1. Estimating the Economic Benefits Derived From Forward-engaged Naval Forces Dr. Robert Looney Dr. David Schrady National Security Affairs and Operations Research Departments Naval Postgraduate School Research Undertaken for N8C - N81 - N3/N5 CSIS Conference on Naval Forward Presence Washington, DC May 5-6, 1997

2. 12/14/2015Naval Postgraduate School2 Outline The Approach Used Assumptions in the Economic Analysis The Three Cases Studied – Gulf War – 1994 Iraq-Kuwait Border Incident – 1987 Iranian Attacks on Gulf Shipping Conclusions Areas for Further Research--Force Structure

3. 12/14/2015Naval Postgraduate School3 Approach Used Analysis examines the economic impact of the differential in oil futures prices resulting from U.S. Naval forward engagement and crisis response – impact on the United States and countries comprising the Organization for Economic Development and Cooperation (OECD) – oil is essential commodity » price movements produce greatest economic impact – futures prices reflect market expectations based on available economic, political, military information » best unbiased estimate of likely daily prices when contracted delivery date arrives

4. 12/14/2015Naval Postgraduate School4 Economic Analysis Naval forward engagement and crisis response affects market outlook – futures prices decrease following naval crisis response – differential in oil futures prices before and after naval crisis response allows the economic benefits of naval forward engagement and crisis response to be estimated Measurable economic benefits include increases in Gross Domestic Product (GDP), reduced unemployment and inflation, expanded industrial production, construction, etc. – this briefing concentrates on GDP

5. 12/14/2015Naval Postgraduate School5 Notional Relationship Between Naval Crisis Response and Oil Futures Markets

6. 12/14/2015Naval Postgraduate School6 Linkages

7. 12/14/2015Naval Postgraduate School7 The Three Cases The Gulf War – August, 1990 The Iraq-Kuwait Border Confrontation – October, 1994 The Gulf Shipping Crisis – January, 1987

8. 12/14/2015Naval Postgraduate School8 The Gulf War Occurred at a time of excess inventory and production capacity – mitigated oil price increases resulting from invasion of Kuwait – OPEC incapable of establishing firm production quotas – prices fell throughout the year up to latter part of July Oil prices increase after August 2 invasion of Kuwait – decline in prices following naval crisis response August 7 – stabilization in prices around August 9

9. 12/14/2015Naval Postgraduate School9 The Gulf War Occurred at a time of excess inventory and production capacity – mitigated oil price increases resulting from invasion of Kuwait 2-Jul2-Aug2-Sep Iraq threatens over-producers OPEC agrees to reduce output - target price $21/bbl 17 27 Iraq invades Kuwait U.S. commits to defend Saudi Arabia 6 8 Eisenhower CVBG in Red Sea USMC troops & equipment in theatre 15 Independence CVBG in Gulf of Oman 5

10. 12/14/2015Naval Postgraduate School10 The Gulf War

11. 12/14/2015Naval Postgraduate School11 The Gulf War

12. 12/14/2015Naval Postgraduate School12 The Gulf War Three measures of the naval crisis response effect: – August 9th futures profile - August 7th futures profile » Direct impact – August 9th futures profile - August 24th futures profile » pattern produced by no naval crisis response, assuming oil prices would increase to $30 at this time – August 9th futures profile - Tight oil market profile » pattern produced by no naval crisis response with oil shortages producing an additional $5 per barrel price increase

13. 12/14/2015Naval Postgraduate School13 The Gulf War Complexity of this case led to development of three measures of the economic impact of naval crisis response

14. 12/14/2015Naval Postgraduate School14 The Gulf War Three measures of the naval crisis response effect: Effect #1 (Aug 7th profile - Aug 9th profile): – U.S. Oil Import Bills: Potential savings of $3.2B – U.S. GDP: Potential losses of $55.2B were averted – OECD GDP: $69.5BWorld GDP: $83.6B Effect #2 (Aug 24th profile - Aug 9th profile): – Oil Import Bills: Potential savings of $5.4B – U.S. GDP: Potential losses of $94.0B were averted – OECD GDP: $119.6BWorld GDP: $143.9B Effect #3 (Tight oil market profile - Aug 9th profile): – Oil Import Bills: Potential savings of $10.0B – U.S. GDP: Potential losses of $182.7B were averted – OECD GDP: $231.4BWorld GDP: $278.4B

