Oil and Iraq

Louis Proyect lnp3 at panix.com
Fri Sep 20 07:48:05 MDT 2002

 From Saddam Hussein's letter to the United Nations:

"The U.S. administration wants to destroy Iraq in order to control the
Middle East oil, and consequently control the politics as well as the oil
and economic policies of the whole world. If it succeeded in that, God
forbid, it would dictate on you what each country needs for its economic
development, what quantities of oil it is allowed to buy, and at what
prices, along with other conditions. . . . "

full: http://www.nytimes.com/2002/09/20/international/middleeast/20ITEX.html


The Economist, September 14, 2002 U.S. Edition

Don't mention the O-word - Iraq's oil

AMERICA'S chief interest in going after Iraq's president, Saddam Hussein,
is doubtless to save the world from his actual or potential weapons of mass
destruction. Another large consideration, secondary as it may be, has
attracted less attention than it should have: the effects that would follow
from the opening up of the country's enormous reserves of oil.

Iraq's reserves are the second-biggest in the world, after Saudi Arabia's
(see table on next page). At present, thanks to UN sanctions and Mr
Hussein's attempts to evade them, the country is producing a fraction of
its potential. If it were to produce oil at a rate to match its reserves,
say some geopolitical strategists, it could end Saudi Arabia's domination
of world oil markets. That would not come too soon for the United States.
America is by far the world's biggest oil-user, burning up a quarter of the
total consumed. Its imports have risen in recent years, to more than half
its total consumption. Since Saudi Arabia is the chief supplier of those
imports, successive American presidents have gone to great lengths to
cultivate the unsavoury and dictatorial House of Saud. They have also
tolerated Saudi Arabia's command of the Organisation of Petroleum Exporting
Countries (OPEC), which keeps oil prices much higher than they would be if
market forces prevailed. Now America's leaders increasingly feel--as
Winston Churchill remarked of converting the British fleet from coal to
petroleum before the first world war--that "safety and certainty in oil lie
in variety, and variety alone."

In hopes of finding such variety, George Bush is now changing American
policy. He has openly embraced Vladimir Putin's goal of expanding Russia's
oil industry, with talk of increased exports and a big ministerial
conference on energy planned for Houston in October. Another opportunity,
openly acknowledged or not, is the present showdown with Iraq. Rumours of
war are likely to dominate the meeting of OPEC ministers on September 19th
in Osaka, in Japan. The fear premium

Conventional wisdom says war drums are good news for OPEC and the Saudis
today, but bad news in the longer term. Talk of war always heats up the oil
price, giving producers an instant windfall. Yet tomorrow, if America
succeeds in toppling the bully-boy of Baghdad, the world could be awash in
Iraqi oil. Look closer, and matters are more complicated.

In the short term, jittery traders are already handing oil producers a
handsome windfall profit. Last week, on ill-founded rumours of a huge air
strike by American and British planes in western Iraq, prices shot to their
highest level in a year, passing $30 a barrel for West Texas Intermediate,
America's benchmark crude. Daniel Yergin, head of Cambridge Energy Research
Associates (CERA), an industry consultancy, estimates that the "fear
premium" on each barrel of oil is now $3-5.

As war gets closer, prices seem bound to go higher. During the Gulf war, a
decade ago, prices spiked past $40 a barrel in nominal terms. Phillip Ellis
of the Boston Consulting Group, who has analysed the history of oil shocks
and their impact on prices, argues that prices fall into two ranges. The
peace curve, as he calls it, "forms around an average of about $22-24 in
today's money. The war curve forms around a price north of $50."

Some would put it higher. Sheikh Zaki Yamani, Saudi Arabia's oil minister
during the shocks of the 1970s, gave warning last week that if America
invades Iraq, Mr Hussein could attack Saudi Arabia and Kuwait and so send
oil prices to $100 a barrel. Iraq's vice-president, Taha Yassin Ramadan,
stirred the pot further this week by goading fellow Arabs to strike
American targets in the Middle East if Iraq is attacked.

High prices are clearly a nightmare for consumers. Paradoxically, and here
is where the complications begin, they are bad news for producers, too.
Prices much above Mr Ellis's "normal" range act as a brake on economic
growth. There are signs of this happening already, especially in Asia. Some
economists worry about an oil-induced global downturn. As the earlier oil
shocks have taught OPEC, prolonged periods of high prices only kill the
goose that lays the golden egg.

