Oil Wars

It has been interesting to watch over the past couple of years how it has again become fashionable to discuss that black gooey substance called oil. A couple of years ago anti-war protesters in the U.S faced ridicule when they suggested the invasion of Iraq was largely a desire to control oil. No, that’s ridiculous – we were told – we’re are stopping the spread of WMD, fighting terror, or spreading democracy we were told. In no way would the U.S. be so cynical as to spill blood for oil.

It’s amazing how the price of gasoline going over $2.50 quickly changes that mindset. Now there are so many web-sites, newspaper articles, editorials, and even blogs on oil no-one can possibly keep track of them all. Moreover, not only is it largely accepted a major foreign policy goal of the United States to secure inexpensive oil for itself many advocate the use of military force to do it. Where once mentioning oil as a driving source of U.S. policy was scoffed at now even top U.S. officials admit it is front and center:

Rising global oil prices are bolstering the power of America's enemies around the world, strengthening the regimes in Iran, Syria, Sudan and Venezuela and increasing Russia's assertiveness in eastern Europe, US intelligence agencies said on Thursday.

Two days after President George W. Bush called for the US to end its "addiction to oil", John Negroponte, the Director of National Intelligence, said the combination of rising demand for energy and instability in oil-producing regions "is increasing the geopolitical leverage of key producing states".

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The Director said that world energy markets seem certain to remain tight for the foreseeable future. Robust global economic expansion is pushing strong energy demand growth and—combined with instability in several oil producing regions—is increasing the geopolitical leverage of key energy producer states such as Iran, Saudi Arabia, Russia, and Venezuela. At the same time, the pursuit of secure energy supplies has become a much more significant driver of foreign policy in countries where energy demand growth is surging—particularly China and India.

Negroponte said that the changing global oil and gas market has encouraged Russia’s assertiveness with Ukraine and Georgia, Iran’s nuclear brinksmanship, and the populist “petro-diplomacy” of Venezuela’s Hugo Chavez. Russia’s recent but short-lived curtailment of natural gas deliveries to Ukraine temporarily reduced gas supplies to much of Europe and is an example of how energy can be used as both a political and economic tool. The gas disruption alarmed Europeans—reminding them of their dependence on Russian gas—and refocused debate on alternative energy sources.

Foreign policy frictions, driven by energy security concerns, are likely to be fed by continued global efforts of Chinese and Indian firms to ink new oilfield development deals and to purchase stakes in foreign oil and gas properties. Although some of these moves may incrementally increase oil sector investment and global supplies, others may bolster countries such as Iran, Syria, and Sudan that pose significant US national security risks or foreign policy challenges. For example, in Venezuela, Chavez is attempting to diversify oil exports away from the US.

Now, given that these comments were given by the U.S. intelligence director they tended to de-emphasize one thing – how vulnerable the U.S. is to high oil prices and the damage they can, and likely will, inflict on the U.S. But for that perspective we can turn to Martin Feldstein, one of the most prominent economists in the U.S. who is a professor at Harvard and President of the US National Bureau of Economic Research [from the Financial Times, Feb 3, 2006]:

The price of imported oil in the US doubled between the summer of 2003 and the summer of 2005, reducing consumers’ purchasing power by more than 1 per cent of gross domestic product. Nevertheless, the economic slowdown that was widely expected never occurred. Consumers kept spending kept spending and businesses kept investing. The growth rate of GDP rose and unemployment fell to 4.9 percent.

The continued strong growth contrasts sharply with the economic weakness that occurred after almost every previous significant rise in the oil price. How do we explain this remarkable difference? And what are the implications for the likely response to a future rise in the oil prices?

The key to the economy’s strength in 2004 and 2005 was that household saving declined dramatically while the price of oil rose. Household saving fell from 2.5 per cent of after-tax income in the third quarter of 2003 to a remarkable minus 1.8 per cent two years later. This 4.3 per cent shift of after-tax income was equal to a rise in consumer spending equal to 3 per cent of GDP.

In dollar terms, saving fell from a $205bn annual rate in the third quarter of 2003 to a dissaving at a rate of $159bn two years later. This shift of $364bn in the annual rate of saving far outstripped the fall in income caused by the higher cost of oil. This fall in saving allowed households to raise consumption spending on non-oil goods and services while paying for the higher cost of imported oil.

The primary cause of this dramatic shift was the fall in interest rates and the resulting rise in mortgage refinancing. Homeowners who refinanced their mortgages took out cash and reduced their monthly payments at the same time. Much of the cash obtained by refinancing was spent on consumable durables.... The lower monthly payments permitted a higher level of sustained spending on all non-durable categories.

