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Aug. 14, 2003
The Saudis' oil power over America - a house of cards, By Max Singer
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Overestimates of Arab oil power are an important and harmful influence on policy toward the Middle East. The following myths, or outdated facts, support the world's misjudgment of the power of the Persian Gulf oil producers - especially Saudi Arabia, but also Iran, Iraq, and the Gulf states.
* Most of the world's oil reserves are in the Middle East.
Wrong. That is only true of conventional oil, the stuff that flows easily. When you count "unconventional" oil, Canada has larger reserves than Saudi Arabia. There is more unconventional oil than conventional oil, and most of it is in the Western hemisphere - principally Canadian oil sands and Venezuelan heavy oil.
Technological developments over the past 10 years have reduced the cost of producing unconventional oil to below $15 a barrel, so it is being produced profitably at the price at which oil has sold for almost all of the past 30 years. Already a million barrels a day of unconventional oil are being produced, and it is just as good as the black goo pumped in the old-fashioned way.
All kinds of objections are made to the recognition of unconventional oil, partly because of the long history of disappointments with it. Some of the oil sands are much harder to exploit than others. Production requires a lot of energy. Greens will prevent some of this oil from being recovered. Even so, 30 million barrels a day of new production can be added by 2020, with costs below $15 a barrel. There is plenty of time to bring production cost down on the more difficult half or three-quarters of the total resource.
* The world can't get the increased oil supply it will need in the coming years without buying a larger share from the Persian Gulf.
Wrong. There are many potential sources of increased oil supply - in addition to unconventional oil. In 2020 the Gulf may supply even less than the 23% of the world total it provided last year.
New oil production technology - such as the use of computers to reduce finding costs and directional drilling to reduce production costs - has greatly expanded the amount of oil available outside the Gulf region. And the end of the Soviet Union started a process of opening large deposits in Russia and the Caspian Basin. As a result, much more oil will flow from West Africa, the former Soviet Union, off-shore South America, the Gulf of Mexico, and other regions than those people expected a few years ago. And the reduced cost of liquefying and shipping natural gas may reduce the demand for oil.
If there is to be enough oil in 2020 without an increase in the share coming from the Gulf, the rest of the world will have to add roughly 100-120 million barrels a day of gross new production by then (including both replacements for existing and new wells as their production falls, and programs to get more oil from old fields).
BUT THERE are probably almost 200 million barrels a day potentially available by 2020 outside the Gulf. This includes up to 40 million barrels a day in the former Soviet Union (more than half in Russia and the rest in the countries of the Caspian Basin), 40 million barrels a day of unconventional oil from Canada and Venezuela, another 45 million barrels a day from the Western hemisphere, mostly offshore, 25 million barrels a day from West Africa, and 40 million barrels a day from the rest of the world. Of course, none of these totals will be reached; the world doesn't need that much oil, and investors won't drill for more oil than is needed.
Most people have never seen such high numbers for any of these regions because ordinary projections try to match world demand to world supply and therefore limit each regional estimate to fit within the estimated worldwide demand.
None of the standard estimates of future oil supply from each region is an estimate of how much oil could be produced in that region; each is an estimate of what will be produced.
The different question asked here - What is the maximum each region could produce by 2020? - gives a sense of the options available to oil companies deciding where to drill wells and build pipelines.
Political or other problems could prevent most of these regions from reaching their maximum potential, even if enough investment were available.
Another reason these estimates may strike people as excessively high is that they do not refer to either of the familiar categories, "proven reserves" and "total resources."
Proven reserves is not relevant to projections as far ahead as 17 years because no one spends the money to prove reserves that far in the future. Total resources includes oil that will be exploited far in the future, if at all. The numbers here are based on what experienced oil people, familiar with the geological work that has been done, would estimate could be found and brought on line in the next 17 years.
Such estimates obviously could prove much too high or much too low. But since there seems to be nearly twice as much oil potentially available as will be needed, it is entirely plausible that oil companies will be able to produce what is needed. And it would take only a little more production from outside the Gulf to reduce the Gulf's share of total supply to below the 23% level of 2002 if the Gulf countries do not provide for investment to expand their capacity.
* The low production cost of Gulf oil lets the Gulf countries determine how much of world demand they supply.
