Leonardo Maugeri. Foreign Affairs. Volume 82, Issue 4. July/August 2003.
Since oil became vital to industrial societies, it has been the subject of mythmaking. This is not surprising since the control and pricing of energy is an emotionally charged issue that lends itself to conspiracy theories and distorted interpretations of past events. Conspiracy theorists are once again active, spurred on by the conflict in oil-rich Iraq. They see multinational oil corporations working with the U.S. government to dominate the supply, distribution, and cost of oil. To them, the ultimate goal lurking behind major international crises, such as Iraq, is access to oil. But the relationship between oil and politics is not so simple. Neither oil scarcity nor energy security—the twin concepts that underpin much thinking about this issue even in some official circles—is a sound starting point for thinking about oil policy. Getting beyond such notions, however, requires an examination of the myths and the realities of oil.
The Golden Age
In World War II, oil played an important international role, proving essential to the conduct of mechanized warfare. That experience, coupled with the Soviet threat, prompted U.S. policymakers and their British and French counterparts to choose oil over coal to fuel the rapid reconstruction of Europe’s industries and societies. But this daunting task and growing U.S. demand required fresh sources of oil. Whereas before the war the United States had been able to supply 90 percent of Europe’s then modest oil needs, by 1948 the country had become for the first time a net importer of oil. Thus attention focused on the Middle East, which alone possessed the huge oil resources needed to serve as Europe’s oil tanker and as America’s supplier of last resort.
The region, however, was wrenched by Arab nationalism, anticolonialism, and the emerging Israeli-Palestinian conflict, and the resulting political instability provided fertile ground for the expansion of Soviet influence. In response, the Truman administration devised a multistage strategy, whose rationale was eventually codified in National Security Council Resolution 138/1, to secure oil resources for the Western world. The initiative turned out to be a great success.
Between 1948 and 1972, world oil consumption grew fivefold, ushering in the golden age of oil. Given its higher initial level of demand, North America’s consumption only tripled, but elsewhere oil demand increased by as much as 11 times. This range yielded an average compound growth rate of 11 percent per year, or a doubling of oil consumption every six and a half years. Oil changed everyday life and work in the developed world by spurring mass motorization, broader access to electricity, and the spread of synthetic materials. Above all, oil fueled the greatest economic leap forward by any group of countries in modern history.
This extraordinary phase in economic development depended on the flow of cheap and abundant energy from the Middle East. In the region, oil production cost 20 cents per barrel, as opposed to 80 cents in Venezuela and 90 cents in Texas. Middle Eastern oil therefore flooded the world right through the 1960s, with brief interruptions from 1951 to 1953 due to the expropriation of Iran’s British-owned oil industry and again in 1956 due to Egypt’s nationalization of the Suez Canal Company.
Ample Middle East oil supplies drove down prices, thereby swelling consumption and increasing Western dependence. By the early 1970s, U.S. producers pumped without restrictions to fulfill growing demand. All upkeep of U.S. reserves was ignored, thus leading the United States to lose any spare oil capacity. The West’s heavy consumption and loose security policy progressively transferred power to Middle East countries, which wielded oil to achieve political ends. The 1973 embargo was a rude shock to the Western system, with oil prices rising fourfold, from $2.90 per barrel to $11.65 at the end of the year.
Retrospectively, it became clear that many U.S. decisions had actually endangered the interests of oil multinationals and incited Arab upheavals against Western interests. In 1959, for example, President Dwight Eisenhower limited foreign oil imports to aid small and medium-sized U.S. oil producers, whose production costs were higher than those of the multinationals operating in the Middle East. Deprived of the U.S. market, the multinationals had to contend with surplus production by lowering prices and, in turn, sending less revenue to the producing countries. Those countries reacted in 1960 by forming the Organization of Petroleum Exporting Countries (OPEC), thereby inaugurating a new era of struggle that increasingly weakened the multinationals’ position in the Middle East. Their influence was further undermined by growing White House support for Israel after the Six-Day War in 1967—a policy that also isolated Saudi Arabia, America’s main oil ally within the Arab world, and drove it to unsheath the oil weapon during the 1973 Yom Kippur war for fear of becoming a target of Arab radicalism. Moreover, the United States’ support of Iran’s aggressive oil pricing (meant to enhance the shah’s military prowess in the Persian Gulf) continued to erode the multinationals’ power, as did Iran’s competition with Libya to extract more favorable conditions from them. Finally, their Middle East oil concessions were completely nationalized by the producing countries between 1974 and 1975.
