George W. Bush’s regime-changing war in Iraq is widely seen as an oil war — a grab for the second-largest petroleum reserves in the world. In the minds of many, this interpretation was confirmed when the United States pressed for, and secured, a UN resolution giving the US-British occupying authority control over expenditure of Iraq’s oil revenues. Without a doubt, Washington does see a major role for foreign oil companies in the expansion of the Iraqi oil sector — a vision it shares with senior officials in the Iraqi oil ministry. But calculations about “controlling” Iraqi oil figured most prominently in the strategic, rather than the merely commercial, thinking of the Bush administration about the invasion. Washington hawks saw a US-allied Iraq as an alternative to Saudi Arabia as the strategic supplier of oil to the United States. They also thought that increased Iraqi output would create structurally lower oil prices, putting financial pressure on Saudi Arabia and other oil-producing states of the Gulf, and forcing those states to reform economically and politically to avoid internal upheavals. Iraqi oil, in the hopes of the neo-conservatives and their allies who pushed the war, would eventually become a weapon for undermining Arab regimes and Iran, bringing “democracy” to the Middle East and making the region safer for the US and Israel.

The US invasion of Iraq does have the potential to change the dynamics of the global oil market fundamentally. Given the centrality of oil (and gas) to the political economies of Gulf countries, it logically follows that oil market changes will radically alter politics in the region. That much is certain.

But the exact pathway and timing of these changes are quite uncertain. Recent history teaches one not to underestimate the adaptive capacity of Gulf regimes to changes in the oil market and corresponding threats to the patronage politics they have created. Cooperation between Gulf states and with other OPEC members to maintain high oil prices and, therefore, sufficient revenues has proven unexpectedly resilient. The absence of effective pre-war planning for the “day after” in Iraq, and the subsequent inability of the US and British occupying forces to restore state services and local security, could throw a spanner in the works of the neo-conservatives’ grandiose strategic plans. Though the US may have delivered the intended shock to OPEC with its audacious war, the calculus of the players who will shape the future of the world oil markets will respond to deeper historical trends — particularly Saudi Arabia’s conscious drift away from exclusive dependency on Washington.

The Swing Producer

Saudi Arabia, home to the world’s largest petroleum reserves, maintains its strategic importance — especially to Washington — by intervening in the market to ensure moderate prices for the world economy. This imperative must be balanced, however, with the Saudis’ other key objectives of keeping a large market share for themselves and keeping prices high enough that other OPEC countries will not rebel.

Until 1995, Saudi Arabia was very concerned to protect its market share. The Saudis have bitter memories of the early 1980s, when they reduced their production to barely 2 million barrels per day (when they could have produced 10 million) to keep prices low. Other OPEC members did not make comparable sacrifices, and oil companies began to buy proportionally less oil from the Saudis. After Iraq invaded Kuwait and the UN embargoed its oil sales, the Saudis drew a “line in the sand,” refusing to cut production or their OPEC quota under 8 million barrels per day (b/d). Part of this new share (up from the 5.6 million b/d it was allowed to produce before August 2, 1990) Riyadh had appropriated for itself from lost Iraqi output. Moreover, King Fahd’s unequivocal support for US geopolitical interests led the Saudis to back a price range of $15-18 a barrel through 1995.

That oil price range proved disastrous for OPEC finances. Saudi Arabia was virtually bankrupted by 1994. The combination of depleted foreign assets, partly due to payments to the US for expelling Iraq from Kuwait and subsequent arms purchases, a rapid buildup in domestic debt and growing political demands required a change in course. Then Crown Prince Abdallah assumed the reins of power due to King Fahd’s illness. Gradually, the Saudis’ stance at OPEC became more amenable to higher oil prices, though they were careful not to say this explicitly so as not to alarm the US. This Saudi shift from a market share policy to a price defense policy was the basic building block of higher oil prices for OPEC. During 1995 and 1996, OPEC engineered a rise in prices above $18 a barrel to annual averages of $21.

