Oil

A dangerous addiction

Dec 13th 2001
From The Economist print edition

The world is increasingly dependent on Middle Eastern oil. After September 11th, this could be cause for increased alarm—or just common sense

HOW much is a barrel of oil worth? In the Middle East, reserves can cost barely a dollar to lift out of the ground. Add a decent profit margin, and you still have an exceedingly modest price. Yet quite a bit of the world's oil comes from far more expensive places. Last year, the price averaged $27 a barrel.

It is not geology that determines the oil price, however, still less the free interplay of supply and demand. Mostly, it is the whims of the Organisation of Petroleum Exporting Countries (OPEC), the ill-disciplined cartel led by Saudi Arabia. Small wonder, then, that the price of oil has yo-yoed in the past three years. Prices have recently plunged to below $17 a barrel as an anaemic world economy and a stand-off between OPEC and Russia, the biggest non-cartel exporter, pushed the oil market to the brink of short-term collapse.

Only Osama bin Laden, it seems, can give you a fixed price for a barrel of oil. He makes it $144. Several years ago, the leader of the al-Qaeda terrorists issued a little-noticed proclamation on energy economics. In it, he accused the United States of “the biggest theft in history” for using its military presence in Saudi Arabia to keep oil prices down. In his view, that larceny adds up to $36 trillion. America, he insisted, now owes each Muslim in the world around $30,000, and still counting.

After September 11th, energy-security experts have Mr bin Laden, his sympathisers and terrorists in general very much in mind. America used to assume that, if a hostile group or regime took over the Middle Eastern oilfields, it would send in its troops to quash the troublemakers and protect the oil. Now those terrorists may have nuclear weapons that they could turn either against America or against the oilfields themselves.

Yet the real cause for worry, a related one, is much longer-term. Because the world remains so dependent on oil for transport, it cannot stand any disruption in supplies. And there is a strong possibility of such a supply-shock at some time in the next few decades. How will the United States cope with this?

In too few hands

Oil is not scarce. Enough lies underground to keep the world's motors humming for several decades yet. The snag is that the lion's share of it—and almost all the oil that is cheap to extract—lies under the desert sands of a handful of countries around the Persian Gulf (see map).

Today, Saudi Arabia alone sits on a quarter of the world's proven oil reserves, and four of its neighbours can boast about a tenth each. Because the Saudis choose not to produce as much oil as they could, OPEC's share of world oil exports is only about 40%: influential, but not enough to control prices completely. As the world continues to deplete non-OPEC oil, however, that share will increase dramatically—and with it, the market power of those Middle Eastern regimes. All the more likely, then, that supplies may be disrupted. This threat is particularly acute for the United States, which is both the biggest oil-guzzler and the de facto guarantor of oil supplies for its allies.

The Saudis, unsurprisingly, deny that a shock is in prospect at all. Oil is “a global market,” said Ali al-Naimi, the oil minister, two years ago. “Those who propagate the issue of supply insecurity, dangers of import dependence and perceived instability of the Arabian Gulf are ignoring realities.” He pointed out that his country intentionally maintains a cushion of excess capacity against any disruption of supply. It was his country's buffer, not any non-OPEC production, he noted, that came to the rescue during the Iranian revolution, the Iran-Iraq war and the Gulf war.

All this is true, but what if the Saudi regime were overthrown by some rabidly anti-western band? Not to worry, argues John Browne, chairman of BP: “However fundamentalist, a regime still needs money to look after its people.” His sentiment is echoed by many economists, who insist that oil is a “fungible” commodity that is worthless unless it gets to market. In the long term, that is doubtless true. But even short-term disruptions can wreak havoc on the world economy: when the Iranian revolutionaries booted out the shah, Iran's oil exports collapsed. And some future revolutionaries may choose to forgo oil revenues and live in poverty to punish the West.

Donald Losman, in a provocative paper published by the Cato Institute, a libertarian think-tank, goes further. He argues, with some justification, that the pain associated with previous oil shocks had more to do with foolish policy responses by western governments meddling in the market than with disruptions to supply. He calculates that America wastes $30 billion-60 billion a year safeguarding Middle Eastern oil supplies even though its imports from that region totalled only about $10 billion a year during the 1990s. He also observes that semiconductors, the backbone of the digital economy, come mostly from one place (Taiwan), but American soldiers do not guard chip plants.

Oil's uniqueness

Yet semiconductors and oil are not at all the same. The American economy could manage without new semiconductors for some time, but it would grind to a painful halt the moment oil dried up. Semiconductor plants can also be built anywhere, but oil is found only in certain spots. The petrol riots in Britain in the autumn of 2000 showed how easily a modern economy can be brought to its knees when its oil supplies are disrupted.