Meanwhile, once-low prices were now high, leading to public outrage and widespread suspicion in the United States that giant oil companies secretly plotted the 1973 oil shock in alliance with Arab countries. A U.S. Senate investigation was marked by efforts to link multinationals to U.S. policies that had left the nation overly dependent on Middle Eastern oil. Despite such speculation, the final Senate report debunked the perceived influence of oil multinationals on U.S. foreign policy. If anything, the reverse turned out to be true: in the early aftermath of World War II, the U.S. government had encouraged the multinationals to develop Middle East oil under its umbrella, only to later take up policies that injured their interests.
Still, indulgent Western habits and contradictory policies did not alone cause the oil shocks of the 1970s. The cheapness of Middle Eastern oil also discouraged oil exploration and production outside the region, leaving no immediate alternatives to Arab oil. Small populations, which then characterized the oil-rich states, allowed them to sustain the embargo and still cover their social needs. In addition, the impact of the Arab oil embargo was amplified by the absence of reliable figures on effective consumption or on the impact of cutbacks and their geographical distribution. Finally, the Soviet Union had ominously stepped into the Middle Eastern arena, posing a political and military counterbalance to Western interests.
Security and Scarcity
The Western obsession with oil security grew out of these conditions and then continued long after a number of forces had dramatically reduced OPEC’s power. The second oil shock developed in stages from 1979 to 1981. After the closing down of the Iranian oil industry in December 1978 and the departure of the shah in January 1979, oil prices began to rise. Nonetheless, in 1979 the price increase was between 30 percent and 40 percent. That year was the annus horribilis. It opened with the near meltdown of the Three Mile Island nuclear reactor, went on with the seizure of the U.S. embassy in Iran by revolutionary Islamic students and the outbreak of the hostage crisis, and closed with the Soviet invasion of Afghanistan. Less than a year later, in September 1980, Iraqi forces crossed into Iran, launching a bloody war that would last for another eight years. This combination of factors made oil prices skyrocket to more than $40 per barrel in the last part of 1980.
Relief through energy efficiency and the promotion of alternative sources of energy did not kick in until 1982 and 1983. World oil demand, which peaked in 1980, froze and decreased, particularly in 1982-84. The birth of a competitive oil market was signaled by the flotation of oil on the New York Mercantile Exchange in 1983.
Meanwhile, many OPEC members undercut the organization’s discipline in order to sell more oil, even breaking long-term contracts so as to take advantage of rapidly rising prices for spot sales. The irrational speculation fostered by many producers and the lack of immediate reliable figures about world consumption shadowed an emerging oil glut that began to drive oil prices down starting in 1982. The “oil bubble” finally exploded in 1986 when Saudi Arabia ceased underwriting OPEC’s lack of discipline and flooded the world with its own oil to regain market share. Oil prices plummeted to below $10 per barrel, driving home the lesson that using the oil weapon injured the oil producers as well as Western countries. Since 1986, the oil market has functioned smoothly, and OPEC has constantly tried to ensure oil-price stability, promptly intervening to supply more oil in times of temporary disruption. In recent years, therefore, price hikes and volatility have been caused more by market factors than by political issues.
Dire predictions of scarcity go hand in hand with fears about oil security. The truth is that oil supplies are neither running out nor becoming insecure. Today, the average world recovery rate from existing oil reserves is 35 percent, as compared to about 22 percent in 1980. Given current oil consumption levels, every additional percentage of recovery means two more years of existing reserves. This evolution also partly explains why the life index of existing reserves is still growing even though the world is replacing only 25 percent of what it consumes every year with new discoveries and major new oil discoveries have decreased since the 1960s. Today’s ratio of proven oil reserves to current production indicates a remaining life of 43 years for existing reserves, compared to 35 years in 1972 and 20 years in 1948. Advances in technology explain the apparent contradiction between fewer discoveries and more oil. Whereas an oil field does not change, knowledge about it does, sometimes dramatically.
