oil supplies, geopolitical risk, war in Lebanon, invest

Why oil and war is an explosive mixture

21.07.2006

by Bill Bonner

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Markets typically react to ‘geopolitical risk’, sometimes exaggerating the danger… sometimes brushing it off. At present, investors judge the war in Lebanon as a minor threat. Gold fell $22 on Tuesday, to $629. Oil sold off too, to just over $75. The burden of today’s little reflection is that investors might want to change their minds. Not that we have any idea what the future will bring. The gods still keep their secrets. But the past blabs: oil and war is an explosive mixture.

Investors are aware that war affects oil. It was war in the Levant that drove up the price of oil in the 1970s and caused the worst world economic slowdown since the 1930s. Every hint of war since has caused the oil market to shudder.

Oil, war, money: the example of WWII

What is under-appreciated, in our view, is how oil affects war. With the advent of mechanised warfare, oil – not superior generalship nor better weapons – has been decisive. In World War I, Germany could not win because oil had already become the key ingredient of modern warfare and it didn’t have any.

In World War II, the allied war effort was fuelled by the gush of Texas oil rigs, while the Axis powers were always running out of gas at critical moments. The Allies could pursue their enemies with full tanks, while the Germans and Japanese had to chase petroleum. Hitler shifted troops from the crucial attack on Moscow in order to secure his oil supplies in the south. Tojo stretched out his army throughout the South Pacific so as to protect his “Southern Resource Area.” Both distractions proved fatal.
How the world has turned since 1945! Texas oil fields peaked out 30 years ago. The North Sea rigs hit maximum production two years ago. Now, it is the Anglo-American empire that fears for its oil supplies and bends its wars to fit its energy needs.

Oil, war, money: the consumer economy under threat

America today, like Japan and Germany in the 1930s, buys most of its oil on the open market. And as with the Axis powers in the 1930s, most of the world’s oil comes from places that it cannot readily control. Using military force to try to secure access to energy is both expensive and oil-consuming. In just three weeks of combat in Iraq, the US military used 40 million gallons of fuel – more than had been burnt by all the allies in all of World War II. America’s armed forces use 395,000 barrels/day, or 30% more than before the Iraq war began.

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James Ferguson is probably right (What's the real reason for the oil price rise?). The war isn’t likely to have much immediate effect on the quantity of available oil or the price. It’s going up anyway. But risk is measured in terms of consequences as well as probabilities. The collateral damage could be huge. Already, oil at $75 is doing to marginal householders what Israeli warplanes are doing to southern Lebanon. From both sides of the Atlantic, reports of weakness in the consumer economy are drifting into camp like soldiers after a major defeat – wounded, hungry and discouraged. House prices are slipping, retailers suffering, automakers are putting on the brakes, disposable family incomes are going down. What would it take to put oil at $100? Maybe not much. Then, consumers are likely to feel as if they are in Dresden rather than Beirut.

Recommended further reading:

See Byron W. King's article on how a lack of oil lost Japan the war. For more on rising oil prices, see our MoneyMorning piece on how you can profit from the energy crisis. A full list of articles on oil can be found in our section on investing in commodities.