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From the Spring 2015 issue "The Unknown"
By David A. Andelman
Pull up to a gas pump anywhere in Saudi Arabia, and you can fill your tank for 45 cents a gallon. The price hasn’t changed since the King dropped it from 90 cents in 2006. It’s the King who sets the price because the number has little or nothing to do with the price of oil on the world markets. It has more to do with how much it costs to lift each gallon out of the ground and refine it. Because, after all, the Kingdom owns it all.
That’s hardly the case anywhere else in the world. Saudi Arabia is outdone in the cost of gallon of gas at the pump only by Libya and Venezuela, where gasoline goes for a heavily state-subsidized four cents a gallon. But in Norway, despite its offshore reserves, gas clocks in at $9.26 a gallon (down from a high of $10.08 last Fall), while in France, it’s hovering around $5.40. That’s down from a high of $8.52 last Summer. Clearly all these wild price swings are causing some substantial disconnects in any number of countries—to which Saudi Arabia pays little heed, indeed may even be prepared to aid and abet.
Conventional market economics would suggest that lower oil prices damage countries that produce oil and live off the proceeds of its sale, while helping the vast part of the world that must rely on oil imported from the producers and where prices have been falling like a rock over the past year. In fact, it’s not quite as clear-cut as all that. Certainly, Iran and Russia are among the leading oil producers. At 10.6 million barrels per day, Russia is the world’s leading oil producer, though it sits in the eighth position in terms of recoverable reserves. Clearly it’s doing its best to milk these reserves while there is still a market—before solar and other forms of energy make oil an increasingly less critical commodity. Iran is producing a third of Russia’s daily production—barely 3.5 million barrels per day, though it has nearly twice Russia’s reserves and ranks fourth in the world.
Both Russia and Iran are being held hostage, however, to geopolitical and economic forces far beyond their control. Iran, of course, has been dealing for years with an outright embargo on the sale of its oil and a whole lot of other products. In fact, Iran has always consumed a large amount of its oil output, refining and distributing it within its own country. Russia, by contrast, has been a substantial oil exporter—indeed the world’s top exporter, even ahead of Saudi Arabia. Still it sells its gasoline to its own people at more than $3 a gallon, and as Bloomberg Analytics points out, since the average daily wage in Russia is barely $39, it takes 8.3 percent of that income to buy a gallon of gasoline. But Russia is really hurting because crude oil today is fetching less than $50 a barrel—half the level of a year ago, and at a time when Western economic sanctions, especially in the banking field, are really beginning to bite. In short, Russia is an importunate oil economy living quite literally from payday to payday, with none of the cushions available to the likes of Saudi Arabia.
Few economies or societies have been built around the world market price of a single commodity like oil. The economy of the Netherlands nearly floundered after the 1637 collapse of the price of tulip bulbs. At the height of the bubble, a single bulb went for ten times the annual wages of a skilled craftsman. The fourth largest export of the Netherlands (after gin, herring, and cheese), much of the speculation involved no delivery of bulbs at all—but rather the equivalent simply of contracts to buy or sell—not dissimilar to todays futures markets. Traders in such commodities as oil, gas, copper, gold, silver, or platinum rarely expect to see oil drums or a load of copper dumped on their front lawn. Their trade is on the potential value of these products as numbers dance before their eyes. Nor do most countries ever expect to base their entire economies or financial well-being on a single commodity. But some do, and it’s a most dangerous practice.
Indeed, there have been any number of such countries that have done so in recent years, and it would appear that the practice is only accelerating.
Such a foolhardy system has developed largely because of a perception that all but prices can be manipulated quite effectively. Then there’s the belief that certain countries, because of their size, military might, and/or alliances, can make themselves immune from forces of nature or economics. And oil is the most frequently discussed manipulation.
The real, potentially manipulable value of oil doesn’t date back much more than 100 years, to the dawn of the age of the automobile and the airplane. Indeed, when the drafters of the Versailles Treaty that ended World War I were drawing the boundaries of the nations they were creating in the Middle East, none had any idea where the liquid gold lay beneath the sands of these inhospitable desert landscapes. In fact, the real gold in Saudi Arabia—not even yet a sovereign nation—was believed to exist in the mines of King Solomon. It wasn’t until 1932 that the united nation of Saudi Arabia was created and the first American oil explorers invited. Much of the early exploration for oil was done by foreign companies, which managed to isolate and hoodwink individual countries and their rulers. Eventually, though, after World War II, some scattered oil producers realized that they might be able to manipulate rather than simply wait to be manipulated. Iran and Venezuela were the first, and in 1949 persuaded Iraq, Kuwait, and Saudi Arabia to exchange information. But it took these five countries another 11 years before they realized they could band together and actually begin setting the price of oil.