Oil abundance, rather than scarcity, has been recurring since John D. Rockefeller’s era. Barring unexpected disruptions, it should continue to be the norm, given that the average growth rate of world oil demand is expected to remain at less than two percent annually over the next 15 years. Major producing countries have taken steps to avoid repeating past excess-capacity cycles. Nonetheless, their expansion potential is huge. Saudi Oil Minister Ali Naimi has noted that Saudi Arabia is producing oil from only 9 to 10 of the country’s 80-plus oil fields, and 8 of these were discovered more than 40 or 50 years ago.
Oil supply is also limited by restrictions on investments by international oil companies in the Persian Gulf’s large and cheap reserves. The dictates of the financial markets play a role as well. Return on capital measurements and premiums on the cost of capital oblige oil companies to dismiss many investment opportunities because they do not fit tight requirements. And higher production levels require higher replacement ratios, thus raising the bar even higher. Basically, the financial markets’ prudent approach (indeed, an illogical one from an economic point of view) depends on the assumption of oil depreciation in the long term. Oil is considered a semi-mature commodity, the fate of which is closely connected with that of most raw minerals, all affected by a rise-and-fall consumption pattern in modern economic history. According to this pattern, just as the Stone Age did not end for the lack of stones, the oil age will not end because of the scarcity of oil. Rather, oil will inevitably be surpassed in convenience by a new source of energy.
Ironically, new investments in non-OPEC areas, where oil costs are higher, are made possible by OPEC’s production ceilings, which sustain oil prices. If oil prices were below $18 per barrel, the output of the United States, Canada, the United Kingdom, Norway, and Russia would be partially displaced. In Russia’s case, a recovery in the price of oil and natural gas has boosted oil output and revenues. This in turn has led some observers to envisage Russia as a future main supplier of Western oil needs, displacing Saudi Arabia. However, considering that the Russian Federation has only one-fifth the oil reserves of the Saudis and that old Soviet techniques have damaged many oil fields, it is reasonable to assume that current Russian oil production is inflated by specific circumstances that cannot last forever. Russia’s own consumption, for instance, will recover and will absorb a growing part of domestic production. Overall, a return to low oil prices would dampen any major leap forward by the Russian oil sector and thwart needed investments in its export infrastructure. Thus, although Russia remains an excellent long-term opportunity for oil and gas companies, particularly once the current inflated outlook vanishes and legislation improves, it is misleading to compare its potential role in the world oil market with that of the Saudis.
In short, the world is not running out of oil, and there is no oil security problem in today’s world market. The problem instead is that many Western observers speak about oil security when what they have in mind is stable and cheap oil supplies. This confusion of two very different things usually stems from public hysteria when oil prices soar. When prices drop, oil matters are forgotten. Few remember the general refrain in 1998-99, when oil prices plummeted to about $10: “Bad for oil companies and producing countries, good for everyone else.” No one spoke then about oil security and energy alternatives.
A Double Curse
Cheap oil has always been and remains a curse for industrialized countries and is the most elusive enemy of oil security. It constricts the development of expensive energy alternatives and new oil regions. It discourages conservation and perpetuates lax Western consumption habits. Finally, it increases dependence on the Persian Gulf countries with the lowest production costs. Cheap oil is harmful to the producing countries as well. Today less than 25 percent of global production but 65 percent of the world’s proven oil reserves are concentrated in five countries: Saudi Arabia, Iraq, the United Arab Emirates, Kuwait, and Iran. All of these countries, as well as other OPEC members, need decent oil prices; since 1999, they have finally managed a certain degree of internal discipline in order to limit output and regulate prices. This policy leaves few alternatives for the Persian Gulf producers because their economies remain heavily based on oil while their demography has changed dramatically.