Wrong. Where the world's future oil supply comes from depends on where oil companies decide to drill wells and make other investments. Since there is much more oil available in the ground than will be needed in the next few decades, investors have much choice about where to get oil.
Right now there is practically no investment being made in increasing - or even maintaining - production capacity in the Gulf region; instead, almost all drilling is being done in other parts of the world.
There are two reasons the oil industry is not investing in the Gulf. Owners, not producers, control the benefit of low production costs, so low costs in the Gulf don't necessarily give companies an incentive to invest in Gulf oil. And oil producers have strong incentives to avoid sources that are as politically vulnerable as the Gulf seems to be.
The Gulf countries could theoretically produce their oil themselves - or give the companies strong incentives. But this requires capital and/or effective decision-making, and so far only some of the smaller Gulf states are expanding their capacity. We have reason to hope that there will be improved regimes in Iraq and eventually Iran, which could very well lead to major production increases - but if Iraq and Iran are both removed from the "axis of evil" we will have even less reason to be concerned about how much of world oil supply comes from the Persian Gulf.
* The US and other consumers need Gulf oil much more than the Gulf countries need the money paid for the oil.
Wrong. Most of the Gulf countries have become very dependent on their oil income, which provides almost all their foreign currency. The oil-consuming countries get less than a quarter of their oil from the Gulf, and have stockpiles that could replace Gulf supply for six months or more.
Twenty years ago, oil gave Saudi Arabia a per-capita income of $20,000 and huge financial reserves, while the rapid growth of income made it easy for the government to afford a boycott or other temporary reduction in oil sales.
Today Saudi per-capita income is down to $6,000, the huge financial reserves have been replaced by a large national debt, and much of the country is dependent on government agencies having a regular flow of cash.
It used to be thought that if oil from other regions, or unconventional oil, threatened the dominance of the Gulf producers, the Saudis and other Gulf countries would blow away the competition by taking advantage of their low production costs to force the price down below the competitors' production costs.
Even if that were true in the past, it is not true today. No Arab regime has the stomach - or the funds - to endure very low prices for an extended time, if at all. And almost all the non-Gulf producers make a profit even if the price is as low as $15 a barrel. Many are profitable at even lower prices.
* Saudi Arabia has the power to determine how much the world has to pay for oil, and therefore the power to help or hurt Western economies.
Mostly wrong. So long as Saudi Arabia has the ability quickly to produce more oil than it is selling, it can bring down prices in periods of tight supply. But the Saudis understand that keeping prices from going too high is in their national interest as well as ours, because they would lose more than most producers if high prices chased consumers to other energy sources.
But the Saudis and other Gulf suppliers don't determine whether there is plenty of oil available for sale or whether supply is tight. On any day the world's ability to produce oil is the result of the decisions oil-producing companies took two to 10 years earlier about how much to invest in new wells and other facilities. If companies invested enough in the past, there is plenty of capacity. If investors were too cautious in the past, or if demand grew faster than expected, there is a shortage and prices are liable to rise - especially if producers can cooperate in holding back supply.
If, because investment was sufficient, worldwide production capacity is comfortably above demand (as it was a few years ago, but is not today), then producers rarely have the ability to restrict production enough to raise prices. It is too hard to prevent "cheating" on OPEC quotas. They are lucky if they can restrict supply enough to keep prices from falling.
Since there is more than enough oil in the ground (at least for the next 20 years), the amount of supply from 2006 to 2020 doesn't depend on what nature has created; it depends on how much money oil producers decide to invest. If Western oil companies invest enough, there is nothing the Gulf countries can do to make supply tight enough to sustain high prices.
The Gulf countries have the opportunity to create shortages and high prices by restricting their own sales only when there has been a prior failure by companies from the consuming countries to make the necessary investments.
THE MAIN conclusion American policymakers have been drawing from these myths - or outdated ideas -about oil is that the US had better be deferential to Saudi Arabia because it has the power to ruin our economy. The US pays more deference to the Saudis than to any other government in the world.
If any other government imposes restrictions on American diplomats in their country, the US applies the same restrictions to that country's diplomats in the US. The only exception is Saudi Arabia - which, for example, pays no price for denying American women with diplomatic passports the right to drive in the kingdom. There have been a number of recent stories about American mothers suffering as a result of US deference to Saudi Arabia when their children were kidnapped by their fathers and taken to Saudi Arabia.
