- In the 2002-early 2003 run-up to the US invasion of Iraq
speculation ranged widely about US motives for attacking that country.
Weapons of mass destruction, a Saddam alliance with al Qaida, Iraqi involvement
in 9-11, and Iraqi support for terrorism were all advanced as reasons for
unseating Saddam Hussein. But on the Internet from the beginning the leading
suspect was oil. Apparently before he was fully in the loop on Bush team
and neocon plans for Iraq, Secretary of State Colin Powell responded to
the suspicions about oil by stating that Iraq's oil belonged to the Iraqi
people. Since the invasion refurbishing Iraq's oil industry has been turned
over to major US companies, and where that may lead is a question of great
concern to Iraqis. How much difference Iraq will make to American oil needs
is an even more difficult question.
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- What Are The Leading Issues?
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- The leading issues for Iraq's oil future center on how
substantial are Iraq, s oil resources (potential oil) and active oil reserves
(known developed oil), and on what role those reserves can play in world
oil exports, versus the constrained and harassed position Iraq has occupied
since the first Gulf War. An interesting additional question is just how
that role, with the US directly involved in production and exports, would
differ from the one a self-governing Iraq would play in the world oil market.
The answers will be provided, at least suggestively, by the degree of
sovereignty the designated Oil Minister Thamir Ghadbhan and his ministry
will be able to exercise over oil industry decisions in the coming months.
The industry has now been returned to the new Iraqi Government, at least
symbolically. How well Iraq will be able to reassert its role in OPEC will
provide some of the answers.
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- How Did OPEC Come About?
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- Before 1960, with the exception of the Soviet Union,
world oil discovery, drilling, production and distribution were in the
hands of large international companies, mainly American, British, French,
and Italian. Prices for crude oil were quoted ex-Caribbean, at the gateway
to the largest oil consuming market, the United States. In 1960, however,
the Arab producers and the Venezuelans, whose countries contain most of
the world's developed oil reserves, got together in an effort to take national
control of their petroleum assets. Their solution was to form the organization
now called OPEC, the Organization of Petroleum Exporting Countries. At
the time western observers thought OPEC was not important. However, the
founding of OPEC actually heralded the end of a colonial chapter in the
Middle East.
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- Apparently only one of the founding fathers of OPEC is
still living. He is Adnan Pachachi of Iraq, now the senior statesman in
the Coalition Provisional Authority who just declined the offer to become
President of Iraq.
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- What Were OPEC Goals?
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- The overall goal of OPEC members was to take over ownership
of their oil industries. But their first objective was to gain control
over oil prices and the distribution of profits. It took OPEC about a decade
to get off the ground, and even a bit longer to have real impact, but in
the early 1970s it began to assert itself. A succession of OPEC moves brought
OPEC country shares (the tax) to 55% of the crude oil price in the early
70s and sent crude prices toward a spike of $38 a barrel in 1978. Prices
gradually drifted down from that peak to around $27 a barrel for Saudi
Light in 1985, when supply manipulations by the Saudis caused prices to
plummet to around $12 a barrel and lower, and prices since have fluctuated
widely, going as low as $10 in the late 1990s, rising toward $30 per barrel
in the reactions to the invasion of Iraq, and most recently going above
$40 per barrel in reaction to chaos in Iraq and terrorism in Saudi Arabia.
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- What Was Changed?
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- The entry of OPEC and the progressive nationalization
of their individual country oil operations by OPEC member countries did
not really change the international side of the oil business. It still
remains in the hands of the major companies, the so-called "Seven
Sisters. They were pushed out of their ownership positions in the national
companies but retained control of the international business while themselves
undergoing national and international reconfiguration. The international
companies also became contractors to the new national oil companies because
they had the relevant technologies and skills. But the big change was that
OPEC members gained a major role in decisions respecting the quantities
and the prices of their oil exports.
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- What Is OPEC's Present Goal?
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- Over the past several decades, literally since the Oil
Shock of the early 1970s, OPEC and others sometimes allied with it have
experimented repeatedly with answers to a simple question: Just what will
the traffic bear? The answers to this question are crucial. It is important
nationally for oil producers to satisfy their people that they are getting
the best price for their national asset. But the answer most sought goes
well beyond mere fairness: How aggressively can oil exporter countries
raise the price, how much income can be transferred from buyer countries
to seller countries without starting a war or at least provoking a diplomatic
or financial crisis?
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- The same questions apply to the international companies
who rule world oil trade. The answers are not fixed, because tolerance
varies with economic conditions in oil consuming countries, those conditions
fluctuate separately and not necessarily in the same directions from place
to place and, of course, the speed with which supply changes occur is always
a factor. Price speculation in OPEC, oil company, financial, and share
market circles only add to the uncertainty.
