Strategic Analysis

Strategic Analysis:
A Monthly Journal of the IDSA


April 1999 (Vol. XXIII No. 1)

Oil Price Crisis: Implications for Gulf Producers
By Shebonti Ray Dadwal *

 

The Glut

In mid-February 1999, the price of crude oil, which had averaged between $13 to $11 per barrel in 1998 (from around $19.30 per cent in 1997), slipped into single digit figures of $9.96 per barrel of Benchmark Brent, sending the international oil market into a fresh tailspin. Though news of continued depressed oil prices was welcome to oil-importing countries, including India, it brought little cheer to oil-producing and exporting countries, especially those belonging to the increasingly ineffective Organisation of Petroleum Exporting Countries (OPEC). Concern was voiced that the producers did not have the political will to tackle an increasing crude oil stockpile; some members like Saudi Arabia complained that fellow members like Venezuela and Iran were showing no inclination to implement the cuts which had been agreed to in 1998 while Kuwait tried to rally others to agree to additional production cuts. Meanwhile, non-OPEC members like Mexico and Norway, who in a rare show of solidarity with OPEC, had agreed a year ago to a historic agreement to shave around three million barrels per day (b/d), declared that they would not consider any fresh output cuts till there was full compliance by all producers. In fact, the OPEC Secretaries said that an average of secondary sources showed that the cartel’s supply had increased in the month of January by 280,000 b/d to 27.47 million b/d. 1

The fall in oil prices began in end-1997 due to several factors. Despite signs that an Asian financial crisis was setting in, in December 1997, OPEC, led by the biggest producer, Saudi Arabia, decided to go in for a 10 per cent quota hike, thereby raising the cartel’s production to 27.3 million b/d. At the time, the Saudis, fed up of playing the role of swing producer, had reasoned that this would stabilise production and put an end to the quota busting indulged in by some of the members, like Nigeria and Venezuela. But the timing was wrong and had disastrous consequences on oil prices and the market in general. The financial crisis in South-East Asia, which had over the last decade seen phenomenal growth in energy demand and where energy demand over the next five years was expected to grow by 42 per cent, saw around 600,000 b/d being taken off world demand. At the same time, a general stalemate in economic growth in other regions, largely due to a fallout of the Asian crisis and a concurrent increase in OPEC output, took place resulting in massive build-up in oil inventories. At the same time, mild weather in the Northern Hemisphere also contributed to a fall in demand in the Organisation for Economic Cooperation and Development (OECD) countries. The expected rise in demand in winter did not take place, leading to a further rise in stock build-up and a downward spiral in oil prices.

Other factors responsible for the slide in oil prices are the growth in crude oil production from the Caspian Basin, West Africa, Latin and North America and even China. “With the Iron Curtain down, the West now has access to huge supplies in Kazakhstan and Azerbaijan never before available, which rival the Saudi reserves,” says a report by Salomon Smith Barney’s research department.

Also, the oil-for-food programme which previously allowed Iraq to produce oil worth $2.6 billion over six months, was revised to allow Baghdad to sell oil worth $5.2 billion. Though Iraq was unable to increase its production to pre-1990 levels, it nevertheless hiked output to about 2.45 million b/d in November 1998, further flooding an already weakened oil market. Now with the US allowing Iraq to buy spare parts for its oil industry, the possibility of a further hike in production increased.

New technology too has made exploration cheaper and has opened up new frontiers, so much so that the industry has reduced the cost of producing oil by 50 cents to $1 a year for the past 10 years, according to Mark Moody-Stuart, head of the Royal Dutch/Shell Group. As a result, increasing amounts of high cost reserves have now become available. Today, horizontal drilling technology, as opposed to vertical drilling, has made oil reserves in places which were considered inaccessible, more available.

On the other hand, new technology is also decreasing the growth in oil demand. For example, planes and cars are now being designed with computer technology and coming up with products that are far more energy efficient than their predecessor. At the same time, conservation policies and environmental laws are being increasingly adopted by oil-deficient industrialised countries, further reducing the demand for oil.

Lower crude oil prices are starting to affect production by hitting at company and country profit margins as well. As a result, the world’s biggest oil companies have been merging and slashing overheads. For example, Royal Dutch/Shell said it would lay off thousands of workers, write off $4.5 billion in assets and trim costs by $2.5 billion per year, while Exxon and Mobil agreed to merge largely to save roughly $2.8 billion per year by eliminating overlapping staff and expenses. They have also sharply reduced their estimates for future oil prices, which in turn has prompted a cut in their capital spending plans. 2

Some time back, Sheikh Ahmed Zaki Yamani, former Saudi oil minister and current head of the London-based Centre for Global Energy Studies, predicted that prices would remain low for years to come and cited a number of reasons for this: growing competition from other energy resources like natural gas, increased taxation on oil products worldwide and rising environmental regulations. Neither was he hopeful that Asian demand would pick up to pre-crisis levels, even if their economies rebounded over the next couple of years. Other oil executives also tended to agree with Yamani, with some analysts predicting that world oil demand would grow at less than 0.8 per cent per year over the next decade, compared with 1.3 per cent per annum over the previous 10 years. 3

Though the consequences of the price shock have taken their toll on the international oil market in general, it is the oil producing countries of the Persian Gulf (and Russia) that have been the worst hit.

This article will attempt to look at the effect of the current oil “shock” on the Persian Gulf countries and the possible political fallout on the same.

