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An Ode to Oil

THE WALL STREET JOURNAL

America’s oil dependency has some benefits. Roger Howard on how the diminishing resource acts as a source of stability, and forces countries to work together.

By ROGER HOWARD

In its collective mindset, every nation not only harbors aspirations, fears and delusions but also conjures rogues, villains and scapegoats upon which it vents its anguish, insecurities and resentments. And for many Americans, one such villain is a highly prized commodity.

Oil is, after all, a primary source of man-made global warming, while spillages and drilling have sometimes inflicted lethal environmental damage. Despite the sharp falls of recent months, dramatic price rises have also underwritten every postwar global recession, including the current economic malaise.

Oil lies at the heart of bitter civil wars in several parts of the world, notably West Africa, while several governments have recently been scrambling to stake their claims over the newly discovered deposits of the Arctic. Above all, it is often regarded as America’s strategic Achilles’ heel. President-elect Barack Obama has promised to end U.S. “foreign oil dependency,” claiming that it can be used as a “weapon” that allows overseas governments, particularly “unstable, undemocratic governments…to wield undue influence over America’s national security.” Last weekend, Mr. Obama announced his plan to create a major economic stimulus package, including spending on alternate energy.

Alarming as these scenarios are, they disguise the true picture, one that is really much more complicated and much more reassuring. While there are, of course, circumstances in which oil can exacerbate tensions and be a source of conflict, it can also act as a peacemaker and source of stability. So to identify America’s “foreign oil dependency” as a source of vulnerability and weakness is just too neat and easy.

This identification wholly ignores the dependency of foreign oil producers on their consumers, above all on the world’s largest single market — the United States. Despite efforts to diversify their economies, all of the world’s key exporters are highly dependent on oil’s proceeds and have always lived in fear of the moment that has now become real — when global demand slackens and prices fall. The recent, dramatic fall in price per barrel — now standing at around $54, less than four months after peaking at $147 — perfectly exemplifies the producers’ predicament.

San Francisco Chronicle/Corbis

An engineer walks across an oil field in Bakersfield, Calif.

An engineer walks across an oil field in Bakersfield, Calif.

An engineer walks across an oil field in Bakersfield, Calif.

So even if such a move were possible in today’s global market, no oil exporter is ever in a position to alienate its customers. Supposed threats of embargoes ring hollow because no producer can assume that its own economy will be damaged any less than that of any importing country. What’s more, a supply disruption would always seriously damp global demand. Even in the best of times, a prolonged price spike could easily tip the world into economic recession, prompt consumers to shake off their gasoline dependency, or accelerate a scientific drive to find alternative fuels. Fearful of this “demand destruction” when crude prices soared so spectacularly in the summer, the Saudis pledged to pump their wells at full tilt. It seems that their worst fears were realized: Americans drove 9.6 billion fewer miles in July this year compared with last, according to the Department of Transportation.

Instead, the dependency of foreign oil producers on their customers plays straight into America’s strategic hands. Washington is conceivably in a position to hold producers to ransom by threatening to accelerate a drive to develop or implement alternative fuels, realizing the warning once uttered by Sheikh Ahmed Zaki Yamani, the former Saudi oil minister who pointed out that “the Stone Age did not end for lack of stone.” Back in 1973, as they protested at Washington’s stance on the Arab-Israeli dispute, Middle East producers were in a position to impose an oil embargo on the Western world. But a generation later, technological advances, and the strength of public and scientific concern about global warming, have turned the tables.

The United States has powerful political leverage over producers because it holds the key to future oil supply as well as market demand. The age of “easy oil” is over, and as fears grow that oil is becoming harder to get, so too will the dependency of producers on increasingly sophisticated Western technology and expertise.

Such skills will be particularly important in two key areas of oil production. One is finding and extracting offshore deposits, like the massive reserves reckoned to be under the Caspian and Arctic seas, or in Brazil’s recently discovered Tupi field. The other is prolonging the lifespan of declining wells through enhanced “tertiary” recovery. Because Western companies have a clear technological edge over their global competitors in these hugely demanding areas, Washington exerts some powerful political leverage over exporters, many of whom openly anticipate the moment when their production peaks before gradually starting to decline.

Associated Press

A man rides a bicycle in front of an Iranian oil refinery in Tehran. Many oil wells in Iran are aging rapidly.

a man rides a bicycle in front of an Iranian oil refinery in Tehran. Many oil wells in Iran are aging rapidly

a man rides a bicycle in front of an Iranian oil refinery in Tehran. Many oil wells in Iran are aging rapidly

Syria illustrates how this leverage can work. Although oil has been the primary source of national income for more than 40 years, production has recently waned dramatically: Output is now nearly half of the peak it reached in the mid-1990s, when a daily output of 600,000 barrels made up 60% of gross domestic product, and can barely sustain rapidly growing domestic demand fueled by a very high rate of population growth. With enough foreign investment Syrian oil could be much more productive and enduring, but Washington has sent foreign companies, as well as American firms, a tough message to steer well clear. It is not surprising, then, that the Damascus regime regards a rapprochement with the U.S. as a political lifeline and in recent months has shown signs of a new willingness to compromise.