Another reason why sky-high prices are bad for OPEC, and especially for
Saudi Arabia, is that they spur oil production from uneconomic places. In a
genuinely free market, most of the world's oil would be produced by Saudi
Arabia and its neighbours, where the cost of exploration and production is
a dollar or two a barrel. In contrast, trying to force drills through rocks
in the Arctic or beneath deep water can heap up costs to $10-12 a barrel.
Getting round the Saudis

Because OPEC's "price-defence" strategy has kept prices above $18 a barrel
for three years, argues the Petroleum Finance Company (PFC), an industry
consultancy, projects in non-OPEC regions--the frozen wilds of Russia, the
turbulent Caspian basin, the deep waters of the Gulf of Mexico--have
attracted many billions of dollars in investment. High prices have already
inspired the development of 2.6m barrels per day (bpd) of non-cartel oil,
besides investment in projects that promise to deliver another 5.2m bpd
from alternative sources by 2008. This new supply, says the PFC, "has and
will continue to eat up all the increase in global demand, leaving OPEC no
room to expand its own output and making the cartel's price-defence
strategy increasingly difficult to maintain."

However, the pain is not equally shared among cartel members. It is felt
mostly by Saudi Arabia, the self-appointed "swing" producer. That is
because higher prices have also encouraged some of the smaller fry in the
cartel, such as Nigeria, Algeria and Libya, to develop new production
capacity and to bypass existing production quotas set by OPEC. John
Mitchell, an energy analyst at Britain's Royal Institute of International
Affairs, offers a more fundamental reason to suppose that the cartel's
"aggressive collusion" will not endure: the ratio of production to reserves
varies greatly among cartel members, and so the incentive to increase
output rather than keep it flat also varies greatly.

The result, according to estimates by Deutsche Bank, is that new supply
could outstrip expected demand by as much as 1m barrels a day by 2004. The
only country that has historically been willing to reduce its own
output--and revenue--by such a large volume to "balance" the market and
prevent a price collapse is Saudi Arabia.

All this explains why Saudi Arabia has long advocated a moderate stance on
prices. Yet when ministers meet in Osaka next week, they face a dilemma.
Thanks to fears about war with Iraq, prices are high and the markets are
anxious. Winter is on the way, and with it a seasonal upturn in demand for
oil. On September 11th the International Energy Agency (IEA), a
quasi-governmental watchdog set up by the world's biggest oil consumers,
said that stocks of crude were "uncomfortably low" going into the winter,
and the whole situation "every bit as precarious" as in 1999, before a
notably volatile spell for oil prices.

This being so, the Saudis might argue at Osaka for a modest increase in
quotas. On the other hand, as Venezuela and Iran point out, the greatest
risk facing the cartel is not high prices but a price collapse. That could
happen if OPEC releases oil into a weakening global economy. It did
precisely that in the run-up to the Asian economic crisis a few years ago,
and oil prices fell to around $10 a barrel.

Even if Saudi Arabia somehow smooths over the meeting in Osaka, some argue,
the longer-term picture for the cartel is bleak. The expulsion of Mr
Hussein, which looks likelier than not, could turn the oil market upside
down. This is because Iraq, with its vast reserves, is the only country
that could challenge the Saudis by throwing open the taps.

If a post-Saddam regime did that, Saudi Arabia's strategy of keeping OPEC
prices between $22 and $28 a barrel would be under threat. If the flood of
Iraqi oil continued indefinitely, goes the argument, the Saudis would have
no choice but to abandon price (and, with it, their allies in OPEC with
higher costs and smaller reserves) and go for volume instead. Though
politically difficult, that need not be economic folly: Deutsche Bank
calculates that Saudi Arabia could maintain oil revenues at $60 billion or
so either by producing 6m bpd at around $30 a barrel, or by cranking out
10m bpd at about $17 a barrel.

Will the flood of Iraqi oil occur? It is possible. Any future government in
Iraq, needing vast amounts of money to rebuild the country, will try to
expand the oil sector as fast as it can. At least some oil executives
believe that this bonanza could draw much foreign capital into Iraqi oil
production. Even if the new government did not break ties with OPEC, as the
United States might like, it would probably argue--bearing in mind the
years of UN supervision of its oil exports--for a lengthy exemption from
quotas. OPEC, RIP?