If oil is essential, then, why not simply boost non-OPEC supplies? President Bush, extolling America's “energy independence”, has been trying to push a bill through Congress that would open part of the Arctic National Wildlife Refuge in Alaska to oil-drilling. But America consumes so much that all the oil in Alaska would not dent its reliance on the imported stuff.

The dramatic wave of non-OPEC discoveries in the 1960s and 1970s in the North Sea, Alaska and other places has helped to counterbalance OPEC's pricing power. But these big fields are about to enter a phase of rapid decline. Part of the explanation is simple old age. In the North Sea, for example, most large fields are now 70-90% depleted. And the dramatic techniques that have allowed big oil companies to improve oil-recovery rates have ended up draining fields all the faster.

Harry Longwell, a top manager at ExxonMobil, insists that a new wave of non-OPEC development, from the Caspian to the deep waters of the Gulf of Mexico, is technically feasible. However, he says that it will require “huge new investments”. How much? The International Energy Agency reckons big oil firms will have to invest a whopping $1 trillion upstream over the next decade. Developing non-conventional hydrocarbons, such as Canada's tar sands, would prove even more expensive. Such stuff would also take much longer to bring to market, and so prove less valuable as a buffer stock. In other words, the real concern is not the scarcity of hydrocarbons, but the ever-higher cost and commercial risk of finding non-OPEC reserves—especially since price volatility discourages investment.

Now here's the rub: even accepting in full the oil industry's optimistic assessment that it can meet this challenge, the “call on OPEC” will still increase dramatically over the next 20 years (see chart). In order to meet the world's unchecked thirst for oil, forecasters are assuming (perhaps praying is a better word) that Saudi Arabia and its neighbours will invest the vast sums needed to expand output. If they do not, it will be the world's consumers who will pay the price.

Saving and conserving

What can be done? Unfortunately, petroleum has a near-monopoly grip on transport. The best thing governments can do is to buy some insurance against politically inspired supply disruptions, and the panics and hoarding that go with them, by greatly expanding buffer stocks of oil.

This is all the more urgent because structural changes in the oil industry (mega-mergers, cost-cutting and a move to just-in-time inventories) mean that privately held reserves have fallen steeply from their levels in the 1970s. Add to this the official neglect of government stockpiles, and you get a world that is needlessly vulnerable to the next oil shock.

Mr Bush has now begun to rebuild America's Strategic Petroleum Reserve. Conservation, too, after years of sneers, is firmly on the American political agenda. Yet even conservation has drawbacks: it may simply mean less mobility and less trade. The better way forward is to promote energy efficiency. The United States now imports about 11m barrels of oil per day (bpd), around a seventh of the world's total production. Philip Verleger, an energy economist, reckons that the figure would be only 5m or 6m bpd if America had made a serious effort to improve fuel efficiency after the previous shocks.

One efficiency measure under debate is the strengthening of the Corporate Average Fuel Economy (CAFE) laws: raising them for cars, and closing the loophole that allows light trucks and sport-utility vehicles to use more petrol. A study done by America's National Academy of Sciences (NAS) earlier this year was certain that, with technologies that are readily available, reductions in fuel use of up to 20% could be achieved comfortably. Some vehicles could achieve a 50% increase in fuel economy—and more if radical new technologies, such as fuel cells, take off.

Against shocks, taxes

However, a world powered largely by fuel cells (which combine hydrogen and oxygen to produce electricity) could be decades away, especially if all America does is tinker with fuel-efficiency standards. The best way to encourage the development of new transport fuels and technologies is through taxation that reflects the “energy security” risk (as well as dangers to health and the environment) of burning oil. Europe recognises this, and over the past decade has started to shift the burden of taxation from income to, for example, carbon emissions.

What are the chances that America too will start to tackle its petro-addiction? James Schlesinger, a former energy secretary, says he still bears the bruises from attempting to propose higher oil taxes in the past. A recent encounter on Capitol Hill suggests that times have not changed much. After the NAS panel had prepared a preliminary report, Paul Portney, its chairman, was asked to address a congressional panel. George Allen, a senator from Virginia, was plainly unhappy with the report's suggestion that fossil-fuel use could be easily curbed by tightening CAFE regulations. The visitor was asked whether there was any other way to encourage fuel efficiency without resorting to market-distorting regulations.

Why, yes, said Mr Portney: you could make a significant increase in the federal petrol tax. Mr Allen was astounded. The notion, he said, was “just flat ignorant”. Senator John Kerry, the panel's chairman, retorted in frustration, “I can see the headlines tomorrow: ‘Virginia senator calls Europeans ignorant', or maybe worse.” Mr Allen was unrepentant. The road away from dependence on OPEC and Middle Eastern oil could be long indeed.