Viva Chavez

Three factors came to undermine OPEC’s attempts at sustaining prices above $20 per barrel as the 1990s wore on. Venezuela, a key OPEC member with the ability to influence Atlantic Basin markets, and its national oil company PDVSA adopted a radically new strategy under the company’s dynamic new president, Luis Guisti. Guisti began buying up refineries in the US, creating “captive buyers” for Venezuelan crude. As Venezuela’s overseas refining capacity increased, it set in train plans to increase domestic crude oil capacity to feed into its downstream assets overseas. In this way, Caracas planned to become North America’s main oil exporter and shut out the competition. Guisti’s bid for higher production meant he paid little attention to OPEC quotas and even threatened to withdraw Venezuela, a founding member, from the organization.

Around the same time, Iraqi oil returned to the market under the auspices of the UN Oil for Food program. At first, exports were restricted to a dollar amount, but eventually all external constraints on Iraqi oil sales were removed. When it came on the market in the winter of 1997, Iraqi oil added a further burden to world oil markets already reeling from weakening demand.

The third factor, a major contributor to weaker demand, was the Asian financial crisis in 1997. Gulf producers saw Asia as their principal growth market — the market that had saved them during the grim days of the late 1980s when non-OPEC crude from the Soviet Union, the North Sea and Mexico had crowded them out of the Atlantic Basin. Now, with Venezuela’s strategy targeting North America and the Atlantic Basin, the Gulf producers, particularly Saudi Arabia, feared the effects would be doubled. The threat to the Saudis was real enough for them to allow prices to fall in 1998 to single digits. Much to the surprise of many, the oil price was allowed to bump along the bottom until early 1999.

Two years of low oil prices completely knocked the bottom out of the beleaguered Venezuelan economy just as elections were held in late 1998. Those elections saw the rise to power of Hugo Chavez. Under the tutelage of former guerilla leader Ali Rodriguez, a member of the National Assembly with a keen interest in the oil markets and current head of PDVSA, Chavez brought Venezuela back into the OPEC fold. Higher oil prices were necessary for Chavez’s plans to accelerate income redistribution in the country. Higher oil revenues would go directly to his core constituency, the poor underclass of Venezuela’s main cities, who had long maintained that Venezuela is a resource-rich country largely monopolized by a small circle of businessmen, bureaucrats and an “aristocracy of labor.” At the March 1999 OPEC meeting, in a landmark deal that bespoke new Saudi attitudes toward oil prices as much as those of Chavez, the Saudis agreed to cut output below their “line in the sand” of 8 million b/d, while the Venezuelans cut theirs below 3 million b/d. With other OPEC members and even non-OPEC members (including Mexico and Norway) cooperating, a substantial amount of oil was removed from the markets.

Traders took this as a strong indication that OPEC members had stopped competing for market share. Supported by unprecedented OPEC cohesion and global economic recovery from 1998-2000, oil prices reached the upper $30s per barrel by the summer of 2000. World oil markets were giving the oil producers’ organization the best of both worlds — high oil prices and higher production.

Living in the Neighborhood

The blossoming relationship between Iran and Saudi Arabia has strengthened OPEC cohesion before and since the March 1999 meeting. President Ali Akbar Hashemi-Rafsanjani, breaking sharply with Ayatollah Khomeini’s hostility to Saudi Arabia, perceived that a cordial relationship with his Gulf neighbor had several advantages. A non-threatening stance toward Riyadh might signal the US and the West that Iran was ready to rejoin the world community. Greater regional stability would improve the environment for desperately needed foreign investment in Iran. Possibly, warming to the Saudis might yield higher oil prices, which Iran also needed badly, not only to meet basic needs but, after 1992, to repay its large foreign debt. The Iranians feared US pressure would undermine debt renegotiations with the Europeans leading to extremely onerous terms.

Until the election of President Mohammad Khatami in 1997, the Saudi-Iranian relationship remained largely in the closet, due to divisions within the ruling family. By 1998, however, the Saudis became newly sensitive to Iran’s precarious financial standing, which reminded them somewhat of their own at the time. Both Iran and Saudi Arabia wanted higher oil prices, but that was not the only basis of the maturing partnership. As much as Tehran wanted the Saudi seal of approval for consumption in the West, the Saudis needed to show their own populace that the Kingdom’s regional policy was becoming more rooted in the neighborhood. Growing popular anger within the Kingdom toward US failure to move the Oslo “peace process” forward and staunch US support for the UN embargo on Iraq required that the Saudi royal family distance itself from Washington. An entente with Iran, under US sanctions, provided the means to achieve this makeover. The Saudi price defense strategy, the election of Chavez and the Saudi-Iranian entente helped OPEC to defy many forecasts and keep prices around $26 per barrel through 2003.

