Oil - The indispensable resource, by Brij Khindaria

17 September 2009
Oil - The indispensable resource, by Brij Khindaria

oil, petrolieum, economy, brij khindaria

What would truly be a nightmare for our quickly globalizing world economy? Most likely, successful terrorist attacks on major Saudi oil fields that send crude oil prices through the roof. That would greatly impoverish the developing world, destabilize world trade and financial systems, and possibly trigger an economic recession. Serious, perhaps irretrievable, damage would occur to global peace, security and prosperity. Emboldened by success, terrorists might conduct more bloody attacks against innocent civilians to overthrow governments and seize political power.
This is not far-fetched. At meetings in late May 2004, OPEC confessed its inability to increase oil output sufficiently to reduce oil prices. That is bad news for jobs and living standards around the world. At the same time, America is floundering in its war against global terrorism.

Remember, oil is vital not only as an input into almost all aspects of economic life but also as a source of tax revenues. At 70%- 80%, gasoline and fuel taxes are major components of national budgets in almost all countries. Crude prices crossed $42 a barrel in May 2004. If terrorists destroyed a major Saudi oil field, crude prices could hit $80 -$100 or more.

The West would be particularly hurt. Governments would be forced to raise interest rates to control inflation. They may also be forced to reduce oil taxes to bring down gasoline and fuel prices for angry consumers. Lower tax revenues would make expensive social welfare and other public services unsustainable, greatly reducing Western quality of life. Production capacity may be restored in a year but the economic damage will take much longer to repair.

Why would destroying a major Saudi oilfield be so hurtful? Because the Saudis alone have enough surplus capacity to put more oil on the market each time prices rise too sharply. The increased supply brings prices back into a politically acceptable range of $25-$33 per barrel. Although the Saudis are sitting on 25% of world crude oil reserves, they are already pumping close to their physical limits and new capacity cannot be added quickly. The International Energy Agency and Western governments have large stockpiles for emergencies but cannot cope with prolonged shortfalls.
The US Department of Energy estimates that current global spare capacity for producing oil is at the lowest level in 30 years. Iraq is the Gulf’s second oil power after Saudi Arabia but is in so position to help.

Such concerns underlie America’s controversial attempts to establish a pro-West government in Iraq. It fears that disruption of oil supplies caused by terrorists could bring the entire world economy to its knees. A chaotic Iraq that becomes an incubator of trained terrorists scarcely bears thinking about.

Moving forward in insecurity and risk

Gulf countries, including Saudi Arabia, Kuwait, the United Arab Emirates, Iran and Iraq have about 70 percent of the world’s known oil reserves. Russian oil is simply no substitute for Saudi oil because extraction is very costly and the quality of reserves is lower. At 25 billion barrels, Russia has large reserves but Kuwait alone has twice as much.

Nor can the Caspian region come to the rescue, even if several new pipelines were built. The largest estimate for Caspian Basin reserves is about 50 billion barrels, which is equal to Kuwait’s reserves. But only about 25 billion barrels are accessible and bringing them to market will be very slow and expensive.

Iraqi oil might be the only hope because its reserves, estimated at 112 billion barrels, are easily accessible and high quality. A U.S.-friendly Iraqi regime might produce and sell oil according to Western preferences, but its installation and survival is far from certain.
Although Saudi Arabia proactively manages supplies to prevent high prices, its reasons are not altruistic. It does not want prices to be so high as to make alternative energies profitable enough to be pursued in a big way. That would kill the goose that currently lays the golden eggs for Saudis.

Meanwhile, China and India are rapidly increasing their oil consumption because of industrialization and have the dollars to pay for it. Together they are home to 2.5 billion people who would like to use energy as freely as their Western counterparts. There is so much unfilled demand that it will rise in absolute terms even if leading edge conservation technologies are put in place.

Some of that rise may be dampened by falls in rich countries, which have nuclear electricity and high technology for energy conservation. They are also becoming service rather than bricks and mortar economies. But third world demand will inevitably rise as they industrialize. They have no choice but oil since they are denied nuclear electricity because of Western fears of accidents or misuse to produce weapons grade materials. Coal-based thermal power is declining and alternatives such as solar and wind energies are still too expensive.

The indispensable resource

There are only two paths out of this gloomy, but realistic, scenario. The first is much greater energy conservation and efficiency in all spheres where oil is an input. That would help to create a better match between supply and demand. But it involves huge investments and much more aid for developing countries, which is unlikely to happen soon.

The other is a success in ending terrorism. That is a very tall order because terrorists seem to want regime change in Saudi Arabia, unchallenged power in Iraq and political influence as kingmakers in all Islamic countries. The US, Europe and most non-Islamic countries will never allow that to happen.

Success is possible if moderate Islam turns the silent majority of Islamic people against the terrorists. But that would mean turning against the fundamentalist Islamic mullahs who finance, arm, organize and command the terrorists. That is almost impossible in the near or medium terms, particularly as the fundamentalists do not hesitate to kill their Muslim opponents, as in Algeria, Morocco, Tunisia, Egypt, Indonesia and Malaysia.
Oil is the indispensable resource because everybody covets it. The terrorists want to control it to get the money needed to seize political power or to use it as an economic weapon. Those fighting terrorism prize it because it is indispensable for the prosperity of people of all nations. The US is the world’s number one oil consumer but oil from the Gulf is less important for it than for almost all other rich countries. It imports only 9 percent of needs and just one quarter of those imports come from the Gulf. The percentage shares of imports and the Gulf’s share in those imports are much higher for almost all other industrialized countries.

In fact, if America tried to enrich itself by owning and selling Iraqi oil it would fail because sudden increases in supply would cause prices to crash. But all of us will be in trouble if terrorists controlled Iraqi oil to finance training camps, buy weapons, blow up Saudi oilfields or destabilize Kuwait to capture its oil fields.
Of course, Iraqi oil must remain in Iraqi hands. But in which hands: those of messianic Islamic radicals or Iraqis wishing to join the modern world economy? That is the real question. The fates of people in all countries are tied to the answer because oil affects jobs and prosperity everywhere.

Many argue that Mr. Bush triggered much suffering through an unnecessary invasion for illegitimate reasons. Whatever the truth, we cannot turn back the clock. We have no choice but to act together to help bring peace to Iraq. Otherwise, oil may be turned into a nightmare weapon, instead of being a gateway to prosperity.

Geneva May 23, 2004