund stated in a gloomy report last week that even its scaled-back growth forecasts could be affected if oil prices were to rise further or investor confidence took another hit.

It cut its growth forecast for the eurozone to 2.3 in 2003, from April's 2.9.

'The key is how a war is perceived here by financial markets,' Gros explains, especially if oil were to remain above the psychologically-important $30-a-barrel threshold.

Although Iraq possesses the second largest oil reserves in the world, delivering 2.1 million barrels per day to the markets under UN supervision, analysts believe global energy supplies would not be threatened if the tap was turned off.

'Beyond the price level issue, there is currently no sign of the prospect for a severe oil and gas shortage under imaginable scenarios,' says Klaus Becher of the London-based International Institute for Strategic Studies.

'If Iraqi oil supplies are disrupted, then other oil producers are likely to make up for the shortfall,' echoes Gros.

Nevertheless, oil stocks are scraping the bottom of the barrel. US strategic oil stocks, the main global benchmark, stand at 18-month lows, with the energy-hungry winter in the northern hemisphere not yet begun.

If an attack were to be launched in the next few months, it would further exacerbate the shortfall.

However, European markets may not regard a higher oil price as all bad news. 'Oil price levels cut both ways economically as some European countries are major oil and gas producers,' Becher notes.

The North Sea is a leading source of supplies and Europe is home to some of the world's biggest oil firms.

A shot in the arm for, say, Shell and TotalFinaElf could prop up flagging European markets by compensating for the hole left by downgraded telecom and tech stocks.

'A quick regime change in Iraq could be good for EU economies,' Gros adds.

However, even if the US were to go it alone, overthrowing Saddam Hussein is riddled with pitfalls.

Aside from questions of legitimacy, it would, military analysts say, involve a major ground offensive which is likely to inflict major casualties on both sides.

Moreover, there is no guarantee that a US-backed regime would survive Iraqi scepticism of US intentions, or that European firms, several of which already have major oil deals with Iraq, would not be muscled out by American rivals.

If a conflict drags on Vietnam-style, it could plunge the Gulf region into political chaos. An unstable Middle East at Europe's backdoor would have serious political implications for the EU.

'We are aware of a whole range of possible scenarios, some quite serious, which could impact on our relations in the region,' a European Commission source confirmed.

Even if the economic damage proves to be limited, the medium to long-term political consequences of a unilateral engagement could prove extremely serious.

In addition to further alienating pro-Western regimes in the Middle East, it could drive another wedge in relations between Washington and its traditional allies in Europe.

'If the US didn't bother to go down the UN path and launched a pre-emptive attack, they wouldn't win any support in Europe,' concludes Cameron.

Military action against Iraq is likely to have serious economic and political ramifications for Europe.