Growing Ill Will

At first, the US chose to ignore the changes taking place in the Gulf in the mid-1990s. But with persistently high prices continuing beyond the winter of 1999 into the summer of 2000, mainly due to natural gas shortages, Washington began to make public comments about Saudi Arabia’s role in lowering oil prices. The Clinton administration feared that high energy prices would exacerbate the slump in the economy, which began in 2000. With the 2000 presidential elections nearing, the White House and the Gore campaign panicked. The economic boom — the campaign’s strong suit — looked to be in jeopardy. Worse still, the Democrats suspected that the Saudi ruling family’s closeness to the Bush family may have contributed to their seemingly slow response to US demands for higher production and lower prices. Energy Secretary Bill Richardson, who had aspirations of becoming Gore’s running mate, publicly berated the Kingdom. Worse still from the Saudi perspective, the White House ordered a small release from the Strategic Petroleum Reserve.

Whether the Saudis were playing the market to favor the Bush campaign is not at all clear. Certainly, at the time, Gulf regimes — even senior Iraqi officials — believed that Bush would be more “pro-Arab” and less partial to Israel than the Clinton administration. But Saudi interference in internal US politics, beyond insider lobbying, seems a stretch. There is, however, considerable evidence that the Clinton administration and Saudi Arabia enjoyed less then cordial relations. Saudi Ambassador Prince Bandar, who enjoyed easy access to the first Bush White House, was hardly consulted in the Clinton era. The Oslo process, though welcome in Riyadh, lacked even the minimal Arab input of the Madrid process initiated by Bush Senior. The US was rigid in its position on Iraq, despite much Arab sympathy for Iraqi civilians under sanctions. With the terrorist attacks on US personnel in Saudi Arabia and the Gulf, relations deteriorated as each side accused the other of insufficient cooperation. The collapse of the Camp David summit in July 2000, followed by Clinton’s public statements blaming Arafat for the failure, played into the growing mutual ill will. Riyadh saw Richardson’s public pressure as portraying the Saudis as mere economic pawns of the US, the last thing the Saudis wanted in the charged atmosphere. The oil ministry technocrats saw the strategic reserve release as an attack on their ability to manage the market. By the end of Clinton’s term, the Saudis had abandoned King Fahd’s policy of pursuing moderate prices in line with Washington’s interests and clearly signaled that Saudi oil policy pursued distinctly different objectives than those of Washington.

September 11

Upon George W. Bush’s capture of the White House, Riyadh made it known that the Kingdom would increase output in the winter months as a welcoming gift to the new administration. In this atmosphere of initial good will, the Bush administration made the right public noises and private gestures. New Energy Secretary Spencer Abraham, an Arab-American, was dispatched to Riyadh to “privately” impress on the Saudis the need for an easing of prices. The Saudis, too, made the right public sounds, seeming to indicate that they were willing to reassume their old stance, at least in style if not in substance.

The September 11, 2001 attacks and the discovery that 15 of the 18 hijackers were Saudi Arabian citizens had a profound impact on US attitudes toward Saudi Arabia and its strategic role as the world’s swing producer. The media and prominent think tanks began to question the stability of the regime in Riyadh and its ability to carry out its duties as stabilizer of oil markets. This scrutiny built on earlier unease with changes in Saudi oil policy that had been simmering under the surface. Now it burst out into the open, with calls for the US to seek out new strategic partners for the maintenance of sufficient and economical supplies of energy. Pro-Israel groups within the US, who had long chafed at the need for the US to accommodate the Saudis, exploited the ambient sense of alarm. They contended that the Kingdom was a hotbed of Islamic fundamentalism that could and would hold global energy supply hostage.