For the next three decades, that’s exactly what these five did as they were eventually joined by eight others on three continents (though Indonesia would withdraw in 2008 after it confessed to being a net oil importer). It’s difficult today to appreciate the power held by the oil ministers of each of these countries. In 1976, the ministers converged on the Pertamina Cottages—a collection of luxury bungalows on a pristine sandy beach of the Indonesian island of Bali to set the world oil price. Journalists, who in other settings had the luxury of being able to snag ministers passing in and out of the conference room of hotels where they would gather in Geneva or Vienna or some other neutral venue, were confined to a small concrete bunker-style building nearly a mile across a large field next to Bali’s airport. Once a day a press spokesman would materialize and inform hundreds of members of the international press that he had nothing to convey. Several enterprising oil journalists were able to snag the direct-dial phones into several of the cottages, but learned little more intelligence than the rest of us for their efforts.
What everyone was seeking was a single number—the production quota that the ministers would fix until the next time they’d meet some months in the future. The news agency that managed to beat others with this number could move not just mountains but huge volumes of money that washed across global oil trading desks.
As it turned out, at this meeting, they did nothing—shortly before midnight an OPEC spokesman arrived with a simple statement he read to an exhausted bevy of reporters, explaining that the oil ministers had decided simply to keep oil production quotas unchanged. As I wrote in The New York Times, they’d chosen the path of “bowing to the demands of the largest producing member, Saudi Arabia.” Even so, the story wound up leading the paper on page one for May 29, 1976, a tribute to the power even of no news out of OPEC. “The decision seemed to reflect,” I continued, “the realization that the recovery from the worldwide recession had not progresssed enough to sustain higher prices,” two years after the OPEC oil embargo.
In those days, each of these oil ministers had at his hands not only colossal power, but Croesian wealth. In the course of several of these meetings, I got to know the oil minister of the United Arab Emirates—a large, genial gentleman with a great attachment to The Times, for whom I reported at the time. After many sessions with the oil ministers, especially when they huddled at the Hilton Hotel in Geneva, he would invite me to his suite with a sweeping view of Lac Leman for a brandy and conversation. One time, I remarked on his Rolex wristwatch. It made my GMT Master look like a skidrow imitation. Carved from a single block of solid gold, at least twice the heft of my own stainless steel variety, it marked each of the hours around the dial with a diamond that would have done my wife proud on her third finger. Finally, I could restrain myself no more. “That’s quite a watch you have there,” I smiled. He paused not an instant, whipped it off his wrist and asserted, “It’s yours.” I was for a moment speechless. Dangling in the air in front of my eyes was, at a conservative estimate, a decade of salary for a Times-man. I demurred. It was against my paper’s standards. He insisted. “If a guest admires something of yours, you must present it to him.” I persuaded him that much as I admired his qualities of a host, not to mention the code of the desert Bedouin, we Western journalists had our codes as well. He smiled, shrugged, and I watched sadly as it went back on his wrist.
What he and any number of his OPEC confederates told me was that they took their responsibilities toward the West quite seriously. This was after they had seen the damage that could be wrought by an embargo of the sort that nearly destroyed the American and much of Western Europe’s economy in 1973. The embargo of oil shipments to Canada, Japan, Britain, the Netherlands, and the United States resulted in a four-fold increase in the price of oil—the cartel’s price for Western support of Israel in the Yom Kippur war.
Today, echoes remain of that long ago and, for many alive today, all but forgotten trauma. By now, however, OPEC has lost the ability to re-visit, or re-claim such power. The reasons are clear and simple. First, OPEC is no longer a monopoly. From the first barrel that was pulled from the North Sea off Scotland and Norway, from the Arctic tundra of Canada, and today from the tar sands and fracking grounds of the United States, OPEC’s death knell has sounded. The Saudis certainly recognize this, which is why they are reluctant even to try to exercise what may be a marginal ability to influence the price of oil that plummeted in a matter of months to half its peak value.