The population in the Persian Gulf states has doubled in twelve years, with 60 percent today under 21 years of age. This demographic explosion has created expectations and frustrations to which stagnant, single-industry economies cannot give a credible answer. Only sustained oil revenues allow these countries to temper social unrest by preserving huge social assistance programs. Gulf countries’ oil revenues are already much lower than they were 20 years ago, and cheap oil prices mean a dramatic dip in per capita oil income. Therefore, frustration and violent revolt may erupt whenever the minimum living standards are endangered by decreasing oil prices. Today’s Islamic fundamentalism, like yesterday’s pan-Arab socialism, finds fertile ground among hopeless people.
Beginning in 1962, Saudi Arabia financed the spread of conservative Sunni teaching worldwide to counterbalance the enormous appeal of pan-Arab socialism. Initially, the United States was supportive of this policy, but it progressively abandoned its support during the 1990s. Saudi Arabia dared not follow suit for fear of isolating itself within the Arab world and calling into question its very survival. The Saudi error has been the illusion that it can control and shape the political evolution of radical movements by financing them. Radical movements do pose risks, but they are limited. Divisions within Arab and Islamic societies weigh against any single fundamentalist leader’s emerging. The only centripetal force in these societies is a common distaste for rule imposed by external powers.
But for Arab countries it is difficult to translate creeping political rivalries into competitive oil policies. If a major producer, such as Iraq, were to open its oil fields to foreign investment again, its neighbors would be obliged to react so as not to lose future market share and revenues. In short, they would be compelled to overproduce and accept plummeting oil prices. That is the challenge that Iraq could pose if unregulated foreign investments flowed in to rebuild its oil industry. While Iraq is being reconstructed, care must be taken not to deconstruct the oil market again by sparking fierce competition among major producers.
A radical fundamentalist regime might be interested in launching such an output-and-price war to destabilize vested interests in the region and throughout the world. Such a regime could impose on its people the hardships and privation of lower prices for the sake of a final victory over the enemies it deems unholy. This type of scenario could devastate Saudi Arabia. It could also curb U.S. and Russian oil production, endanger Caspian Basin prospects, and halt new exploration and technology development. At the same time, it would endanger many investments that the international oil companies have already made worldwide. In short, within five to seven years, the world would be far more dependent on the Persian Gulf than it is today with no immediate way out—an outcome that would seem like a real victory for a radical regime. But today the very same outcome could also be caused by blind Western policies designed to undermine OPEC and introduce competition among its members.
Like the Greek god Proteus, the oil market is escaping control by constantly assuming different forms, which makes political manipulation of oil difficult, indeed useless. It is also dangerous because of the concentration of oil reserves in the highly sensitive Middle East. A hypothetical Western search for oil security through control of oil resources would perpetuate the Arabs’ and Muslims’ perception of a looming threat to their future, thereby increasing anti-Western sentiment and diverting the countries of the Middle East from confronting their own problems.
Oil security and scarcity are simply divisive and confusing myths. Western governments must explain clearly to their constituencies that oil is prone to price volatility, which makes occasional high prices unavoidable. Furthermore, they must disabuse their citizens of “bonanza” oil expectations and promote more careful consumption habits and investment in new energy technology.
The West must also commit to a long-term strategy of containment and rollback of any violent or terrorist mutations of Islamic doctrine, without confusing them with Islam. It must also assist Middle Eastern civil societies in their search for a different future, without seeming to pose a choice between two extremes: a Western social model that is not part of their culture and an authoritarian model that does not accommodate freedom and individual rights.
This dialogue needs to be reinforced by Western aid to develop economic activities other than oil. Throughout the 1990s, this task was relegated to private companies or international institutions, which were constrained by restrictive financial and social criteria that only increased Middle Eastern discomfort with the West.
Of course, there is no easy or immediate solution to the Middle East dilemma. Throughout history, the shaping and consolidation of national identities has been a prolonged process fraught with considerable suffering. The countries of the Middle East are relatively new, forged mainly after World War I, and Western states must ready themselves for the long road ahead, on which they must avoid either underestimating the strength of Middle Eastern states or exaggerating the threats that they pose. Western governments must also overcome their misguided obsession with oil security so that they can begin to cope more impartially with the Middle East’s problems. Ultimately, Western nations can prevail in helping to bring about a better future for the Middle East, but only if they debunk the oil myths and hold fast to their deepest values of freedom, self-determination, and tolerance, and the awareness that there is no absolute truth in human affairs.