In the fall of 2001, Russian President Vladimir Putin and a number of oligarchs who had assumed control over some of Russia’s biggest oil companies stepped into the breach, arguing that Russia could be the new strategic partner to the US. They showed that Russia had reversed its huge decline in oil production, and could raise production by a million b/d per annum for the foreseeable future. Higher oil prices and a strategic deal between Putin and the oligarchs were responsible for this turnaround. By the deal, Putin would guarantee the oligarchs’ recent and very controversial acquisition (outright theft in most cases) of the Russian oil companies. In return, the tycoons would make substantial investments in the Russian oil sector, financed through the repatriation of their overseas assets. Putin took this idea to Washington and to Crawford, Texas. He guaranteed safe passage for crude oil from the expanding oil and gas sectors of the Central Asian republics. Foreign oil companies had developed the giant Tengiz field on the Caspian in Kazakhstan and built a pipeline to transport it to the Novorosissk port on the Black Sea. Russia also hinted that it would remove roadblocks to the Baku (Azerbaijan) to Ceyhan (Turkish port on the Mediterranean) pipeline that would transport Azeri crude into the Mediterranean.

Resilient Status Quo

These dramatic gestures, as well as the crash of the stock market in the fall of 2001 and prospects of a deep recession, frightened Saudi Arabia and OPEC going into the winter months of 2001 and early 2002. In the immediate wake of the September 11 attacks, the Saudis had unilaterally raised output as a gesture to the US and as a means of calming market jitters. Now, with a collapse in demand looming and rising non-OPEC supplies, Riyadh and other OPEC members feared that global stocks would rise rapidly, particularly in the spring months of 2002.

They called on Russia to cooperate with OPEC in cutting back production, but were rebuffed. Russia was playing a game of chicken with OPEC — a collapse in oil prices would not have served its economic interests either, since it had just emerged from recession and financial crisis. A large part of Russia’s economic recovery could be attributed to higher oil prices and the oil sector boom, which attracted substantial sums offsetting massive capital outflows. In the short run, Russia got the best of both worlds. OPEC cut supplies massively to support prices above $20 per barrel and simultaneously made room for additional Russian supplies.

But the world oil markets and US policymakers noted two caveats: because of its internal unity, OPEC was very much in control of the markets and had successfully managed prices in very adverse circumstances. Russia could not play this role, either by swinging production up to moderate prices or swinging down to shore up prices. Undoubtedly, Russia had added to diversity of supplies — a key concept in energy security thinking within the Beltway — but it did not have (and could not have, given that the private sector runs the oil industry) the spare capacity needed to stabilize markets.

The resiliency of the status quo was convincingly demonstrated in early 2003. Oil workers and executives of PDVSA walked off their jobs in protest against the Chavez government in late 2002 and remained on strike into the new year. For a period, the world lost nearly 3 million b/d of crude oil and products. At the same time, Nigeria’s oil production was disrupted, and on March 20, nearly 2 million b/d of Iraqi crude production halted when the US and Britain invaded. Saudi Arabia raised output from 8.4 million b/d to 9.5 million b/d while other OPEC members raised output to their maximum levels. The Saudi move was designed to show Washington that there was only one swing producer, one country truly willing to prevent extremely high spikes in oil prices. In the wake of Saudi ambivalence about Washington’s invasion of Iraq and its unwillingness to fully share bases and material with the US, Riyadh at least bought itself some good will.

Occupiers’ Amateur Hour

If Russia cannot replace Saudi Arabia, can Iraq? Some pundits have begun to say so. But before their dreamed-of break with Riyadh can occur, the US will need to execute the much more mundane task of securing the post-war peace in Iraq, a much greater challenge than Washington anticipated. For all its rhetoric and regional ambition, the Bush administration failed to devise any detailed plan for running Iraq after Saddam Hussein was gone. Divisions within the Bush team, and the intransigence of neo-conservative hawks in the Department of Defense and Dick Cheney’s office, prevented agreement on anything more than general guidelines. The consequences of this failure are now readily apparent.

Indeed, US management of post-war Iraq is beginning to look decidedly amateurish. Occupation forces have failed to restore more than a modicum of law and order in many parts of Iraq, particularly the capital, which is suffering from an ongoing wave of armed attacks, random kidnappings and killings, and continued looting of government buildings. The vast majority of the population has been left fearing for their personal security, day and night. Basic services like electricity, water and gasoline supply remain patchy, leading many Iraqis to compare today unfavorably with the deposed regime’s response after the 1991 Gulf War, when security and services were restored quickly after much more massive damage to local infrastructure. To many in Baghdad and further afield, the Office of Reconstruction and Humanitarian Affairs (ORHA) — the occupation authority — is a detached institution that appears to be genuinely ignorant not just of the most pressing priorities, but of the depth of the problems faced outside the well-secured walls of the former Republican Palace on the west bank of the Tigris (which ORHA has taken as its command center). ORHA’s overwhelming preoccupation with the political transition and creating the basis for a free market stands in stark contrast to the quotidian concerns of most Iraqis.