The same predicament confronted Libya’s Col. Moammar Gadhafi, who first offered to surrender weapons of mass destruction during secret negotiations with U.S. officials in May 1999. Facing a deepening economic crisis that he could not resolve without increasing the production of his main export, oil, Col. Gadhafi was prepared to bow to Washington’s demands and eventually struck a path-breaking accord in December 2003. Col. Gadhafi had been the “Mad Dog” of the Reagan years, but oil’s influence had initiated what President Bush hailed as “the process of rejoining the community of nations.”

Oil could also help the outside world frustrate the nuclear ambitions of Iran, whose output is likely to steadily decline over the coming years unless it has access to the latest Western technology. Many wells are aging rapidly and the Iranians cannot improve recovery rates, or exploit their new discoveries, unless Washington lifts sanctions, which have been highly successful in deterring international investment.

Sometimes the markets will prove at least as effective as any American sanctions in keeping a tight political rein on oil producers. For example, when Russian forces attacked South Ossetia and Georgia on Aug. 8, Russia’s stock market — of which energy stocks comprise 60% — plunged by nearly 7%, and within a week capital outflow reached a massive $16 billion, suddenly squeezing domestic credit while the ruble collapsed in value. A month later, the country was facing its worst crisis since the default of August 1998. But the future of the oil sector is so dependent on attracting massive foreign investment, and the wider Russian economy so heavily dependent on petrodollars, that the Kremlin simply can’t afford to unnecessarily unnerve investors.

Today the markets know that Russia needs at least $1 trillion in investment if it is to maintain, let alone increase, its oil production. Just five years ago, output was increasing so fast — energy giants Yukos and Sibneft were posting annual production gains of 20% — that even the Saudis were worried about their own global dominance. But in the past year Russian oil production has started to wane. Leonid Fedun, a top official at Lukoil, Russia’s No. 2 oil producer, admitted back in April that national output had peaked and was unlikely to return to 2007 levels “in my lifetime” and that “the period of intense oil production [growth] is over.” Without foreign money and expertise to extract offshore oil and prolong the lifespan of existing wells, Russian production will fall dramatically.

[fueling up]

Russia’s oil, in other words, acted as peacemaker. This seems paradoxical for it has sometimes been said that the Kremlin’s attack on South Ossetia and Georgia was prompted by an ambition to seize control of local pipelines. But although this was an aggravating factor, it was not the primary cause because Russian leaders would have felt threatened — reasonably or not — by the presence of NATO in what they regard as their own backyard even if the region was not an energy hub. They were also reportedly eyeing Ukraine, which has no petroleum deposits of its own and poses no threat to the dominance of their giant energy company, Gazprom.

Oil can also act as a peacemaker and source of stability because many conflicts, in almost every part of the world, can threaten a disruption of supply and instantly send crude prices spiraling. Despite the recent price falls, the market is still vulnerable to sudden supply shocks, and a sharp increase would massively affect the wider global economy. This would have potentially disastrous social and political results, just as in the summer many countries, including France, Nepal and Indonesia, were rocked by violent protests at dramatic price increases in gasoline.

Haunted by the specter of higher oil prices at a time of such economic fragility, many governments have a very strong incentive to use diplomacy, not force, to resolve their own disputes, and to help heal other people’s. This is true not just of oil consumers but producers, which would also be keen not to watch global demand stifled by such price spikes.

Consider the events of last fall, when the Ankara government was set to retaliate against the Iraq-based Kurdish guerrillas who had killed 17 Turkish soldiers and taken others prisoner in a cross-border raid on Oct. 21, 2007. Even the mere prospect of such an attack sent the price of a barrel surging to a then record high of $85 because the markets knew that the insurgents could respond by damaging a key pipeline which moves 750,000 barrels of oil across Turkish territory every day.

Not surprisingly, the Bush administration pushed very hard to prevent a Turkish invasion of northern Iraq — State Department spokesman Sean McCormack aptly described the frenzy of diplomatic activity as a “full-court press” — not just to avoid shattering the vestiges of Iraq’s political structure but also to stabilize oil prices. In the end it was American pressure that averted a major incursion, allowing crude prices to quickly ease. And the Turks would also have been aware that any invasion could have prompted retaliatory damage on the oil pipeline, losing them vast transit fees.

In general, oil is such a vital commodity, for consumers, producers and intermediaries alike, that it represents a meeting point for all manner of different interests. Sometimes it offers an opportunity for competitors and rivals to resolve differences, as in March 1995, when Iranian President Akbar Hashemi Rafsanjani tried to break deadlock with Washington by offering a technically very demanding oil contract to Conoco. Today, the symbiotic energy requirements of Europe and Russia allows scope to improve mutual relations, not least if European governments act in unison to impose the rules of the European Union’s energy charter on Moscow. Oil also gives consumers a chance to penalize, or tempt, international miscreants, just as U.S. sanctions are forcing the Tehran regime to reassess its cost-benefit analysis of building the bomb.

What cannot go unchallenged is a facile equation between oil on the one hand, and war, bloodshed and, in America’s particular case, strategic vulnerability on the other. For oil, fortunately, can often be our guardian.

Roger Howard is the author of “The Oil Hunters: Exploration and Espionage in the Middle East, 1880-1939,” published by Continuum.

WSJ ARTICLE

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