Effective US energy policy critical to world energy balance
Oil & Gas Journal, April 2-8 issue
By Cyrus H Tahmassebi
It is said that US President George W. Bush is much more interested in
domestic issues than in international affairs, but the country's need for
an effective, all-encompassing energy policy is so compelling that President
Bush can ill-afford to treat it as less than a top priority item.
Although the California energy crisis is now an important issue in need
of urgent attention, and natural gas prices are still at record levels,
experts believe that these problems are dwarfed by issues related to oil.
California energy problems are homemade and require homemade remedies.
But given the growing US dependence on imported oil and the precarious
nature of the world oil markets, crafters of the new administration's energy
policy are likely to find oil-related issues much more compelling and challenging.
To be sure, oil prices have come down from their highs of a few months
ago, but they are still more than twice their levels of a year ago.
Despite the recent slowdown in the economy, the US still imports 11 million
b/d of oil and oil products having an annual price tag of $100 billion.
This high degree of dependence on imported oil, which forecasters project
will rise even further in the years ahead, is taking place at a time when
spare production capacity within the Organization of Petroleum Exporting
Countries is at its lowest level in decades.
The Middle East peace negotiations have hit an impasse, with no clear indication
of their outcome. Iraq, once perceived as contained and isolated, recently
made headlines by threatening its neighbors with military action and the
major oil-consuming countries with cutoff of Iraqi oil.
Meanwhile, the US continues its failed sanctions policy against such countries
as Iran, Iraq, and Libya, while others (including US European and Asian
allies) pour into these countries with garden variety investment proposals,
and some come back with lucrative exploration and production contracts.
Obviously, the US energy policy is in disarray and urgently in need of
a major overhaul.
What can the new administration do to bring some order to this chaotic
situation? Maybe, before it embarks on any action, it would be helpful
to analyze and understand some of the major factors that have contributed
to the current situation.
Dwindling capacity
Spare capacity is dwindling despite rising proven reserves. Estimated worldwide
proven oil reserves now stand at about 1 trillion bbl-virtually a record
level and 300 billion bbl above the 1985 estimate. Despite this abundance
of oil reserves, spare production capacity that stood at 15 million b/d
back in the mid-1980s has now dwindled to 2.5 million b/d, and the bulk
of it is located in Saudi Arabia. Almost all of the other OPEC countries
are producing at or near their full capacity, and at times, some have even
fallen short of their quotas due to capacity constraints.
With abundant reserves and an average production cost of less than $3.00/bbl
in the Middle East, basic economics would lead us to believe that there
should be enough incentive for investment in the oil fields of these countries
at current prices.
However, most OPEC countries are either unwilling or unable to make the
necessary investment in their oil fields to generate new capacity Some
of these countries are reluctant to invest because they are concerned about
a possible decline in world oil demand and competition from non-OPEC sources
that might force them to shut in the new capacity for years.
Others are anxious to invest and produce more, but they face huge budget
deficits or other investment projects of higher priority and thus have
very limited means to expand their capacity.
Obviously, outside capital can be a significant source of investment for
these countries, but it has been slow in coming because of either domestic
opposition to foreign investment in the oil sector or economic sanctions
by the West.
Consequently, over the past few years, the gap between potential supply
and actual demand has rapidly narrowed, and now the cushion against unforeseen
events that was once provided by the spare capacity is virtually depleted.
The huge spare capacity that emerged in the early 1980s and continued for
over a decade created a wrong perception in the minds of policy makers
in major consuming countries.
Policymakers in these countries have come to believe that a certain amount
of spare capacity would always be present in the OPEC countries because,
without it, there would be a significant amount of market volatility, and
OPEC deems such volatility not in its own best interests.
In this regard, too much hope and confidence has been placed on a select
number of the so-called pro-Western countries-i.e., Saudi Arabia, Kuwait,
and the UAE. These countries, by and large, are expected to provide the
cushion necessary to ward off price spikes that might result from rapid
demand growth or a sudden supply disruption.
This may prove to be a misplaced hope and trust, however, because these
countries rarely, if ever, deliberately created excess capacity for the
sake of market stability per se.
The bulk of excess capacity that existed in these and other OPEC countries
can be traced back to the miscalculations regarding demand growth projections.
The biggest of these miscalculations took place 2 decades ago, and its
ramifications lingered on for years.
