Oil after Iraq

If Iraq plays ball with the new inspectors, and gets a bill of health so clean that even George W. Bush is satisfied, sanctions will be lifted. If Iraq resumes its cat-and-mouse game, America and “a coalition of the willing” will depose Saddam Hussein, and the sanctions will be lifted. One way or another, and probably sooner rather than later, Iraq’s oil will start to flow to world markets in ever-increasing volumes.

If Iran’s restless young masses, America-loving and yearning to breathe free, can manage to topple the mullahs that now have the country in their grip, Western investment will flow into that nation’s capital-starved oil industry, and Iran’s oil will start to flow to world markets in ever-increasing volumes.

If Russia’s oil tycoons can agree to fund the multibillion dollar pipelines and ports that must be built if that country’s oil exports are to become more available and competitive, Russia’s oil will start to flow to world markets in ever-increasing volumes.

Substitute “when” for all of these “ifs,” and it is safe to predict a rather significant increase in the volume of crude oil entering world markets. Iraq and Iran possess almost 20 percent of the world’s proven reserves of crude oil between them, not far behind Saudi Arabia’s 25 percent. With suitable investment it wouldn’t take these countries very long to increase production by a total of some 6-10 million barrels daily, and at a cost-per-barrel not very far above the cost of extracting oil from beneath the prolific sands of Saudi Arabia.

The situation in Russia is different. Although it is currently producing almost as much oil as Saudi Arabia, it is unlikely ever to be anything like the player in oil markets that the Saudis are. It has only about one-fifth of the proven reserves on which the House of Saud sits; it needs a good part of its oil for domestic use, rather than for export; and the costs of getting Russia’s oil out of the ground and to market are much higher than they are in the Middle East. In the end, the Russians have to hope that the Saudis maintain the price umbrella that makes the Russian industry viable.

So what does all of this mean for the outlook for oil prices? So far, the Saudis have been relatively successful in keeping prices up in the $25-$30 range, helped by a “war premium” generally estimated to be somewhere around $5 per barrel. They have managed this by restraining their own production while other members of OPEC are cheating on the cartel’s 21.7 million barrel per day quota, to the tune of some 2.5 million barrels daily. Industry experts estimate that the Saudis now have about 3 million barrels per day of excess capacity.

Meanwhile, non-OPEC production is climbing so steadily that it now accounts for about twice as much oil as does the cartel. Worse still from OPEC’s point of view, it is likely that areas outside its control will continue to increase their market share.

Which brings us to the current state of relations between Saudi Arabia and the United States. To say that they are fraught is to put it mildly. Until September 11, the deal forged in 1945 between Franklin D. Roosevelt and Saudi king Abdulaziz Ibn Saud seemed likely to endure forever. The Saudis agreed to meet America’s oil needs at reasonable prices, and America agreed to support the royal family against its enemies, domestic and foreign. The Saudis pumped oil, America trained the Saudi military, stocked its arsenal, and made the Ivy League home to young royals.

Then 15 Saudis flew planes into the World Trade Center and the Pentagon, and American policymakers began to realize that the price of Saudi oil is a lot higher than the one shown on the invoices. Senators on both sides of the aisle are urging the Bush administration to bring pressure on the Saudi royal family to put a stop to the financial support it is giving to bin Laden & Co., and to muzzle the hate-preaching clerics who dominate the kingdom’s religious and educational institutions.

The Saudis have mounted a furious public relations offensive in Washington to counter charges of complicity with terrorists, and they have gotten Secretary of State Colin Powell and his men to come to their defense. But in the end what the United States does will come down to the question of oil.

In the immediate future, America needs that oil. So long as Saudi Arabia remains the world’s low-cost, swing producer, it will have a major influence on oil prices, raising them by cutting output, lowering them by turning on the taps. It can, if it chooses, force a lot of non-OPEC producers to the wall by turning on the taps and driving prices down to single digits. That would not be a costless exercise in a country that has already seen per capita incomes fall from $20,000 to $7,000 in the past two decades, and that needs lots of money to support the profligate lifestyles of its 5,000 princes and fund the benefits ladled out to its unemployed (and largely unemployable) middle classes.

Saudi Arabia also can, if it chooses, replace interrupted supplies from Iraq by making its 3 million barrels per day of excess capacity immediately available to prevent a huge, recession-causing price run-up. That gives the Saudi royals real power when they visit the Oval Office.

Which is why the president is serious about easing America’s dependence on imported oil. He has told White House economists to develop an energy policy that encourages at least a limited increase in domestic production, an expansion of the Russian and much-underfunded Mexican industries, and an increase in the efficiency with which oil is consumed in America’s cars and homes. Until they provide him with workable alternatives to the current level of dependence on the Saudis, he will have to swallow hard and keep U.S.-Saudi relations on an even keel.

This article appeared in London’s Sunday Times on December 8, 2002, and is reprinted with permission.