ORHA’s performance over the next few months will have major implications for US plans for the Iraqi oil sector, and consequently the wider regional ambitions of the neo-conservatives. In the very short term, failure to restore public security will hinder Iraq’s attempts to restore pre-war production, particularly in the south. Ongoing looting and the inability of Southern Oil Company personnel to carry out appraisals of the local fields has severely hampered the process of bringing production back online at the country’s workhorse fields of Rumaila and Zubair. Especially problematic has been the damage looters have caused to the water treatment plant at Garnat Ali, which has halted the water injection crucial for ramping up production in Rumaila (which produced 1.2 million barrels per day prior to the war). A lack of electricity and fuel has also complicated operations in the south, and pushed back the timeline for returning to anything approaching pre-war output.

At the same time, the oil ministry has been rocked by the sweeping de-Ba’thification measures that ORHA introduced in mid-May. While many senior officials within the ministry were party members, the overwhelming majority reached their positions on merit, not favor. The ministry stands to be robbed of some of its best and most experienced talent. Even if exceptions are made — as seems likely — fear of being purged has preoccupied many ministry staff whose attention would have been better directed toward more practical matters. De-Ba’thification has encouraged a phenomenon apparent in all ministries and government institutions since the war, whereby staff have insisted that their new democratic status gives them the right to choose their management far up the totem pole. In the future, difficult management decisions in the oil ministry may be greeted by industrial action and demands that the officials involved be removed.

Klondike Delayed

Given its preoccupation with other issues, ORHA may neglect to address security and inefficiency, leading the whole occupation enterprise to come apart, ambitions for the oil sector included. The occupation forces do not have the luxury of time to get it right. Public hints that they are operating on the basis of trial and error, not to mention ongoing ideological battles within ORHA itself, are not encouraging. Anti-occupation sentiment is already on the rise — not just from members of the ancien regime. If, over the very hot summer months, the lot of average Iraqis is not noticeably improved — especially in Baghdad — violence against US forces may escalate, and any hopes of a relatively smooth political transition will fade away.

Any such instability is sure to hamper long-term development of the Iraqi oil industry. While access to Iraq’s oil wealth, with its 112 billion barrels of proven reserves and very low production costs, will tempt foreign oil companies, they will not throw money down the drain. The costs involved in developing new output in the sector, estimated at as much as $40 billion over 7-10 years, mean that firms will want guarantees before investing. To be sure, firms want to see the dangers of operating in-country mitigated. But more importantly, they will demand a predictable legal and constitutional setup ensuring that the contracts they sign will be worth the paper they are written on a number of years hence. Oil companies will want to see a new, stable sovereign government in place before money, technology and training — the priorities for the sector — start to flow into Iraq.

At the very least, the problems of securing the peace, and the task of political transition, is going to delay the influx of investment. Visions of Iraq producing 5-6 million barrels per day within five years, as some formerly exiled political parties have suggested, are pure fantasy. Contract negotiations for Iraq’s untapped big southern fields, which will provide the basis for most of the new production, will not begin until a new sovereign government is in place, and that could take 18-24 months. Actually concluding a deal to drill in the Iraqi Klondike is likely to take longer still. All of this will push back the lofty production goals that the US and many Iraqis hope to achieve, assuming that Iraq’s politics are sufficiently stable for deals to be struck at all.

The Coming Price War?

The ease with which OPEC manages Iraq’s return to the oil market will depend heavily on how rapidly Iraqi engineers, traders and their US overseers resuscitate the sector. Up to 2-2.5 million b/d of Iraqi output can be managed in much the same way that OPEC dealt with volatile Iraqi production under the UN Oil for Food program. But the longer-term prospect of foreign investment in Iraq and the potential for its output rising rapidly over 3 million b/d has already started to unnerve the organization. Looking ahead, OPEC faces tepid increases in demand, much of which will be met by increases in non-OPEC supplies from the Gulf of Mexico, West Africa, Brazil and Central Asia, not to mention Russia. As a result, OPEC’s own production, after accommodating, Iraq will remain flat well into the last part of this decade.