The Saudis' policy toward the US is based on their perception of our fear of their oil power. That is why Crown Prince Abdullah felt free to patronize President George Bush in Crawford, Texas, less than a year after 15 Saudi citizens attacked the World Trade Center and the Pentagon; why the Saudis have felt safe enough to allow more than $50 billion of Saudi oil money to be exported to stir up hatred of the US in the past 20 years.
When the American political community realizes that the world economy is not in Saudi hands as much as the Saudi economy is in the hands of Western oil buyers, Washington can stop being afraid of the Saudis. Then the Saudi government will understand that it must respond to the US very differently from the way it has in the past.
The Saudis' belief in their oil power doesn't come from their economic analysis of the oil market but from their recognition of our fear of them, of our belief that we are vulnerable to what they can do to us. If we understand that the facts have changed, that we do not have to accept aggressive use of an "oil weapon" against us, they will not risk their fate on the basis of any calculation of the balance of oil power. They may test us, but we have the capacity to pass their test.
The rise of terrorism by militant Islam against the US and the West coincided with the rise in oil prices of 1979-80 and the subsequent transfer of hundreds of billions of dollars from the West to Muslim countries.
The perception of Muslim oil power may well be one reason why Muslims like Osama bin Laden feel that America is weak enough to be attacked and destroyed. Ending the palpable - and now unfounded - Western fear of Muslim oil power is likely to play an important role in reducing Muslim support for militant Islamists who want to attack the US.
When American politicians realize that the new facts of the oil industry destroy the basis for the traditional American awe of Saudi oil power, they will begin to use more normal standards in thinking about Saudi-American relations. To be sure, the Saudis, with or without the other Gulf or OPEC oil countries, can create short-term difficulties for the US and other oil importers; but such difficulties, springing from normal business bargaining, present a limited danger, comparable to that resulting from labor strikes. There is no reason to be afraid of this.
The old fear was that the Saudis could do worse than that. They could decide to withhold their oil, on which we had become dependent, to punish us for our foreign policy. But if the Saudis are removed from their pedestal and treated like a normal country, American leaders will ask whether a small, defenseless government, with little support from its own people and great unpopularity in the Muslim world, could really think of deliberately harming the wealthiest, most powerful country in the world.
The Saudi royal family must realize that if it deliberately attacks the American economy, not just to get more money for itself but to punish the US for its foreign policy choices, the US has many economic and political ways to make the Saudis regret such an attack, without any need to use, or threaten to use, military power.
In other words, the Saudis' power over the US is a house of cards that can be blown away by fresh thinking based on a realistic understanding of the current oil business.
The second conclusion is that there is no strategic imperative for the US to reduce its "dependency" on imported oil by reducing oil consumption.
We should make sure that world oil production capacity stays comfortably ahead of world demand for oil. We should also ensure that there are large stockpiles of oil to improve the short-term balance of supply and demand. And we need to stop feeling dependent when we are not. These measures are all feasible and have moderate costs. They do not require changing our way of life or our economy.
When we move to a more realistic understanding of oil markets, we can also move away from the current approach to oil stockpiles, which insists that they have nothing to do with influencing oil prices and exist only to meet physical shortages. The only meaningful measure of shortage is price. The point of oil storage, and storage capacity, should be to reduce potential fluctuation in prices.
Oil prices have historically moved up and down so dramatically because in the short term, buyers have no alternative to paying whatever they have to pay to get oil, and when prices are low, sellers have to sell their oil for whatever they can get for it.
But when there is a lot of stored oil it can be used to meet short-term demand and prevent the price from rising very far. And when there is a lot of empty storage capacity, it allows short-term demand to prevent prices from falling far enough to jeopardize investment in future supply. Stored oil also reduces producers' ability to blackmail consumers.
Militant Islam's attacks, culminating in 9/11, have led to a new fluidity in the politics of the Middle East. These days are the crucible in which the future Middle East is being shaped.
It has become apparent that Saudi oil money has been one of the decisive reasons for the rise of militant Islam throughout the world. To examine our own policy freshly we need to shake off the myths about Saudi oil power.
The writer is a senior fellow at the Hudson Institute and the author (with Aaron Wildavsky) of The REAL World Order: Zones of Peace/Zones of Turmoil.
Paul Michael Wihbey, president of GWEST Inc., made a major contribution to this article.
(Weekly Standard)
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