It might seem, then, that knocking out Mr Hussein would kill two birds with
one stone: a dangerous dictator would be gone, and with him would go the
cartel that for years has manipulated prices, engineered embargoes and
otherwise harmed consumers. Yet several factors suggest that the transition
to a post-Saddam oil world will be messy--and that such a world could still
have a forceful OPEC in it.

Consider again Sheikh Yamani's fear: that Mr Hussein, in a desperate last
act, may attack the Saudi and Kuwaiti oil infrastructure and bring the
global economy to a halt. The oilfields could be set ablaze, as they were
during the Gulf war. Refineries and terminals could be contaminated with
radioactive or biological agents. With help from outsiders, Mr Hussein
might be able to shut down shipping lanes such as those in the Straits of
Hormuz, preventing Saudi Arabia from getting its oil to market.

On balance, though, the risks of a prolonged physical disruption seem
small. One senior European oilman insists that it would be very difficult
to engineer a complete shutdown of all Middle Eastern oil: "That's a bit
like thinking you could shut down all North Sea production by firing SCUD
missiles from Germany." CERA's Mr Yergin says it is difficult to target all
the oilfields, pipelines and export terminals that matter in the area.
Saudi Arabia has plenty of spare capacity and transport options for its
oil; besides, pipelines are pretty quickly patched up.

The world also holds emergency stocks of oil much bigger than those it held
back in the 1970s. These should not inspire complacency; as the chart on
the previous page shows, they cover only a few weeks of disruption, and a
prolonged war could still mean disaster. Yet the world at least has the
IEA, monitoring oil markets and emergency stocks and engaging OPEC in
"consumer-producer dialogues" (another one will take place in Osaka next
week) to encourage stable prices. If oil supplies are suddenly threatened,
as Robert Priddle, the IEA's boss, explains, governments have even given
him the extraordinary power to release oil stocks unilaterally.

Fears of a physical disruption to supply are therefore overblown. More
worrying, however, is the possibility that Saudi Arabia will decide it does
not want to get extra oil to market. Historically, the Saudis have always
acted as the market's guarantor of last resort. During the Iran-Iraq war,
for example, they stepped into the breach and increased output to smooth
prices. As they intentionally keep a whopping 3m bpd or so of spare
capacity to hand, their country alone can easily compensate for the loss of
Iraq's current output.

But the Saudis do not like the way the Bush administration is setting about
Iraq. The regime also faces great anger on the "street" for its cosiness
with the American government. Add to that the Saud dynasty's precarious
grip on power, and the ruling family might find it politically impossible
to crank up production to help the Americans. The result could be chaos in
the world markets, and OPEC left firmly in control.

Another reason to doubt that an invasion would kill off OPEC is the state
of Iraq's oil infrastructure. Thanks to a dozen years of UN sanctions, and
many more years of mismanagement and over-exploitation, the country's
petroleum industry is in pitiful shape. Even in its best times, the country
produced only 3m-3.5m bpd: a third of Saudi Arabia's peak and half of
Russia's. As one American oil executive says, "Under the very best
scenario, Iraq might manage that peak again." To do better, the country
would need massive investment from the world oil industry. Expect no miracles

That, says the same senior oilman, will be slow in coming until companies
are sure that the new regime will be stable and will respect the rule of
law. Realistically, experts say, it will take Iraq perhaps five years of
hard work, western know-how and big money to turn its oil industry into a
serious force again. CERA puts it bluntly: Iraqi output can only increase
from today's low levels, but that does not mean "a massive, rapid increase
in production that will depress prices, displace other Gulf producers and
render OPEC impotent."

In short, a "regime change" of the sort that Mr Bush has in mind for Iraq
might rewrite all the rules of the oil game--on paper. The president's new
friendship with Mr Putin also heralds an important change in the
geopolitics of energy. In practice, however, the second Bush to take on Mr
Hussein will probably be long gone from the White House before the oil
markets are transformed by Iraqi oil. Don't write off Saudi Arabia, or
OPEC, just yet.

Louis Proyect

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