As it happens, the plunge of oil prices is a weapon nearly as potent as its increase four decade ago. For the United States, which has prided itself on its ability to approach the nirvana of energy independence, a good chunk of this independence was predicated on an oil price north of $60 a barrel. Below that number, such expensive technologies as fracking, oil tar sands, high tech horizontal drilling, and new pipelines, not to mention many small drillers, especially in the American southwest, all become only marginally viable.
But below some magic number that has already been passed is also the very viability of a host of national economies. Russia is the most prominent victim. With some 70 percent of government spending funded by oil and gas revenues, pegged at $100 a barrel of oil for all or most of 2015, the country has a lot of ground to make up. The big hit, though, has been to the ruble, as the IMF suggested in January when economists Rabah Arezki and Olivier Blanchard reported, “Currency pressures have so far been limited to a handful of oil exporting countries such as Russia, Nigeria, and Venezuela,” and observing that plunging oil prices really represent “a shot in the arm for the global economy,” which they then go on to describe as “a gain for world GDP between 0.3 and 0.7 percent in 2015, compared to a scenario without the drop in oil prices.” But not in Russia. There, the Russian currency depreciated by 40 percent in 2014, some 56 percent in the last four months of the year.
But the impact of falling oil prices should not be seen as confined solely to the currencies of Russia, Nigeria, and Venezuela. For the ripple effects are far broader indeed. The social and political fabric, as well as the economies of all three countries, are seriously threatened by plummeting oil prices, while in the case of Russia those effects are only multiplied in intensity by the expanding embargoes in the wake of the Kremlin’s adventures in Ukraine and the Crimean Peninsula.
In the case of Nigeria, it is even more dependent on oil revenues than Russia as some 80 percent of government spending is from oil receipts. The government has been forced to devalue it currency, the naira, while holding benchmark interest rates at 13 percent. At the same time, it’s begun a review of some 6,000 publicly-funded projects and is considering a doubling of the value-added tax, which at 5 percent is among the world’s lowest. At the same time, it’s locked in a potentially existential war with the terrorist group Boko Haram, which has seized control of nearly a third of the country, while a presidential election was thrown into a cocked hat by the absence of large slices of oil funding to prime the pump in key districts. Finally, compared with Saudi Arabia, with reserves of some $800 billion that can serve as a cushion against any oil price jolts, Nigeria has barely $5 billion in such a fund, with Angola, the other venerable sub-Saharan oil producer, in similar circumstances.
At the same time, any number of smaller or nascent African oil producers, from Uganda and Mozambique to Ghana, all counting on big oil dollars to bolster their fragile economies in the short- and medium-term, are finding that pot of gold at the end of the rainbow receding before their very eyes, just as they thought they had it almost within their grasps. A $16 billion joint venture project between France’s Total, Exxon, and others in Angola was said to be in jeopardy with oil prices below $70 a barrel—a level that’s held since last November. There are fears in nascent oil and gas producers, like Uganda and Mozambique, that such price levels could drive international oil companies to abandon promising drilling projects for oil and natural gas respectively and investments ranging from $5 billion to $15 billion.
Of course many developing countries are benefiting from the low oil prices to hold down inflation and encourage economic growth—one reason the IMF has projected a nearly doubling of overall world economic growth this year. But to base long-term planning on such thin reeds could be as dangerous as counting on $100 a barrel crude as the new global standard, like many were doing less than a year ago.
No More Peak Oil
There was a moment when a theory or talking point called “peak oil” drove discussions of just where the world might be heading a generation or two in the future—perhaps even more immediately. This theory gained considerable credibility as oil prices soared, but today has all but vanished from boardroom conversations. That theory, pioneered by Shell Oil geoscientist M. King Hubbert in 1956, suggested that oil production in the United States would peak in 1965 or at the latest by 1970. Not unlike futurists who predict the end of the world is coming within their lifetimes, he lived to see his prediction wildly discredited, only to be picked up by a more populist thinker and investment banker, Matthew Simmons. Using what he described as internal documents from the Saudi oil company Aramco, he predicted in a 2005 book, Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy, that the Kingdom’s oil production would peak “in the near future,” and then begin a long, slow decline, by implication along with that of the rest of the world. On this theory he based a bet that world oil prices would have passed $200 by 2010. He was off by better than 100 percent.
