War with Iraq could spark recession

As the US and the UK discuss strikes on Iraq, BBC News Online looks at how the conflict could hit consumers in the pocket. Imagine the nightmare scenario. Enormous casualties in Iraq lead to major demonstrations in Arab capitals.

Middle East governments react with heavy-handed oppression - and one state, perhaps, descends into anarchy.

Meanwhile, Saddam Hussein attacks Israel with a Scud missile.

Israel retaliates and the Palestinian conflict spills out into a regional confrontation.

"That would be Middle East conflagration," says Ian Bremmer, president of the research firm, Eurasia Group, in New York.

"That'll push oil prices up!

"Conflagration could have a long-term effect on the oil markets and push us into economic recession."

Analyse this

We are, however, only speaking in scenarios - something analysts do a lot.

Although most see war with Iraq as an almost-certainty, the various, possible consequences of such a conflict are still being mapped out.

"The day we start attacking opens up so many risks," says Mr Bremmer.

One of the biggest risks for all of us watching the war on television would be the impact on our wallets.

The chain reaction starts with a spike in the cost of oil, which in turn raises business costs, leads to possible unemployment, or simply makes it more expensive to heat our homes and run our cars.

But for all the political tub-thumping, economists are remarkably sanguine about our economic prospects.

"There is considerable uncertainty about the amount of damage a conflict would do," says Nigel Pain of London's National Institute of Economic and Social Research (NIESR).

"But for a recession there would have to be a sustained spike in the oil price."

The cost of war

At the moment, the cost of Brent crude oil is hovering just below $30 a barrel. During the Gulf War of 1991, it shot up above $40.

Analysts estimate that the current price includes a war premium of between $1 and $5, which means that anxiety about an attack on Iraq is already being priced in.

In the event of war, with Iraqi oil off-tap, the oil price would probably jump, but the question is how high and for how long.

"If it persists at high levels, perhaps for six to nine months, then that could lead to a recession," says Mr Pain.

However, most analysts are expecting a brief military campaign and - in the optimal scenario from their point of view - a change of regime in Iraq.

With a "Hamid Karzai" installed in Baghdad, the oil infrastructure could be upgraded and online within a couple of months, says Manouchehr Takin from the Centre for Global Energy Studies in London.

He believes that would up Iraq's current production capacity and, with the excess supply, even bring oil prices down.

Knocked out

Even so, many are haunted by the oil crisis of 1973-4, when an oil shortage and the subsequent price rise helped cause a world recession.

But oil expert Mr Takin downplays any loss of supply from Iraq.

The cranky state of the country's current oil facilities means its output - 1.5 to 1.7 million barrels a day - is insignificant compared with world production of 76 million barrels.

"Industry is also much less dependent on oil than it was in the 1970s and we are much more efficient at using energy," he adds.

In addition, since then, the US has been building its reserves to avoid a similar crisis - and even in the past few months President George W Bush has taken steps to boost an emergency oil supply.

That said, some of the newly industrialized economies in Asia, including China, would be more susceptible to any oil shortages or price hikes.

The oil-producing cartel Opec, however, is soothing nerves by suggesting it could cover any shortfall to keep prices below $30.

Damaged

But even under the most optimistic scenario, with oil prices high for only a short time, it could crimp corporate profits - as businesses try to absorb rising costs - and dent economic growth.

Industries that are particularly reliant on fuel, such as the airlines and shipping, would suffer more than most.

The big danger is that consumers - worried about their jobs or hit by higher fuel costs - would decide to keep a tight grip on their wallets

And, in a perverse cycle of self-fulfilling prophecy, when they stopped spending, businesses would suffer even more.

Nevertheless, ABN Amro economist Matthew Wickens is still betting on a "sub-par recovery" for the US, rather than a lurch into double-dip recession.

But as the build-up for war gathers steam, the economic risks should loom large, alongside political considerations and the potential loss of human lives.