Ode to Oil - crude curse
Ode to Oil versus Royal Dutch Disease
NOVEMBER 29, 2008
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.
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.
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.
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.
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.
Oil is a curse. Natural gas, copper and diamonds are also bad for a country’s health. Hence, an insight that is as powerful as it is counterintuitive: poor but resource-rich countries tend to be underdeveloped not despite their hydrocarbon and mineral riches but because of their resource wealth. One way or another, oil – or gold or zinc – makes you poor. This fact is hard to believe, and exceptions such as Norway and the US are often used to argue that oil and prosperity for all can indeed go together.
The rarity of such exceptions, however, not only confirms the rule, but shows what it takes to avoid the misery-inducing consequences of wealth based on natural resources: democracy, transparency and effective public institutions that are responsive to citizens. These are important preconditions for more technical aspects of the recipe, including the need to maintain macroeconomic stability, manage public finances prudently, invest part of the windfall abroad, set up “rainy-day funds”, diversify the economy and ensure the local currency does not reach too high a price.
It all sounds sensible, and with Brazil, Ghana and others soon likely to become big oil players, we can expect to witness some rare test cases of these recommendations.
Unfortunately, for most underdeveloped countries, these suggested defences are as utopian as the larger goal they are supposed to help achieve. Countries that already have all these institutional strengths need not worry about the resource curse. For the rest, like an autoimmune disease, the curse undermines the ability of a country to build defences against it. Concentrated power, corruption and the ability of governments to ignore the needs of their populations make the curse hard to resist.
Juan Pablo Pérez Alfonzo, Venezuela’s oil minister in the early 1960s and one of the founders of the Organisation of the Petroleum Exporting Countries, was the first to call attention to the problem. Oil, he said, was not black gold; it was the devil’s excrement.
Since then, Pérez Alfonzo’s insight has been rigorously tested – and confirmed – by economists and political scientists. They have documented, for example, that since 1975 the economies of underdeveloped resource-rich countries have grown more slowly than countries that could not rely on the export of minerals and raw materials. Even when resource-fuelled growth takes place, it rarely yields growth’s usual full social benefits.
A common trait of resource-based economies is that they tend to have exchange rates that stimulate imports and inhibit the export of almost everything except their main commodity. It is not that their leaders fail to realise the need to diversify; in fact, all oil countries have invested massively in other sectors. Unfortunately, few of these investments succeed largely because the exchange rate stunts the growth of agriculture, manufacturing, tourism and other sectors.
Then there is the intense volatility of the exported commodities. In the past 24 months, for example, oil shot up from less than $80 per barrel to $147, then fell to $30, and again moved up, to $60 by mid-2009. These boom-and-bust cycles have devastating effects. The booms lead to overinvestment, reckless risk-taking and too much debt. The busts lead to banking crises and draconian budget cuts that hurt the poor who depend on government programmes. Additionally, oil-fuelled growth does not create jobs in volumes commensurate with oil’s large share of the economy. In many of these countries, oil and natural gas account for more than 80 per cent of government revenues, while these sectors typically employ less than 10 per cent of the workforce. This increases economic inequality.
Perhaps even more significantly, the oil curse nurtures bad politics. Because governments of such countries do not need to tax the population to amass giant fiscal revenues, their leaders can afford to be unresponsive and unaccountable to taxpayers, who in turn have tenuous and often parasitic links with the state. With their ability to allocate immense financial resources pretty much at will, such governments inevitably grow corrupt.
Once in power, such oil-rich governments are hard to dislodge, spending vast public resources to buy out or repress political opponents. Statistically, an authoritarian oil country is far less likely to move to democracy than a resource-poor autocracy. Oil-rich governments in developing countries spend two to 10 times more on their militaries than poor or middle-income countries, and are more prone to go to war. Most oil-exporting countries that do not have strong democratic institutions before they start exporting crude create an inhospitable environment for democracy.
This explains why the sovereign wealth funds, oil-stabilisation funds and other solutions tried by resource-rich countries to avoid the effects of volatility, fiscal excess, indebtedness, export-inhibiting exchange rates and other ill effects rarely work. They get raided before the rainy days or are squandered in poor investments.
So, is all hope lost for poor countries with rich natural resources? Not quite. Chile and Botswana stand out as success stories on continents where the resource curse has otherwise wrought havoc. How they were able to protect themselves is still a mystery. Unlocking the secret of their escape from the resource curse could spare millions from the devil’s excrement. But nobody has done it yet.
The writer is editor-in-chief of Foreign Policy, where a version of this article is forthcoming