The theory of peak oil is founded on several assumptions: that the amount of oil to be found in the world is effectively finite (true), that we have found or identified the vast bulk of it (possibly true), and especially that once we have burned up or otherwise consumed every last molecule of this precious commodity that by the end will be worth countless thousands of dollars per barrel (almost demonstrably false). Clearly, our appetites do not seem to have kept pace with our abilities to satisfy them. How else do we explain oil plummeting to half its peak price in less than a year?
Well, actually, there are several ways. The first is that the rising price of oil contained the seeds of its eventual reversal. With higher prices came the incentive—and the means—to troll with ever more expensive techniques for sources that could satisfy demand. At the same time, there were efforts by many developed nations, particularly the world’s largest consumer, the United States, to curb usage by increasingly inventive means, which in turn are being embraced by other countries with comparable appetites for lower usage and cheaper, especially cleaner energy. When both scenarios kick in simultaneously, the results are especially parlous for governments that rely deeply on oil to fund their day-to-day operations—and their roles in the world.
Oil, of course, is only one of the vast panoply of exhaustible resources our planet has to offer—and that are being consumed at an ever more rapid rate and with little thought to the thousands of generations who may follow us. Few such natural resources are easily replicable, at least with any technology currently available or even foreseeable. Yet many are considered lodestones of economic prosperity or growth. Consumption of copper is seen as an indicator of urban progress. Rare earths, in the bottom row of the periodic table, from lanthanum on the left to lutetium on the right plus yttrium and scandiumare, are essential components of cell phones and a host of other electronic devices. Imagine 20 generations from now when these very earths might be essential to the survival of life on our planet. And we discarded them unthinkingly onto slagheaps when the next Gameboy came along.
There was a time when gold was the most sought-after commodity, beyond oil, diamonds, or any other precious stones. Then the world, wisely, de-linked their currencies from this metal, and it became merely an occasional hedge against fluctuations in stock and bond markets or inflation. It is not impossible to conceive of a future when precious metals and stones, oil and gas, even rare earths take a back seat to fresh water as the commodity over which wars are waged, fortunes made and lost in a nanosecond. Already, arable land—intimately linked to the access to fresh water to nourish its crops—is becoming an investible idea for many countries, particularly those in desert regions of the Middle East.
In areas like the high Himalayas, subtle shifts in patterns of water and especially climate, have caused potentially cataclysmic events. Fragile glacial lakes are being overstocked with the runoff of melting glaciers, threatening to break out of the formations that hold them, and on the thus far rare occasions when they have, sweeping entire towns and villages away in the path of their water. As Jacques Leslie first reported in World Policy Journal, the rising seas, too, are beginning to demonstrate their impact—threatening the very existence of entire nations like Kiribati in the South Pacific, which has even begun to draw up plans to move its entire population to higher or at least less-threatened ground. And we’re not even considering enormous coastal cities from New York, Boston, and Miami to Hong Kong, Singapore, Jeddah, Dubai, Mumbai, Karachi, Singapore, and the list goes on.
We have built much of our world on the clearly flawed perception that our planet will remain largely immutable over centuries or millennia. So we build megacities on shorelines or waterways that may be deeply vulnerable to the ravages of global warming and climate changes over which we have little or no control. Equally we have pulled as many possible resources from the ground as possible in the interest of “energy independence” or rapid development, bootstrapping millions out of subsistence environments in years rather than generations. In short, we are embracing revolution over evolution at every turn.
Instead, we must make every effort to keep our eyes fixed on the long game and not be diverted by transitory fluctuations in prices and fads. There will always be another tulip bulb or its ilk dangled temptingly, Eden-like before us, but we must not succumb to its seductions. There remain vast, utterly unexplored stretches of our planet—the resources they contain buried deep beneath distant sea beds, or uncharted reaches of remote forests and mountains. These are the patrimony of our heirs and should remain untouched until, centuries hence, they may become the salvation of the human race.
For the moment, instead, we must pay close attention to the stewardship of those resources to which we have been granted access—draw on and use them wisely. We have seen the chaos that can result from even the most minor fluctuations in the value or supply of a single commodity—oil. We have, it would appear, largely wrested control of one natural product of our planet away from a cartel that has shown itself capable of using it both malevolently and benevolently. This should be a cautionary tale for all of us
David A. Andelman is the editor and publisher of World Policy Journal.
[Cartoon courtesy of Damien Glez]