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The faster increase in consumer spending caused businesses to invest more and raised the growth rate of GDP. Faster GDP growth caused an accelerated rise in employment and a fall in the rate of unemployment.

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Mortgage interest rates were falling because the Federal Reserve’s fear of deflation had caused it to lower the short-term federal funds rate at which banks lend to each other to the extremely low level of 1 per cent in 2003 and to leave it there in the first half of 2004 before beginning a very gradual process of rate increases.

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The powerful effect of mortgage refinancing on consumer spending was a very happy coincidence for the American economy at a time when oil prices were depressing consumers’ real incomes. If oil prices were to rise again in 2006 or 2007, the adverse effect on consumers’ real incomes would not be offset by increased mortgage refinancing. Mortgage refinancing has now peaked and is declining. The Federal Reserve is raising interest rates again to counter the inflationary pressures that remain from the rise in energy costs. And individuals no longer have the large amounts of household equity against which to borrow.

A rise in the oil price could happen again at any time. There is little spare capacity in global oil production and oil demand is rising rapidly in China and other Asian countries. A shock that reduced the production or shipping of oil could drive its price sharply higher. Speculative forces could compound this problem. The US was lucky after 2003 to escape the contractionary effect of an oil price rise even without an explicit change in monetary or fiscal policy. It would not be so lucky if a big oil price happened again now.

So the U.S. dodged the oil bullet once. But as is made clear, it is unlikely to be so lucky again. This means getting control over oil resources and bringing prices down is an imperative for the United States. Further, unlike the past, the U.S. now has major competitors for oil which further complicates matters. This will drive their strategic relationship with Russia, the Middle East, and even Venezuela.

Why Venezuela you ask, when they are so much smaller in terms of oil production than the Middle East and Russia. Two words, Hugo Chavez. The influence of Chavez over the world oil market extends far beyond Venezuela’s own oil reserves, as large as they may be. Whereas Venezuela had been a key country in the undermining of OPEC he almost single handedly revitalized the cartel. Even today, Venezuela and Iran are the two price hawks within the organization consistently pushing for production cutbacks to keep prices high.

What is more, Venezuela has served as a role model for other countries wishing to maximize the value of their oil resources. Example number one would be Russia were Vladimir Putin has re-exerted state control over much of its oil industry and restrained production further helping boost world wide oil prices. A much smaller example closer to home is Bolivia where Evo Morales has made it clear there will be no giveaways of Bolivia’s hydrocarbon resources.

Yet as bad as all that is for the U.S. their biggest nightmare is the Middle East lurching further out of their control. Certainly Iraq is refusing to submit to their occupation and Iran is newly assertive. If this radicalism spreads to more Middle Eastern countries, and in particular the oil rich states of the Gulf, the U.S. would face a disaster. And Hugo Chavez, simply by being a role model for change, can help this nightmare scenario be realized if people in the Middle East start to take note of what he is doing in Venezuela. And they are as this Muslim scholar shows [consider reading the whole article linked to as it is excellent]:

In summary, Chavez from the very outset of assuming power has been opposing American interests tooth and nail. With America reeling from the wars in Afghanistan and Iraq, its preoccupation with the war on terror, the failure to remove Chavez from power has become a source of consternation amongst US politicians. No doubt America will try to over throw him but he has so far proved extremely resilient and has survived a number of coups attempts. This in itself suggests that Chavez's grip on power is strong and extensive.

Chavez's escapades against the most powerful nation on earth contain important lessons for the Muslim world. Muslims countries, especially those that have abundance of oil and gas reserves should start using these resources as weapons

If a single country like Venezuela can have a huge impact on American foreign policy then a collection of Muslim countries pooling their resources together are likely to have devastating affect on America's standing in the world.

Indeed it is this very reality that the Bush administration is clambering to prevent. Warnings about the re-establishment of the Caliphate are now part of the official parlance of the American government. So much so that dealing with Chavez's resistance to US policy in Latin America has become a low priority for the Bush administration. Could it be that America is on the verge of loosing both the Muslim world, as well as Latin America? No one would have entertained such a notion five years ago, but now such a prospect seems more and more feasible.

Indeed, if you want to understand why the U.S. is obsessed with Chavez and removing him from power remember oil and then this: “If a single country like Venezuela can have a huge impact on American foreign policy then a collection of Muslim countries pooling their resources together are likely to have devastating affect on America's standing in the world.” It’s not Chavez alone that gives them fits. Its the example he sets and the possible ramnifications for the U.S. of that example being followed by others. So while there are always multiple drivers in international politics it really is now largely about oil which in turn makes it largely about Chavez.
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