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- What Leverage Does OPEC Have?
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- In supply terms, OPEC members have most of the proven
oil reserves outside oil importing countries. As domestic shares in oil
consumption decline in the importer countries, OPEC leverage increases.
The 95% dependence of the United States on oil for transportation is probably
OPEC's most powerful weapon, because it is the least elastic area of our
need, while US oil imports are about a quarter of world import demand.
Thus OPEC oil export price decisions get immediate attention because they
show up quickly in market behavior.
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- What Do We Want?
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- Our long-term goal remains stable supplies and prices.
The decline in US domestic oil production since the late 1970s and growing
total demand for oil, both for transportation and industrial uses, mean
we must look more and more to imports. We want clean air, but not enough
to adopt rigorous standards. We are not as a society of one mind on the
causes and consequences of global warming, and to now, perhaps because
it suits our convenience, we have given the oil industry and vehicle makers
the benefit of the doubt.
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- How to keep the United States, with persistent and foreseeable
heavy demand for imported oil, out of the oil exporter crosshairs is a
major item in the national agenda. Every President of the United States
and every leader of an oil importing country must attend to the day-to-day
answers to this question. Oil alone represents more than one percent of
US national product; the oil import account is the largest in US foreign
trade; and it is a far bigger matter than that in our lifestyles.
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- How Will Iraq Figure In This?
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- Putting US companies in charge of the Iraqi oil industry
sounds very reassuring. But international companies, American or others,
are just that, and the temptation of US companies if they run the Iraqi
industry to take a lesson from OPEC will be irresistible. In the Iraqi
case this could mean that at least alongside the Iraqi government, foreign-based
American and other international companies will be playing the game of
how much income can be transferred or can be kept abroad in their coffers.
In supply terms Iraq is now exporting about 2.5 million barrels per day,
and the pre-invasion peak was 3 million barrels a day. Greater output
appears unlikely in the near term, and significant expansion is likely
to require heavy investment in oilfield development. One optimistic forecast
suggests Iraqi output could double by 2020.
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- What Is The Outlook?
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- "How much profit can we take without upsetting the
market is the critical question asked by OPEC, and unless the players allow
the market to descend into chaos, there will be only one set of prices
for all the oil that moves in international trade. Thus American consumers
stand to lose the same amount, that is pay the same overhead in income
transfers abroad, no matter whether the exporter to us is a foreign government,
or an American/international company operating abroad, or a cartel in which
those two groups of players are working together.
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- But there are strong indications that the international
oil outlook is worse than consumers generally suspect. There are differences
of opinion among industry experts, but the most sober opinions emerged
recently from the group called the Association for the Study of Peak Oil
now meeting in Berlin. This group includes at least one OPEC member, an
international company rep, geologists, academics and others who know their
subject all too well. Their view is that global oil production is about
to peak. When it does an inescapable pattern of shrinking supplies and
rising prices will begin. Their blunt message is we face the end of what
we know as cheap oil. In that case the threat of terrorism will pale by
comparison with the impact of shrinking oil supplies and rising costs that
will threaten our country's future, and the next President of the United
States had better look to America's defenses in this crucial area of vulnerability.
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- Is OPEC Really In Charge?
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- Whether OPEC is in charge actually depends on whether
OPEC members are working together or are operating separately as Saudi
Arabia did in the early 1980s, at one stage driving the posted price of
oil below $10. In that game, however, a major problem for OPEC, as for
any organization that attempts to manipulate a large and complex commodity
market, is knowing just when and for how long to pursue a strategy. If
prices go too high, the customers complain, even go to war, and begin to
look for alternatives both habitual and material, while exporters may break
ranks and increase exports to take advantage of the windfall. If prices
go too low, the members of OPEC must act as a group to reduce exports,
because they are losing money, but then so are all other exporters and
producers.
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- What About Energy Alternatives?
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- Up to now, change, as we have seen, has not occurred
quickly in this realm. The urgency of the search for energy alternatives
obviously grows when prices are high. Even so, there is a sizeable American
public interest in energy alternatives for both economic and ecological
reasons. However, the pace of searches by consumers for alternative remedies
slows when prices decline. As a matter of public policy higher average
fuel prices would force feed the search for alternatives and, based on
experience, would achieve permanent changes in energy use. These tendencies
represent a potentially powerful market mechanism for reducing oil dependencies,
as well as greenhouse gases, but politicians have to have strong stomachs
to force their application so long as oil remains available at tolerable
prices.
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- Who Can Manipulate The Market?
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- With the reserves of Iraq more fully developed and able
to come on stream on fairly short notice, US companies and/or the Iraqis
could challenge other OPEC exporters for the lead price setting role.