To complicate matters further, OPEC’s own capacity has risen substantially. A number of OPEC members, notably Algeria, Libya and Nigeria, allowed foreign companies into their nationalized oil sectors in the 1990s to expand capacity. To comply with stringent OPEC discipline, they constrained their nationalized production, allowing oil pumped by these companies to come online. While they benefited from higher prices, the prospect of a large portion of their capacity going unused is exacting a burden on their sectors. These excess-capacity countries are now arguing, sotto voce, that, given Iraq’s expected return, Saudi Arabia, which gained so much from Iraq’s exit in 1990, should absorb a disproportionate quota reduction and provide them with room to increase their production. OPEC is set to revisit the basic disputes that animated its meetings and deliberations in the late 1980s and 1990s.

Will Saudi Arabia accommodate its fellow OPEC members or will a price war ensue? There are a number of compelling arguments for a new price war. Lower oil prices will likely knock out more expensive non-OPEC oil in the US, Canada and the North Sea. Moreover, it will discourage new investment in costly projects such the tar sands development in Canada, deep offshore high-tech production and remote areas of Russia. Lower prices could also lead to another round of mergers among private companies in the West, thereby diverting capital from new development to buying existing oil assets. These losses in non-OPEC production would then provide extra room for OPEC output. This extra room could be allocated to the countries demanding disproportionately higher quotas. For a country like Saudi Arabia, lower prices are a stick with which to beat OPEC’s quota cheaters, given the damage their budgets and balance of payments would sustain while they wait for a larger chunk of world demand.

Can Saudi Arabia afford to allow prices to remain low for several years? Less than a decade ago, Saudi budgets were in severe disrepair. But over the last four years, Saudi Arabia has built up foreign assets, stabilized its domestic debt and instituted limited structural reforms that have restored not only macroeconomic stability but also growth. The private sector, fearing increased scrutiny of its foreign assets in the West and sensing more accommodation by the ruling family of its economic demands at home, is repatriating capital, adding buoyancy to Saudi Arabian investment, stock and real estate markets. If the ruling family opens infrastructure, energy and industrial projects to the private sector, many larger companies and merchant families have argued they would be willing to repatriate even larger sums. Another period of low oil prices will force the government to incur sizable budget and external payments deficits, and may lead back to capital outflow. But a calculated move to reimpose control over world oil markets through lower prices may be worth the limited depletion of some of the foreign assets built up during the last few years.

Politically, the ruling family has also cleared more space for itself. Since 1995, with the ascension of Crown Prince Abdallah, the ruling family has reasserted its primacy and, to a certain extent, improved its legitimacy in the Kingdom. The policy drift of the early 1990s, political agitation in the heartland of Kingdom and calls for more accountability by the private sector are things of the past. Abdallah’s attempts at better governance, limited controls on ruling family power and expenditures, general fiscal probity, new economic plans and institutions to manage them, and the reoriented and more activist foreign policy have paid dividends for the family. Popular anger at the US has been deflected.

Nonetheless, even Abdallah’s supporters within the Al Saud recognize that the guarded reforms are not enough. While they wanted to overturn earlier concessions toward more representation at home, they now appear to tolerate calls for national and regional elections. Economic plans in the mid-1990s favored foreign investment as the engine of growth for the economy. Now, Abdallah and his advisers appear to be siding with the view that Saudi Arabia’s image and minimum demands for investment may deter foreign investment and that the domestic private sector should be encouraged. The government may even accept the private sector’s demands for a greater say in policy if domestic businesses will hire more Saudi Arabians.

Given enormous uncertainty over US intentions and talk of a “democratic” domino effect in Washington, the Saudis have an interest in tinkering with “democracy.” Already, Riyadh has matched the promulgation of a new code of law and restrictions on the morals police with an invitation to Human Rights Watch to assess the prison system in the Kingdom. Riyadh is also going to some lengths to convince at least parts of the US government that it is becoming more tolerant in matters of religion.

