-Caveat Lector- International Perspective, by Marshall Auerback
War With Iraq May Not Equal Cheap Oil November 5, 2002 Hours after Congress authorized President Bush to use force in Iraq last month, an economic adviser under four U.S. presidents told business leaders in Grand Rapids, Michigan that going to war "is probably the most bullish thing I can think of." Former FDIC chairman Bill Seidman, who served during the Nixon, Ford, Reagan and the senior Bush administrations, said defeating Saddam Hussein and controlling Iraqi oil is "at least as important as eliminating weapons of mass destruction." Speaking at the Peninsular Club, Seidman had just arrived from a State Department briefing in which the Bush administration outlined for the first time a post-Saddam power structure in Iraq. "I think probably the most bullish thing I can think of today is winning the war. We are planning to set up a MacArthur-like" government, said Seidman, referring to U.S. General Douglas MacArthur's temporary rule over Japan after its surrender in World War II. "Getting control of that oil," and thereby gaining sway with neighbouring Saudi Arabia's oil production, "will make a vast difference (to the economy) in all sorts of things, but particularly the price of oil." It all sounds too good to be true: Forget about the costs of fighting the war at a time when America suffers from unprecedented financial imbalances. Forget about the precarious state of the dollar. Ignore the prospect of oil supply shocks. Put the idea of blowback out of your mind. Although not a member of the Bush government, Seidman's argument is symptomatic of the disingenuous manner in which the Bush administration has prepared the country for this impending conflict. His tone echoes Paul O' Neill's carnival barker act in the immediate aftermath of September 11, when he urged his fellow Americans to charge into the stock market for the buying opportunity of a lifetime. But closer analysis suggests that Seidman and the happy warriors in the White House and Pentagon, who imply that policies aimed at changing the political and even the social character of the Middle East will come relatively cost-free to America, are indulging in dangerously na�ve assumptions about the economic and political fallout from the impending conflict. A case there may be for attacking Iraq, but not on the surreal grounds implied in Bill Seidman's speech. Let us quickly dismiss the silly "MacArthur" analogy for a post-Saddam Iraq. The use of this parallel displays complete ignorance about the post-war history of Japan, which in turn begets further scepticism in regard to the other optimistic assumptions underlying the "bullish case" for war. The Potsdam Declaration ending World War II may have ordered MacArthur to "democratize" Japan, but MacArthur himself displayed little enthusiasm for the idea. The Japanese Emperor, Hirohito, was retained on the throne. All occupation edicts came from the emperor, but MacArthur controlled policy in the background much like a "shadow shogun". Indeed two years into its occupation of Japan, virtually all American government officials began to change their minds about allowing genuine democracy to flourish in the country. By then, Cold War considerations and worries about the corresponding rise of the Japanese Socialist party (the one organisation largely untainted by the militarism of wartime Japan) induced the American government to bring back many of the pre-war and wartime leaders who had been purged at the conclusion of hostilities. If the Bush administration is truly sincere in its intent to follow the "MacArthur model", it will have to keep Saddam Hussein in place and work through him, hardly a likely scenario given President Bush's long expressed enthusiasm for "regime change". A more significant difference lies in regard to oil itself. During the early days of the Allied occupation, the Americans did not have any economic interests in Japan. But Seidman's speech implies that oil diplomacy is superseding the objectives of confronting global terrorism. He implies that American oil interests, the government, and US consumers are all drooling at the prospects of access to cheap Iraqi oil, which he suggests will have an economic benefit comparable a massive tax cut. Which brings us to the second assumption implicit in Seidman's speech: The history of the Gulf conflict has led many to assume that cheaper oil invariably flows from a successful American-led invasion of Iraq. This confidence appears to be misplaced. As one of America's leading independent energy analysts, Henry Groppe of Groppe, Long & Littell has argued, "The premise for the second element of energy policy is that other nations will be willing to increase oil production and invest in refining at lower prices. The appeal of the premises is that other policies - foreign affairs, saving the wilderness, etc. - can be pursued without conflict with energy policy." Indeed, there is a built-in contradiction in the aspiration for cheap oil, given that a precipitous fall in the price of crude will diminish the incentives for massive investment flows required to sustain the increasing supplies for a steadily tightening market. In particular, Russian and most non-OPEC crude have a much higher marginal cost of production. Were cheap Iraqi oil to flood the market in the manner that Seidman outlines, billions of marginal investment projects might be placed at risk. In regard to this alleged flood of low-cost Iraqi oil, a prevailing view of the impending conflict is that the U.S. would succeed quickly and that, following a transfer of power in Iraq to a more pro Western government, investment by foreign oil companies would lead to a quick ramp up in Iraqi oil output. As Iraqi oil exports have already been six hundred thousand to one million barrels a day below capacity, any further shortfalls during the invasion period would not be large and would readily be offset by increased production by Saudi Arabia, Kuwait, and the UAE. It is true that a U.S. invasion of Iraq may not in itself interrupt the flow of global oil, as Saudi, Kuwait and UAE production could readily compensate for any loss of Iraqi production. Of course, this presupposes that these countries would readily make up the difference and there is as yet little public sign which indicates such readiness on their part (Saudi enthusiasm for current American foreign policy is hardly likely to be great, given the recently expressed enthusiasm by some hawks for regime change in the Kingdom next). Indeed, should a U.S. invasion lead to civil unrest by Islamic extremists in Saudi Arabia, the world could experience a serious shortfall in oil output. Hawks among American policy makers recognise this risk and that U.S. military occupation of the key oil fields in the Middle East has been planned to deal with such an outcome; hence, the flawed "MacArthur" analogy. Even assuming a successful occupation of the oil fields, can Iraqi oil production be readily ramped up after a successful invasion? Again, we suspect the risks are being understated. Because