Abstract
Fears of an oil embargo are unwarranted. Nowadays, price manipulation is the preferred setting for the oil weapon.
President George W. Bush never Actually uttered the phrase “oil weapon” in his 2006 State of the Union address. He didn't have to. When he warned that “America is addicted to oil, which is often imported from unstable parts of the world,” he was tapping into the anxieties of many Americans who remember the economic chaos that followed the 1973 oil embargo, instigated as retribution for aiding Israel in the Yom Kippur War.
At first glance, fears of another oil embargo–and of the inflation and economic recession it might provoke–appear unwarranted. Countries such as Norway, Mexico, and Angola, nonmembers of the Organization of the Petroleum Exporting Countries (OPEC), who are motivated solely by immense short-term profits, would like to sell as much oil as possible and are completely uninterested in production and sales restrictions. OPEC representatives have emphasized that they are making outstanding efforts to keep up with demand and are expanding their production capacity. And member state Iran, which depends on oil for 80 percent of its export earnings, has sought to reassure consumers that it has no intention of cutting off oil in response to the escalating dispute over its nuclear program.
Yet the United States remains dangerously vulnerable to the oil weapon, as do other industrialized nations. This peculiar kind of punishment is now less likely to take the form of a full-fledged embargo. These days, it's more like a stealth weapon: Producers can manipulate price and/or supply to influence the behavior of consumers–and may be able to use their power to destabilize the strongest of nations.
Oil producers are fully aware that petroleum is such a vital commodity for a modern state–both economically and militarily–that an oil embargo would be viewed as an act of war, no matter what the justification. (For example, prior to 1941, the United States made every effort to avoid halting the flow of petroleum products to Japan, in spite of that country's criminal behavior and its invasion and occupation of large parts of China.) Arab oil producers were able to declare an embargo in 1973 thanks to a unique set of circumstances that allowed them to feel confident that the United States would not retaliate. The United States was being torn apart domestically by an imperial presidency, while the long, bitter guerilla war in Vietnam had thoroughly demoralized both the U.S. public and armed forces. Oil consumption had been increasing rapidly, and there was no spare capacity outside of the Persian Gulf to counter any disruption in supply. If it had not been for the crippled state of U.S. executive authority, the embargo would have likely provoked a forceful and aggressive response.
Though the 1973 embargo wrought havoc, price manipulation is perhaps the preferred “setting” for the oil weapon; it is more flexible than an embargo and ultimately much more effective. Demand is broadly insensitive to price, so small changes in supply can gradually, without attracting attention to the process, lower or raise the price to achieve the desired effect.
A 1986 price collapse engineered by Saudi Arabia illustrates this tactic. In late 1985, it appeared that Iraq was about to lose its war against Iran. Meanwhile Iran, which was dependent on oil revenues to fund its war effort, was much more vulnerable to lower oil prices than Iraq, which was supported openly by the Gulf monarchies and surreptitiously by the United States. In an effort to swing the momentum toward Iraq, Saudi Arabia, over a period of three months, abruptly increased production and lowered the price of oil.
As it turned out, the lower oil prices did not force Iran to abandon its effort to defeat Iraq, perhaps because low prices could not be sustained for a long enough period without destroying most of the non-OPEC oil industry, including that of its protector, the United States. Even so, the sudden price collapse inflicted major collateral damage on the U.S. oil sector, as the boom based on high oil prices disappeared virtually overnight, resulting in many personal bankruptcies and abandoned energy projects. Meanwhile, consumers–carefully conditioned not to ask any questions–were blissfully unaware of the strategic reasons behind these manipulations and were simply delighted to pay less for gas.
Price increases can also be deployed, but naturally can arouse considerable hostility. To be successful as an oil weapon, such increases must be imposed subtly with large fluctuations so as to mask what is happening and keep consumers off balance.
Today's high gasoline prices, for example, are not the product of a sudden price hike but represent the end point of OPEC's long, convoluted strategy of managing the oil market. In 1998, when the United States was (again) distracted by a constitutional crisis, the Saudis, in an effort to impose market discipline, refused to cut their production to match demand, causing prices to fall from $18.70 per barrel in October 1997 to $9.40 per barrel in December 1998. Two years later, OPEC hiked prices up to $30.50 per barrel, well above where they were in the mid-1990s. After considerable U.S. protest, OPEC officially proposed a target price range of $22-$28 per barrel. This was significantly higher than the earlier range, but the United States was mollified because OPEC had “lowered” its prices.
The aftermath of the U.S. invasion of Iraq likewise demonstrates the skillful use of oscillating price increases and decreases to arrive at a grossly inflated price tag. Immediately following the March 2003 invasion, the price of crude dropped from $32 per barrel in February to about $26 per barrel. As the Saudis had promised, the Gulf oil producers increased production to compensate for the temporary loss of Iraqi exports. However, oil prices soon began to increase with considerable variability as OPEC understood that demand was rapidly increasing from the Far East and that prices could be raised significantly without disrupting the world economy. As of mid-April 2006, despite adequate supplies in the market, the New York spot price of crude was more than $70 per barrel due to increasing concerns over a potential U.S. Tran confrontation.
In the United States, average gasoline prices are about $3 per gallon (late April 2006), compared to an average of $1.35 per gallon in 2002. OPEC revenues have soared and are now higher than they have ever been since the early 1980s. The OPEC price range has been officially abandoned and has curiously disappeared from popular commentary and analysis.
The effect of higher prices is much more significant than U.S. consumers realize. The U.S. trade deficit has grown rapidly over the past few years and, in 2005, was about $725 billion, or nearly 6 percent of the annual gross domestic product. Net U.S. petroleum imports were about $230 billion, or more than 30 percent of this total. No other country in the world could sustain a deficit of this magnitude for any length of time. Many economists understand that this condition is unstable and unsustainable, and that at some point foreign investors will lose faith in the dollar and demand ever-higher interest rates.
In addition, there looms the question of resource constraints. OPEC has conducted its own studies that indicate (based on highly optimistic output estimates from the North Sea and Mexico) that non-OPEC production should peak by about 2015. ExxonMobil and another U.S. petroleum consulting group place the date earlier, in 2010. From that point onward, OPEC will be expected to supply all of the incremental demand, about 1.2 million barrels per day per year, which it will not be able or willing to do for very long. The ensuing bidding war will make the remaining OPEC reserves even more valuable.
And what of the United States? As a consequence of OPEC's stealth oil weapon, rising deficits will undermine the use of the dollar as the world's reserve currency. Such an economic reordering–on top of America's growing weariness with overseas military ventures–could compel the United States to adopt a less belligerent and more cooperative approach toward the rest of the world. OPEC nations still rely on the United States as an ally and protector, but they probably hope that the diminished possibility of U.S. aggression and the likelihood of a more multipolar world will work in their favor by allowing them to maximize their income without fear of military retaliation.
An administration that paid attention to such facts should not only sound the alarm, but should also formulate policies and implement programs to more urgently reduce U.S. petroleum consumption. For example, a move to much more efficient cars could be encouraged by offering a $5,000 rebate directly from the U.S. Treasury toward the purchase of vehicles that obtain at least 40 miles per gallon. It could be funded by a graduated tax on inefficient vehicles. The use of oil (and natural gas) for home heating should be rapidly phased out by offering rebates for the installation of heat pumps powered with renewable electricity.
Such measures are vital to countering the oil weapon of today–the product of several decades of hard experience and refinement, and perhaps fatal to U.S. dominance of the world economy.