15. 12/14/2015Naval Postgraduate School15 Iraq-Kuwait Border Confrontation Oct 7: Iraqi troop movements Oct 8:George Washington CVBG/Tripoli ARG respond Oct 10:Prices fall when markets open on Monday Oct 13:Medium term equilibrium in oil markets Oct 17:Slight rise in oil prices from final adjustment in oil markets

16. 12/14/2015Naval Postgraduate School16 The Iraq-Kuwait Border Confrontation Three measures of the naval crisis response effect: Short Run Impact – October 10th futures profile - October 7th futures profile Medium Term Impact – October 13th futures profile - October 7th futures profile Final Adjustment – October 17th futures profile - October 7th futures profile

17. 12/14/2015Naval Postgraduate School17 The Iraq-Kuwait Border Confrontation

18. 12/14/2015Naval Postgraduate School18 The Iraq-Kuwait Border Confrontation Three measures of the naval crisis response effect: Short Term (Oct 7th profile - Oct 10th profile): – U.S. Oil Import Bills: Potential savings of $1.1B – U.S. GDP: Potential losses of $7.1B were averted – OECD GDP: $5.7BWorld GDP: $6.9B Medium Term (Oct 7th profile - Oct 13th profile): – Oil Import Bills: Potential savings of $3.5B – U.S. GDP: Potential losses of $11.1B were averted – OECD GDP: $17.9BWorld GDP: $21.5B Final Adjustment (Oct 7th profile - Oct 17th profile): – U.S. Oil Import Bills: Potential savings of $2.9B – U.S. GDP: Potential losses of $11.7B were averted – OECD GDP: $15.1BWorld GDP: $18.2B

19. 12/14/2015Naval Postgraduate School19 The Gulf Shipping Crisis Occurs well into the Iran-Iraq war Excess production led to depressed oil prices Crisis evolves over time as part of larger conflict – 9-21 Jan:Iranian offensive – 19 Jan:Iranian use of Sea Killer missiles in night attacks on Gulf Shipping – 27 Jan:Crisis response in form of U.S. announcement of stepped-up presence – 27 Jan:Immediate impact/equilibration in oil markets – 12 Feb:Medium term equilibration in oil markets

20. 12/14/2015Naval Postgraduate School20 The Gulf Shipping Crisis Two measures of the naval crisis response effect: Initial Impact – January 27th futures profile - January 26th futures profile Medium Term Impact – February 12th futures profile - January 26th futures profile A potential final adjustment (23 Feb - 26 Jan) was not calculated because it was more conjectural

21. 12/14/2015Naval Postgraduate School21

22. 12/14/2015Naval Postgraduate School22 The Gulf Shipping Crisis

23. 12/14/2015Naval Postgraduate School23 The Gulf Shipping Crisis Two measures of the naval crisis response effect: Short Term Impact (Jan 26th profile - Jan 27th profile): – U.S. Oil Import Bills: Potential savings of $0.4B – U.S. GDP: Potential losses of $5.7B were averted – OECD GDP: $6.9BWorld GDP: $8.3B Medium Term Impact (Jan 26th profile - Feb 12th profile): – Oil Import Bills: Potential savings of $0.8B – U.S. GDP: Potential losses of $11.2B were averted – OECD GDP: $16.4BWorld GDP: $23.3B OECD: Organization for Economic Development and Cooperation Oil import and GDP savings are in CB$97

24. 12/14/2015Naval Postgraduate School24 Conclusions Linkage between oil prices and naval forward engagement and crisis response has been established – oil prices decline a day or so after naval crisis response and the declines spread rapidly through the futures markets – linkage occurred in three different economic/political settings Spot price movements by themselves may seem small yet produce significant positive economic impacts when they ripple through the economy These patterns are consistent for the United States as well as the other major world economies

25. 12/14/2015Naval Postgraduate School25 Areas of Further Research: Links to Force Structure Smaller force structure may cause slower response times and a less robust response – Effect on futures prices is expected to be a larger price shock and slower reaction to naval crisis response