Iraq plays oil-for-food card in sanctions standoff

By Peg Mackey

DUBAI (Reuters): Iraq's sabre rattling over the smart sanctions proposal by Britain and the United States has oil dealers on edge but not yet at panic stations.

Iraq's Deputy Prime Minister Tareq Aziz said on Monday that Iraq would suspend exports under the United Nations oil-for-food program if Washington interfered with its renewal. The current six-month oil sales tranche is due for renewal on June 3.

Just how Baghdad defines interference remains to be seen.

"Any suspension of exports would depend on the nature and impact of the American intervention," an Iraqi source said.

"The oil market is growing tighter now and the U.S. and its allies would be hurt badly if Iraq stopped exporting."

Oil traders, for now at least, are treating Iraqi statements as the start of a war of words.

"We're being cautious, but we expect there will be a relatively smooth transition into the next phase of the program," one dealer in Iraqi crude said.

Oil prices on the London and New York futures exchanges are likely to rocket if Iraq halts exports although supplies of physical crude could withstand a short suspension.

"The physical market could take a week-long disruption with no problem, but a three-to-four week break really alters the equation," an industry source said.

The U.S., whose refiners are lapping up at least one-third of Iraq's 2.1 million barrels per day of oil sales through second parties is particularly at risk.

"A three-to-four week outage would play right up to the Fourth of July holiday in the U.S. ," an oil executive said. "The reputation of the Bush administration would be tarnished."

Meanwhile, on a purely commercial basis, it's business as usual for Iraqi state oil marketer SOMO.

"They're making more of an effort than ever to ensure oil continues to flow," an industry source said. "The June loading programs for Kirkuk and Basrah Light are done and dusted."

And an official from state oil marketer SOMO said crude oil price formulas for the whole month of June were now under internal discussion.

Oil sales contracts have been signed as far out as August, industry sources said.

Smart sanctions aim to lift controls on civilian imports to Iraq but keep restrictions on military-related items. The UN would still control the bulk of Iraq's oil revenue, deposited in an existing escrow account.

Baghdad is concerned that the new arrangements aim to stop smuggling through routes through neighboring countries Turkey, Jordan and Syria -- vital direct income to the government.

For that reason, Iraq wants a straight rollover of the UN oil program and would see changes as means of pressuring it into cooperating with the new sanctions, said a source in the Iraqi capital.

To hammer home its point, Baghdad might be inclined towards a prolonged disruption of oil-for-food, some analysts said.

"Aziz's warning should be taken seriously," one diplomat said. "They have done it before and they will do it again."

Others argue the impact of Iraq's oil weapon has been blunted by the world's leading oil producer, Saudi Arabia.

"Using oil as a weapon is a tool of the 1970s," said an oil executive. "It won't work now because the Saudis will fill the void."

A Saudi oil source repeated on Tuesday that the kingdom, together with OPEC, would step in to fill any serious supply disruption.

For that reason, some analysts said Iraq would keep its absence brief in order to safeguard the market share it has built up since the inception of the UN oil for-food program in 1996.

Diplomats in Baghdad said Iraq's hardline statements were apparently aimed at piling the pressure on the Security Council and its neighbors in an attempt to throw the current deliberations off course.

Washington and London intend to get a vote by May 31 before the next phase of the United Nations oil-for-food program starts on June 4.

But some diplomats view that as an unachievable goal and expect the current ninth phase of the oil-for-food program to be extended for several months.

Iraq's UN envoy Mohammed Aldouri said on Monday that a short- term extension through the end of June "is not practical."

"I expect to see a real tug-of-war between Iraq and the UN during June," an oil executive said.