Demand response to the huge price increases of the 1970s and early 1980s
was slow in coming. While most major oil companies and OPEC were awash
in cash, the projections were for a continued increase in the demand for
oil. Thus, investing part of the rapidly rising oil revenues back in the
oil fields to generate new capacity seemed a very smart decision at the
time.
But as demand collapsed in the late 1970s and the 1980s, a huge surplus
capacity emerged and lingered on for almost 2 decades. The existence of
this huge, unused capacity was the main reason for low oil prices the last
20 years.
Moreover, without this standby capacity, the increase in world oil prices
would have been much more severe and prolonged during the Iran-Iraq war
and the Persian Gulf war.
However, this excess capacity is now almost nonexistent, and consequently,
world oil markets are much more vulnerable to both supply disruptions and
strong seasonal demand growth.
The erosion in real oil prices since the late 1970s has changed OPEC from
a group of rich and cash-surplus countries to a group of deficit-ridden,
debtor nations.
Given this background, to expect Saudi Arabia, Kuwait, and the UAE-who
are facing budgetary problems of their own-- to commit billions of dollars
to generate excess capacity for the sake of market stability per se is
imprudent at best. Not only do they lack the financial means, but they
also are well aware that capacity overhang can lead to overproduction and
price deterioration.
Moreover, any investment by these countries to generate spare capacity
for the sake of moderating price increases or as a means for empowering
them to negotiate for higher quotas in OPEC deliberations is normally deemed
by other members to be an unfriendly gesture.
They probably would have disregarded such ill feelings of others if the
consequences were financial only, but they could be much more than that,
as the Iraqi invasion of Kuwait in 1990 well demonstrated.
Iraq is again emerging as a regional hegemonic superpower, and, according
to some press reports, Saddam Hussein's popularity in the Arab world is
on the rise again. In such an environment, it is quite understandable that
some of these socalled pro-Western countries would be reluctant to offend
their neighbors and would be concerned about possible retributions in the
future.
Today, the world oil markets are indeed in a precarious situation again.
Not only is spare capacity virtually exhausted, the sources of the world's
oil supply are also becoming increasingly more concentrated in one region
and largely in a handful of countries. If there was a vulnerability index
that could take all these and other related parameters into account, it
most likely would have raised a red flag a long time ago.
Sanctions' impact
Both producing and consuming countries have used oil as a policy instrument
to achieve political objectives. The Arab countries initiated an oil embargo
in 197 against Western countries that were backing Israel in the Arab-Israeli
War. As a result, oil prices skyrocketed.
However, there were no discernible long-term economic or political gains
for the Arabs. Instead, the supply interruption and the ensuing price increases
led to conservation, fuel substitution, and higher production in non-OPEC
countries.
Consequently, OPEC lost a significant amount of market share, and the competition
between OPEC and non-OPEC nations eventually forced the price even below
the 1973 level. Moreover, it undermined OPEC's credibility as a reliable
source of supply.
Because of these setbacks, many observers branded the 1973 Arab oil embargo
as a political blunder. If it indeed was a political blunder, the indiscriminate
use of economic sanctions by the West against a number of major oil-producing
countries over the last 2 decades should be branded as a super political
blunder. Whereas the Arab oil embargo lasted for only a short while, the
economic sanctions deployed by the US and the United Nations against Iran,
Iraq, or Libya have been in force for years.
Just as the Arab oil embargo failed to achieve its goals, so have the economic
sanctions that the US and others imposed on those oil-producing countries.
And just as the ill-effects of the Arab oil embargo eventually engulfed
all of the oil-producing countries within OPEC, the adverse consequences
of the US economic sanctions, manifesting themselves in the form of tight
markets and higher prices, are impacting all of the major oil-consuming
countries and their economies.
History shows that most US economic sanctions have begun with the strong
support of its allies.
As the sanctions drag on, and the results become difficult to ascertain,
however, the political objectives of the US and its allies begin to diverge,
and eventually the allies gradually back away.
Consequently, after a few years, the US government not only finds itself
alone and isolated but also betrayed by its former allies' rapproche- ment
and business dealings with the target country. Thus, the US ends up bearing
all or the lion's share of the economic burden resulting from the lost
trade.
History also shows that economic sanctions seeking to achieve financial
goals-i.e., opening markets to imports or lifting tariffs-have a much better
chance of succeeding.
On the other hand, sanctions seeking political gains often fail, even if
they remain in effect for years. In fact, some observers believe that politically
motivated sanctions have often rendered results that are exactly the opposite
of the ones intended.