Between Tehran and Washington

Even if the home front is secured, the Saudis will have to assess Iran’s willingness to go along with lower prices. Only five years ago, Iran defaulted on its foreign debt payments for the second time in a decade. In 1998, its foreign debt was $25 billion and its foreign assets were a meager $1 billion. At the end of March 2003, the end of the last fiscal year, Iran had reduced its foreign debt to $7 billion and increased its foreign assets to $25 billion. This dramatic reversal came in the wake of higher oil prices, a concerted effort to pay down debt as a matter of national security, increased access to foreign capital markets, more European project finance and the creation of an oil stabilization fund. Economic growth also returned to Iran for the first time since the early 1990s. This time, however, it was accompanied by fiscal stability, a competitive exchange rate and lower inflation.

Iran is much better placed to take the hit of lower oil prices from a purely financial point of view. But one potentially dangerous development for Iran is the presence of the US on all of its borders. US failure to stabilize Iraq will directly and indirectly drag Iran into a confrontation with Washington, as happens intermittently with verbal, diplomatic and physical skirmishes in Afghanistan. Neo-conservative hawks, who already see Iran as the next target, will be invigorated by the predictable US accusations that Iran is fomenting opposition to the US occupation. They believe Iran is ripe for popular revolt if the right pressure is brought to bear on the regime. If the US turns more aggressively toward Iran, it will undoubtedly start with UN sanctions and restrictions on financial and trade flows. For this reason, Iran may view lower oil prices as undermining the financial cushion it will need for this eventuality.

The Saudis also have to take US interests into consideration should they opt for lower prices. Under normal circumstances, 2003 would be a perfect time to reduce oil prices, with the world economy is in a slump. If there is one critical weakness in Bush’s reelection campaign, it is the sagging economy. But today the US runs Iraq, giving Washington a keen interest in sufficient oil revenues to help restart Iraqi economic activity. A major decline in prices at this juncture would prove costly for the US budget as the US attempted to fill the spending gap in Iraq. Worse still, the US might ask the Gulf countries to shoulder portions of the rebuilding effort — a request for which no Gulf regime has an appetite.

Caution and Cooperation

In the late 1990s, the expectation of lower oil prices for the foreseeable future was seen as undermining the status quo in the Gulf countries. To a certain extent, they did. But the regimes survived, if somewhat shaken.

After the Iraq war, the Gulf countries — particularly Saudi Arabia and Iran — face a much greater challenge. The removal of Saddam Hussein’s regime and US control over Iraqi resources will destabilize long-term oil markets. Much depends on what the US chooses to do with the Iraqi oil sector. ORHA could opt for an approach along the lines of what Saddam Hussein himself wanted to do in the early 1990s: leave current oil assets in the hands of the Iraqi National Oil Company and fund new development under production sharing contracts with foreign oil companies. A new Iraqi government would thereby gain control over timing of investment and production, very much in the way that other OPEC governments who have let foreign oil companies into their countries have done. This approach would be compatible with a cooperative stance within OPEC, although a pro-US government in Baghdad may be willing to entertain Washington’s desires and needs with regard to oil prices. With the resultant concentration of oil revenues in the hands of a new group of leaders, Iraq could return to being an authoritarian rentier state.

Alternatively, the US could push for total privatization of the oil sector. If privatization is done badly, the sector could wind up controlled by an oligarchy, as in Russia. If it is done well, with an eye to maximizing efficiency and competition, the sector would be split among many companies with little individual monopoly or oligopoly power. Both these options would pose significant challenges for OPEC, which would lose the ability to control the speed of Iraq’s reentry into the market. But the latter option would enhance the chances that Iraq will emerge from US occupation with even an imperfect democracy. Direct distribution of taxes and royalties from the oil sector to the people, with the establishment of an income tax system, the diffusion of economic power and the probability of future fiscal stability would further improve the odds of participatory politics in Iraq.

Unable to predict the outcome in Iraq, much less in Washington, the Saudi and Iranian governments will likely choose caution and cooperation as they manage the oil markets. The tools of the Saudi-Iranian entente, along with greater political and economic flexibility on their part, will likely help both regimes cling onto power despite Washington’s new strategic policy of spreading “democracy” by the sword.

How to cite this article:

Raad Alkadiri, Fareed Mohamedi "World Oil Markets and the Invasion of Iraq," Middle East Report 227 (Summer 2003).

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