With some excess productive capacity they could also challenge Saudi Arabia
in the last resort supplier role. However, non-traditional OPEC players
have entered the game; in one instance both Norway and Mexico added their
reserves to OPEC's bargaining strength. Others can do that, including
the Russians, if they so choose. The main challenge device, increase exports
and cause prices to fall, appears an option with limited appeal.
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- The appeal of the overall situation is that any gains
OPEC makes in the level of international oil prices benefits all other
oil exporters. Thus if the US companies in Iraq try to go off on their
own they may suddenly discover they are something of a spoiler but lack
sufficient clout to thwart OPEC with interested third parties in the play.
This situation would only be a somewhat larger version of what has happened
to OPEC before, i.e., members behaving independently frustrate OPEC price
manipulation gambits or destabilize markets and cause prices to fall by
offering excessive crude to the market. OPEC performs most effectively
for its members when they work together and especially when OPEC goals
coincide with those of other exporter countries. To be optimally involved
in this play, therefore, US companies would have to join OPEC in the role
of Iraq. What an ironic outcome!
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- The OPEC Price Band
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- Struggling with the problem of how to maintain their
oil income streams while (a) keeping the members together on production
and (b) still not driving the importer countries up the wall, OPEC established
a price band mechanism on January 1, 1987. Under this arrangement, the
prices of a basket of crude oils from seven different sources are used
to police world export crude oil prices within a band between $22 and $28
per barrel. If the price of the basket of crude oils falls below $22 a
barrel for 20 consecutive trading days, OPEC is supposed to reduce output/exports
by 500,000 barrels per day, and if that does not bring average prices back
within the band, output/exports would be cut another 500,000 barrels per
day and so on. Conversely, if prices rise above $28 per barrel for 20
consecutive trading days, OPEC is supposed to increase output/exports by
500,000 barrels per day, and so on. However, the basket price went above
$28 per barrel on December 2, 2003 and the basket price remained above
$28 per barrel up through the recent climb above $40.
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- If the Peak Oil group is right in its projections, prices
may be soft for a little while at or below $40 per barrel. However, prices
are most likely to rise, and one estimate places possible increases at
a multiple of present prices. The prospect for oil exporters is that they
will get more for less but still face long term shrinking income. The prospect
for consumers is that they will pay more, potentially a great deal more,
for less while facing growing scarcity in total supply. There is a real
question right now as to whether the combination of demand growth in main
user markets and supply uncertainty due to conflict conditions in the Persian
Gulf as well as Venezuela leave OPEC any room to maneuver. So the opening
knell of future oil scarcity is already tolling.
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- Who Benefits From The Game?
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- On its face the idea of managing oil prices within a
range of acceptable fluctuation sounds like a good world market management
tool. People everywhere adjust, one way or another, to stable prices. However,
while it does have a supply stabilization effect, this mechanism is not
being run for the common good of consumers. It is designed to protect
the earnings of the exporters and the international companies. That this
is surely so is reflected in the relationship of the price levels in the
price band basket ($22-$28 per barrel) as compared to average worldwide
crude oil production which is profitable at or below $10 per barrel. For
Iraqi crude, the production cost was about $1.50 per barrel before the
US invasion. Thus the export of crude oil at any price within the price-band
provides substantial windfall profits to the exporter countries. At the
same time, since US oil product prices are pegged to the costs of imported
crude oil"currently about 55% of demand and rising"domestic producers
and refiners receive a significant windfall on their domestic product.
Consumers worldwide pay the price for this neat arrangement without ever
knowing it exists.
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- Who Is Being Had?
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- It is argued that the price band is essential to assuring
that producer exporter countries continue to keep the oil flowing. In
fact it is possible only when OPEC members work together as a monopoly.
Certainly a rate of return that is two to three times the average cost
of production represents a substantial incentive. On the other hand, however,
if the windfalls were not allowed, and profits were merely fair, what would
the exporters do? Keep the oil? Not likely. Seen in this light, we are
all involuntary contributors to sizeable year-to-year windfall profit taking
by the exporter countries and by our own suppliers in the oil industry,
since our suppliers quite sensibly benchmark the price of their product
on the landed price of imports.
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- Being sad sacks we consumers just drive up to the pump
and pay whatever it says, or we pay the price of truck and air transport
on most everything we buy. We therefore make all of the oil pricing and
profit taking possible, because we do not examine the business in any critical
way. Nor do we make any demands of the industry other than keep it coming
at affordable prices. We specifically do not run far enough in front of
the problem, or have not so far, to reduce our oil needs or restructure
our energy use.
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- But we are not being had as much as some. There are
two main reasons we do not change our habits. One is oil product prices
in the US are lower than in virtually any other oil importing country.
That is because taxes, both federal and state, are lower. Our price for
a gallon of regular gas today is nationally averaged at less than $2.50.
