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Wednesday, July 30, 2003

Squeezing the Saudis

Steven Den Beste had a post last weekend about putting pressure on Saudi Arabia after the recent war in Iraq. In it he says this:

I think part of the plan, and yet another reason why Iraq was a good choice as target of invasion and occupation, was to gain control of Iraq's oil fields. Not, as many will instantly claim, so as to let Bush's oil buddies in Houston get rich, but rather because we could use Iraqi oil output to compensate for declines in Saudi oil shipments. During the "oil for food" program, Iraq did ship a lot of oil, but the potential is there for shipments to be even greater, not to mention for those shipments to not be under the bureaucratic thumb of the UN.

Claudia Rosett, worried more about OPEC, write in today's Wall Street Journal:

The great myth, heard even in some parts of the West, is that OPEC is doing us a favor with its self-avowed mission to "achieve stable oil prices, which are fair and reasonable for producers and consumers." OPEC's notion of what's fair and reasonable has less to do consumer interests than with OPEC's basic problem, classic for any cartel, that above a certain price, it becomes so profitable for members to cheat (and for nonmember high-cost producers to increase supply) that the cartel falls apart.

The Saudis are, of course, entitled to offer oil at any price they want, including the OPEC target price of $22 to $28 a barrel for oil that costs them $1 to $2 a barrel to produce. But the Saudi-led collusion that goes into keeping world oil prices high enough to command prices that OPEC deems "fair and reasonable" is the kind of stuff that would get private capitalists in the U.S. fried on prime-time TV and thrown in prison.

Things are not quite that simple. Saudi Arabia's impact on oil markets is somewhat (though not entirely) symmetric--it poses a risk not just by ceasing to pump oil, but also by deciding to pump too much. In 1998, when OPEC's controls had collapsed and prices hit $10 a barrel, may experts seriously worried about the possibility, and impact, of $5 a barrel oil; in such a situation only the Saudis would make any money. A 1999 New York Times story describes what would happen:

[T]he desert kingdom can pump more than 10 million barrels a day at minimal extraction costs of $1 a barrel. This flooding would bring prices down to as low as $5 a barrel in a few months. Few oil-producing countries can take this possibility lightly. In the long run, it would put many producers out of business in the United States, the Caspian Sea, Russia and the prolific North Sea shared by Norway and Britain, where production costs range from $5 to $10 a barrel.

The Saudis may not be able to do this very quickly--while those fields have low running costs, it will take some investment to bring additional wells online. Iraq's fields, though, won't be fully online for a number of years yet, though. The Saudi Arabian ability to flood the market, though, will allow them to keep markets volatile, even though this could hurt them as much as it hurts their major customers. Their excess capacity also allows them to run OPEC as they do--only they can credibly threaten members and non-members alike to drive the price down. This is the reason why oil experts value the stability that OPEC's blatant collusion brings--when it works, oil prices are reasonably predictable, reducing uncertainty.

Ironically, the Journal's Rosett may have a good partial solution to the OPEC situation, by supporting privatisation of he Iraqi oil industry; this, however, may reduce the ability of the US to use Iraqi supplies for directly political ends. David Warsh once noted that "Perhaps the Gulf Wars are best understood as being antitrust policy for oil — industrial reorganization by force in the aftermath of successful monetary stabilization." Liberalising the oil market is something that may be valued on its own, for the benefits it would bring to both producers and consumers.