Pipe Dreams in Iraq

The U.S. invasion of Iraq came and went this year without an Arab embargo or oil shock of the sort that traumatized the world during the 1970s. This outcome may bolster the view of those who suggest that Saudi Arabia is losing its grip on the global oil market-and that the liberation of Iraq’s vast oil bounty will be the undoing of the Organization of the Petroleum Exporting Countries (OPEC).

Well, why not? Iraq has the world’s largest reserves of conventional petroleum after Saudi Arabia, leaving it well positioned to challenge the cartel leader. Also, most Iraqi reserves are cheap to exploit; like those of its larger neighbor, but unlike those in much of the world, they cost hardly a dollar or two per barrel to produce. Moreover, any new government in Iraq will be desperate for revenue and will want to expand the country’s oil production right away. Of course, the nation’s shoddy petroleum infrastructure — last substantially revamped in the 1970s — means that Iraqis could not suddenly ramp up output, but eventually Iraqi oil will put pressure on OPEC and its system of production quotas. Is it really a stretch to think that a pro-U.S. regime in Baghdad would go one step further to undermine the Saudis by leaving the cartel altogether? By flooding the world with Iraqi oil, goes the argument, Iraqis might be able to make billions in oil earnings and please their U.S. liberators in the bargain.

Nice try, but it will take more than the ouster of former Iraqi leader Saddam Hussein to displace the House of Saud from the center of the oil universe. Start with where most of the world’s oil is actually located. Fully a quarter of the globe’s conventional oil reserves sits under the parched expanses of Saudi Arabia. No other country even comes close. Iraq holds perhaps one tenth of the world’s oil, and the much-ballyhooed fields in Russia, the Caspian Sea, and other non-opec regions represent even tinier shares. Meanwhile, the United States, which accounts for one fourth of the world’s oil consumption, can claim only about 3 percent of the world’s reserves. (Consider those sobering sums the next time U.S. politicians and lobbyists talk nonsense about opening up some pristine bit of protected land in Alaska or elsewhere to bolster energy independence.)

The world still needs Saudi Arabia, and though the headlines do not trumpet this news, mainstream energy forecasters at the International Energy Agency and the U.S. Department of Energy recognize this reality. Their long-term oil scenarios predict that the quantity of oil pumped by the Persian Gulf nations — and especially by Saudi Arabia — will double, and the share of the world market held by those countries will increase by 30 percent, in the next 20 years. Such forecasts hardly reflect the limits to growth mindset that dominated energy thinking back in the 1970s. Rather, these analysts assume that major international oil companies will spend hundreds of billions of dollars to develop new exploration and production technology in non-OPEC areas. And still, they contend, the world will need ever more Saudi oil.

Two other factors ensure that Saudi Arabia will not be toppled from its perch atop international oil markets, let alone by Iraq. First, consider spare capacity. In the last two decades, the Saudi regime has kept many oil wells idle to manage market forces. When global oil supplies have suffered disruptions, such as during the Iranian revolution and the Iran-Iraq War, the Saudis quickly brought that idle capacity on stream. They did so again this year as the Venezuelan political crisis, fractious Nigerian elections, and the war in Iraq combined to reduce world oil supply. This buffer gives the Saudis enormous power over the oil market; it would cost tens of billions of dollars for any putative rival to develop oil fields only to keep them idle. Russia’s private oil firms and Iraq’s cash-starved leaders are unlikely to waste capital this way. So the Saudis are likely to remain the globe’s swing producers.

Second, why should the Iraqis drown the world in Iraqi oil — an ambitious strategy that would require more than a decade and tens of billions of dollars in infrastructure investment? At first, of course, Iraq would earn more money, just as any free rider does when cheating on official cartel quotas. However, that would prove a Pyrrhic victory, since the Saudis would respond, as they have in the past, with a price war. A low-price, high-volume approach might make sense for some producers that happen to have low costs. (That rules out high-cost Russian producers, for instance.) But any Iraqi oil minister would recognize the foolishness of provoking a neighbor who enjoys the same low costs but controls more than twice the reserves. The Saudis would undoubtedly win any price war.

Even an unexpectedly vibrant Iraqi oil sector will not turn the oil world upside down. The only catalyst for that kind of revolution will be the emergence of a radically different way of powering cars and buses that challenges oil’s virtual monopoly on transportation energy. Some analysts see precisely such a disruptive innovation in fuel cells, an environmentally friendly technology that uses hydrogen fuel (which can be made from fossil fuels, nuclear power, or renewable energy sources) to power automobiles. But such a change remains a pipe dream so long as oil is plentiful and U.S. consumers pay so little in energy taxes that, in some locations, gasoline is cheaper than bottled water. Indeed, until the United States acknowledges the hidden price tag of relying on petroleum — ranging from health and environmental costs to at least part of the price of keeping troops in the Middle East — the energy economy is unlikely to move beyond fossil fuels. In a couple of decades, the world may find itself still utterly dependent on oil, but with no commercially viable alternatives on hand. And even if a free and democratic Iraq starts pumping crude like nobody’s business, the world would then become even more reliant on Saudi oil than it is today.