In Britain it is more than $5.00. The second reason is that as a share
of individual income gasoline prices in the US today are lower in real
terms than they were 20 years ago. In a rising oil price situation that
gasoline pump price advantage will evaporate.
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- What Next?
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- Things have to change, because it is no idle threat that
we are running out of oil. In about 1956 an oil geophysicist for Shell
Oil, King Hubbert, predicted US production would peak in 1970 after which
our actual output would decline. It was a bit delayed, but US oil production
has peaked, output has declined, and increases in demand result in increases
in imports. Moreover, expert estimates suggest that potential output from
exploitable sources under US control will at best slow the rate of decline
in US output. It is ironic that new US fields could be enormously profitable
to the exploiters, but are unlikely to change the US dependence on imported
oil or to deflect the rise in prices consumers will pay for it.
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- Now What About Iraq?
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- Where does Iraq fit in this international oil picture?
The answer does not depend on who owns Iraqi oil. It depends on what role
Iraqi oil can play in world supply and for how long. As noted earlier,
Iraqi oil reserves are now thought to be second only to Saudi Arabia, and
since three-quarters of Iraq, s expansive sand trap remains unexplored
or at least under-explored, there may be more. As it is drawn down by
anticipated consumption, however, world oil output is expected to peak
by about 2020. Some say the peak is approaching now. That gives us poor
consumers maybe another 16 years to enjoy declining supplies and rising
prices while some of us cling to our oversize, overpowered SUVs and pickups.
But the point is there is truly a decline in sight, and we had better get
with the task of finding/developing alternative energy sources, not tomorrow
or next day, but now.
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- Isn't It Time To Shed Illusions?
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- Iraq is a factor in any US strategy for exiting virtual
complete dependence on oil for transportation and for shifting to alternative
energy systems. But the Iraqi role is not decisive. Actually, as we have
seen in recent sabotage of both northern and southern export facilities,
Iraq has more impact on oil supplies and prices as an unstable conflict
zone than it is likely to have as a stable oil producer. But any notion
that control of Iraqi oil promises long term satisfaction of US energy
needs is an illusion. And the notion that US control of Iraqi oil versus
Iraqi control of its own oil makes any real difference in American supply
or pump price prospects is also an illusion. That prices may come down
again is certainly an illusion.
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- It is not an illusion, however, that the supply situation
is getting worse and it is not going to get better. Nor is it an illusion
that global warming is approaching critical dimensions mainly due to US
and other country energy consumption habits. The planet itself is crying
"Enough! The final illusion is a hope that this prospect would be
significantly altered by drilling for oil, and even finding it, in environmentally
fragile areas of our national parks.
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- What Is The Bottom Line?
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- The big picture is clear enough. Either we get with
the task of developing alternative energy sources, many of which are already
known to us, or we prepare our country for long-term and possibly sudden
increases in energy costs that will bring on severe economic decline. There
is no ducking the costs of the needed changes in energy systems. It is
simply true that we can bear those costs most easily while our economy
is growing. The costs will be most burdensome if we wait until the economy
is in decline. The cumulative damage of delays to our environment may
or may not be reversible.
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- Here then is our simple set of equations: We begin paying
now for the technologies needed to move us into alternative energy sources,
and we pay that as a tax on what it costs us now for oil-based energy.
Let's say we pay a modest 5 cents a gallon, meaning between .75 and 1.00
per tank of gasoline into a dedicated fund for alternative energy development.
Last month US refiners were producing and selling about 9 million barrels
of gasoline per day. That is about 380 million gallons, and the tax revenue
would be $19 million per day. Multiply that by 365 days a year and you
have raised about $7.0 billion in alternative energy development funding.
You could double that if you add airline and truck fuels. As some experts
are now proposing the actual tax could and possibly should be four or five
times the suggested amount, but this way we would amortize new systems
development, not without pain, but with bearable pain.
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- On the other hand, we can continue to pay the rising
costs of oil and make no investment in our energy future. That may be
bearable, even fun along the way, but we will pay higher prices for shrinking
supplies of fuel along with a high price in economic stagnation or failure.
The countries that actually work to solve the alternative energy problems
will take over from us. We may alter the curve a little by taking pre-emptive
military action, but we will make many enemies while using much of our
energy to get and keep supplies of energy. Remember, as only 4.5 % of the
world's people our country needs friends much more than enemies to succeed
in this world. Iraqi oil may influence the timing a little bit, but Iraqi
oil will not change the outcome. We must do it ourselves by changing our
habits, and the handwriting is already appearing on the wall.
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- The writer is a retired Senior Foreign Service Officer
of the US Department of State. He was petroleum industry reporting officer
in Cairo, Egypt when OPEC was formed. He will welcome comments at wecanstopit@charter.net
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