of the very real threat of conflict between antagonistic tribes in the central and south of Iraq as well as between the Kurds, Sunnis and Shiites, absolutely smooth operations in the oil sector might require a U.S. "puppet" government supported by a U.S. military occupation. As we have noted above, the "MacArthur" template is inherently flawed, even though something approaching it appears to be an express objective of the most hawkish faction in the U.S. foreign policy establishment. Leaving aside the historical ignorance which characterizes this position, there are further problems. As Chalmers Johnson, President of the Japan Policy Research Institute, noted in a recent Los Angeles Times commentary: ".MacArthur did not have a serious religious problem in Japan. He forced the emperor to renounce his status as a Shinto god, but religious impulses have always lain lightly on the Japanese psyche. Iraq, by contrast, is ruled by a minority government of Sunni Muslims that has fought bloody wars with the country's Shiite and Kurdish majorities." (Oct. 17, 2002, Los Angeles Times) Religion is one wild-card. There are also innumerable economic obstacles to a rapid ramping up of Iraqi oil production. The oil fields have suffered from years of under investment and mismanagement and are in serious decline. It is the opinion of both Groppe and Steve Strongin of Goldman Sachs that significant investment would at least initially only succeed in stemming further declines in production. The existing contracts for investments in the Iraqi oil fields are with Russia and China, and this could impede investment by Western companies that the US would prefer and that would probably be needed to achieve the most rapid possible increase in output. Given the unstable ethnic composition of Iraq, it might take a long time to create a new stable Iraqi government. Because the oil majors have had their contracts reneged upon so often, it may take a long time for these companies to obtain satisfactory contracts and then make the large upfront investments needed. It is unclear what will be the production response to investment in the older fields (like Kirkuk which has been in production since the 1920's). Groppe himself estimates that perhaps 6 months after significant investment begins, Iraqi output from the older fields will be able to exceed recent peak levels of 2.5 million barrels a day and may then rise by an additional several hundred thousand barrels a day. But a much larger increase in output from those mature fields is unlikely. The significant potential for an increase in output lies with the Rumailia oil field, but, under the most favourable circumstances, it would probably take several years to raise its production capacity close to a million barrels a day. Lastly, there are various pipeline constraints on exporting volumes of oil above the prior peak of 3.5 million barrels a day, and it will take substantial investments and time to overcome these transport obstacles. Overall, it would take 6 to 9 months after a successful U.S. invasion to set in motion the investment program necessary to improve the Iraqi oil fields. Once investment begins, it will probably take on the order of 6 months before the current output decline path is reversed and Iraqi production capacity exceeds recent levels of 2.2-2.5 million barrels a day. It might take another 2 years to ramp up capacity to 3.0-3.5 million barrels a day. Iraq has the geological potential for much higher levels of output, but huge investments and a considerable amount of time would be required to achieve yet significantly higher levels of output. So the rapid fall in crude oil prices forecast by many in the aftermath of the invasion is not by any means a given. There is a further consideration that the Bush administration has chosen to ignore (or, at the very least, has not shared with the American people): by ostentatiously preparing to assume operational and oversight responsibilities in Iraq for years, not months, the U.S. is sending a strong message to Treasuries and Foreign Ministries around the world. It is essentially telling them that on issues of vital concern to them - notably oil and the aftermath of a "remade" Middle East - the U.S. is opting for a unilateralist strategy that will not require it to take account of their interests or views. This renewed enthusiasm for a "go-it-alone" policy comes at a time when the need for effective multilateral action to shore up the world economy is growing urgent. As authors Tom Ferguson, professor of political science at the University of Massachusetts, and Rob Johnson, former managing director of Soros Funds Management, recently wrote in the Los Angeles Times: "Coordination of macro policies to stimulate demand and stabilize the foreign exchange values of the major currencies is sorely needed in these fragile financial times. More ominously, a major economic crisis is clearly brewing in Latin America. Not only Argentina and Brazil, but even Mexico has recently suffered currency runs. In Africa, efforts to provide resources for public health, treatment of AIDS, and social infrastructure are in conflict with debt burdens that are strangling the capacity of the public sector to respond to the challenges. In an atmosphere poisoned by U.S. go-it-along tactics in oil and financial markets, resolving issues of debt relief and rescheduling and international banking supervision and coordination will surely become much less tractable. The current discord between Germany and the United States poses a special obstacle, because Germany remains a financial powerhouse, whatever its military weakness." As we have noted above, all this takes no account of what may go wrong within Iraq itself or in the rest of the Middle East after Iraq is liberated. As they did after World War I, tensions between the US and its major allies may well inflame the ethnic rivalries that will run rife in whatever political structure emerges in the new Iraq. Ferguson and Johnson warn that "in a worst case scenario, a likely casualty of a unilateral US attack on Iraq may well be the system of alliances which the U.S. has maintained since World War II." Going it alone in defence, as the new Bush doctrine proclaims, is dangerous enough. Doing so at a time when the US suffers from historically unprecedented financial imbalances could have catastrophic implications for the US economy, particularly if events in Iraq bring on a recession amidst high oil and gas prices as was the case in 1974 and 1991-92. There may indeed be a strong argument to be made for the removal of Saddam's weapons of mass destruction. But this case should not be predicated on an analysis whose antecedents owe more to P.T. Barnum than any serious study of history or the supply/demand fundamentals of the oil market. <A HREF="http://www.ctrl.org/";>www.ctrl.org</A> DECLARATION & DISCLAIMER ========== CTRL is a discussion & informational exchange list. Proselytizing propagandic screeds are unwelcomed. Substance�not soap-boxing�please! 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