Oil prices hit fresh two-year highs on Thursday as chief UN weapons inspector Hans Blix said he would tell Baghdad it needed to submit credible evidence that it has no weapons of mass destruction, or face war.
With US crude inventories near their lowest level for more than two decades because of a strike in Venezuela, Blix's remarks reinforced fears of a major supply crunch if war cut Iraqi exports as well.
US light crude set a high of $33.98 a barrel and closed up 45 cents at $33.66. London Brent blend was up 44 cents to $31.66 a barrel after earlier hitting $31.80. Both New York and London prices were the highest since Dec 2000.
Blix and Mohamed ElBaradei, head of the International Atomic Energy Agency, are scheduled to travel to Baghdad on Sunday ahead of a key report they are to deliver to the U.N. Security Council in New York on Jan. 27.
"The message we want to bring to Baghdad is, the situation is very tense and very dangerous and everybody wants to see a verified and credible disarmament of Iraq," Blix said in Brussels, where he met European Union officials.
To avoid war, Iraq must be seen as not only cooperative but "proactive" in its cooperation, he said.
A UN spokesman said in Baghdad that UN weapons inspectors found empty chemical warheads during an inspection of a storage area in Iraq on Thursday. The spokesman did not elaborate on the significance of the find.
ElBaradei, in Moscow to meet Russian officials, said earlier: "There have been still lots of open questions, particularly in the area of chemical and biological and missile weapons ... and also some in the nuclear field."
Oil dealers said the remarks reinforced the view on oil markets that an attack could be just weeks away.
"The oil market reaction to the Blix comments shows just how nervous oil traders are," said Steve Turner, oil analyst at Commerzbank in London.
The timing of any attack remains uncertain. Blix said his planned Jan 27 report to the UN Security Council would not be the last word and it was likely that the Council would ask for a further report in February.
Referring to the report deadline, White House spokesman Ari Fleischer said: "That's an important date. Beyond that, events will dictate timetables."
Double hit
Oil dealers are worried that any loss of Iraqi exports could stretch to the limit the spare capacity of OPEC oil producers.
OPEC at an emergency meeting last Sunday raised formal output quotas by 1.5 million barrels a day, but among the 11-member cartel only Saudi Arabia and the UAE have any substantial spare capacity.
"The market's reaction to OPEC's increase shows that oil market fundamentals remain extremely tight," said Turner.
Oil stocks are tightest in the United States. The US government's Energy Information Administration said on Wednesday domestic crude inventories had fallen near critical levels.
In a weekly report, the EIA said crude stocks fell 6.4 million barrels to 272.3 million because of the scarcity of supply from strike-hit Venezuela.
Caracas normally supplies about 13 per cent of US oil imports but its exports have been severely cut by the 45-day strike aimed at forcing President Hugo Chavez from office.
The EIA said stocks were now less than 3 million barrels above a "lower operational inventory level" of 270 million barrels, about the minimum refineries need before they have to start to cutting production of gasoline and heating oil.
Despite low stocks, the US government so far has chosen not to release national emergency stocks from the US Strategic Petroleum Reserve.
Unless the Venezuelan strike ends, that means the Paris-based International Energy Agency might need to order an emergency release, including a release from US reserves, for the first time since the 1990-1991 Gulf War.
Interim IEA executive director William Ramsay told Reuters last week that the 26 industrialised nations, which make up the agency's membership would not need to wait for war to start preliminary talks on a possible release.
The issue could be discussed informally at a scheduled meeting of the IEA's governing board on Friday, called to elect a new executive director.