For example, most Middle East experts believe that the UN economic sanctions
against Iraq have actually helped Saddam Hussein consolidate power and
rally the Iraqi nation behind him. This is mainly because political sanctions
do not bear fruit for very long, if ever.
Consequently, as these sanctions drag on and exacerbate the poverty and
sufferings of the common people in the target country, public opinion gradually
turns against the sanctioning country rather than against the leader of
the country whose policies are alleged to have instigated the sanctions.
Some believe that Iraq is a good example of this kind of backlash.
The US-Iraqi relations turned sour in 1990 when Iraq invaded Kuwait, and
the US government took the initiative to organize the military coalition
that eventually forced Iraq out of Kuwait. At that time and in the following
few years, most Arabs, particularly the Kuwaitis, were quite appreciative
of the US efforts. Now, after a decade, when these people see that Saddam
Hussein is still in power and the innocent Iraqi people are the ones who
are suffering from lack of food, medicine, and other necessities, they
are becoming increasingly more sympathetic towards the Iraqi people and
consider the sanctions no longer justified.
There are no reliable estimates of the exact impact of UN and US economic
sanctions on the aggregate world oil supply. However, some analysts believe
that Iran, Iraq, and Libya would have had the capability to produce 3-6
million b/d of additional oil without the sanctions.
For example, without the US sanctions, Iran would have been able to develop
and better maintain its onshore and offshore oil fields and possibly would
have become a major gas exporter to the rest of the world. Iran also could
have been a major conduit for oil and natural gas exports from the former
Soviet republics in the Caspian Sea region.
Moreover, some political observers believe that, if the sanctions had not
been in place, political and economic issues would have caused more market-share
rivalry among Persian Gulf oil producers.
In addition, without the sanctions, a country such as Iran probably would
have been much more amenable to increasing OPEC production quotas, because
Iran would have benefited also from higher production volumes.
Without much spare capacity or any potential benefits from higher volumes,
however, countries such as Iran naturally would be against quota increases.
Applying sanctions
Obviously, each sanction case has its own peculiarities and may require
a set of specific policy measures appropriate for it. However, there seems
to be a consensus among the experts on a number of major points:
* First, unilateral sanctions are more frequently doomed to fail, particularly
if world opinion considers the issue in dispute highly controversial and
having no direct bearing on the national security of the country imposing
it. Therefore, unless unilateral sanctions can guarantee a quick resolution
of the dispute, chances are they would eventually fail.
* Second, imposition of economic sanctions to achieve political objectives
is predicated on the assumption that the hardship resulting from the sanctions
will prompt the populace to rise against their leaders and force them to
alter their policy or behavior that the sanctioning country is seeking
to change.
It is obvious that in countries where there are no free elections or free
expression of popular will, the much-hoped-for internal pressure on the
leaders may never materialize. Instead, the sanctions may provide an opportunity
for demagogue and a pretext for the government's economic failures.
* Third, there is no guarantee that even a multinational sanctions policy
would succeed if the issue in dispute is highly controversial or if the
political objectives sought by the sanctioning coalition are considered
unjust by the majority of the people in the target country.
There is a distinction between sanctions deployed for commercial purposes
and those used to achieve political objectives. While the former often
lends itself to an objective cost-benefit analysis devoid of emotions,
the latter can easily invoke nationalism and other sentiments.
Therefore, unless politically motivated sanctions are deployed justly,
consistently, and in an even-handed fashion, it is more than likely that
they may eventually backfire and result in more harm than good to the sanctioning
countries.
Cyrus H. Tahmassebi
Energy Trends Inc.
Bethesda, Md.
The author
Cyrus H. Tahmassebi is president of Energy Trends Inc. Prior to his current
position, he was chief economist and director of market research for Ashland
Inc. for 15 years. Before joining Ashland in 1981, he was a Visiting Fellow
at Harvard University Tahmassebi also worked for National Iranian Oil Co.
and National Iranian Gas Co. in senior management positions for more than
16 years. While with NIGC, he represented Iran in OPEC's Gas Committee.
Tahmassebi received his BS and MS from Brigham Young University in Provo,
Utah, and his PhD from Indiana University in Bloomington, Ind. He served
as a member of the National Academy of Science workshop on the Strategic
Petroleum Reserve, the US Congress Office of Technology Assessments workshop
on US oil production, and the energy task force of the Center for Strategic
and International Studies. He also served on the advisory committee of
the Johns Hopkins University's international energy and environment program
and the advisory committee of the Energy and Environmental Policy Center
at Harvard's Kennedy School of Government. |