 

The Gulf States Dilemma

Since oil provides the largest share of government revenues, the slump in oil prices has had a profound effect on the Gulf states economies. Even before the current price fall, they had been experiencing a significant decline in their per capita oil revenues. While in 1981 they earned oil revenue worth $276 billion, with OPEC members enjoying a per capita oil income of approximately $803 (or $1,300 in 1994 dollars), by 1994, their oil income had dropped to about $140 billion. At the same time, their aggregate population has increased, resulting in a drop of almost three times in their per capita oil income; they have also built up huge budget and trade deficits and urgently need finance for projects—in both their oil and non-oil sectors—to increase economic growth.

As a result, the increasingly young population of these countries, affluent only a few years ago, now faces a future that does not look so comfortable. This may have consequences on the future of the ruling elites, many of whom are facing political problems, including strong Islamic movements. Till recently, the regimes had been fending off political opposition by running cradle-to-grave welfare programmes, funded by their massive oil revenues. Now with revenues diminishing, they find themselves in an uncomfortable situation. According to analysts, the fiscal challenge facing these countries is expected to grow in the near future, which in turn could give rise to political instability with serious repercussions for the world oil markets. 4 While the population has been growing at a brisk pace, the Gross Domestic Product (GDP) remains stagnant and in some cases is expected to fall and unemployment in increasing. As a result, the governments have been forced to cut back on spending, including on their welfare programmes. The growing discontentment of the people combined with the resentment of the presence of Western military forces on their soil could result in widespread anti-government sentiments, which in turn could exploited by growing anti-establishment Opposition movements.

More worrying for the regimes is the lack of investment in their all-important oil industry. Most of these countries nationalised their oil industries in the early 1970s, and though subsequently some of them have been quietly reopening the oil industry to foreign companies, others like Saudi Arabia and Kuwait (and Iran) have successfully kept foreign influence away from their oil infrastructure, controlling both upstream and downstream activities. However, massive spending on arms acquisitions, paying for the upkeep of foreign troops and equipment in th Gulf as payment for acceding to the US defence umbrella nd picking up the tab for the allied defence during the 1990-91 Gulf War have taken their toll on their budgets. This has also created resentment amongst the people. Now with oil revenue not matching expectations, these governments are worried that without adequate investments, their oil sectors may be neglected, affecting production in the long run.

To contain the glut in stocks, some of the OPEC members have been trying to control production within the cartel, albeit without too much success, and as some allege, without too much enthusiasm either. However, Saudi Arabia, along with fellow OPEC member Venezuela and non-OPEC Mexico in a historic meeting in Riyadh, signed a pact which promised to restrain production. This paved the way for OPEC to cut 2.6 million b/d of production. But it was too late to stop prices from falling further, and with another OPEC meeting scheduled in March, may OPEC members like Kuwait are lobbying for further cuts. However, Saudi Arabia is reluctant to do this without a firm commitment from fellow members, especially Iran, they they would comply with the cuts already pledged at the March meeting.

There have, however, been some allegations, especially by Iraq, and endorsed by some analysts, that by not cutting its own production, Riyadh is trying to push some high-cost producers out of the market, includig the Caspian states and North Sea producers. After the embargo was placed on Iraqi oil exports, Saudi Arabia was one of the chief beneficiaries and used its surplus production to take up a large portion of Iraq’s quota. Now, it is worried that if the Iraqi embargo is lifted, and given the current state of prices, it would be forced to cut production and may even have to give up some of its market share.

Though Saudi Arabia has vast reserves, low oil prices (and decreasing revenues) have forced it to cut projected spending in 1999 by 12 per cent to about $44 billion (the lowest in this decade) from 1998’s actual expenditure of about $50 billion. 5 Therefore, in an attempt to vet the market, Crown Price Abdullah met top executives from six US oil companies in September 1998 during his trip to the US, ostensibly to discuss probable investment in the Saudi oil sector and to exchange ideas. 6 The meeting fuelled speculation that Riyadh was about to open its upstream oil sector to foreign, especially US, investment. The Saudis, however, insisted that for the time being at least no foreign investments would be allowed into their oil sector, though no such restrictions were present for their gas sector. But, in a recent telling statement, the Saudi Oil Minister Ali Al-Naimi said, “those who invest today in developing the industrial base of Saudi Arabia will probably be the ones that will be involved when, and if, the upstream is available for exploitation.” 7 In other words, any company which desires to invest in the Saudi upstream oil industry, will have to first invest in its infrastructure industry like the power sector, desalination units or in the downstream sector. Riyadh is keen to attract investment into its infrastructure industry like power and water projects as well as its refinery and petrochemicals project, which together require an investment of around $5 billion a year to keep up forecast demand growth. 8

In Kuwait, the debate in the Parliament over opening up its oil sector to foreign companies, has finally given way to a plan approved by the Supreme Petroleum Council (SPC) to invite bids from international oil companies (IOCs) for the conclusion of “operating service agreements” for the upstream development of selected oilfields in the country, as well as to restructure the Kuwait Petroleum Company (KPC). 9 Plans to open up its upstream sector to foreign companies had been in the offing for the past two years. Kuwait’s objectives is to enhance capital investment to develop difficult reservoirs, create a trained pool of technicians as well as create more jobs for Kuwaits, and at the same time maximise its hydrocarbon reserves and achieve production targets. To do this, it realises it has to encourage strategic and economic ties with IOCs, but any revision of policy had to be consistent with the country’s Constitution which states that ownership of hydrocarbon resources must remain in Kuwait’s hands. In other words, Kuwait has to retain ownership of all the oil produced in the country as well as the revenues derived from the same.

Now under the new policy, a comprise has been reached with the IOCs being responsible for funding and managing project operations, increasing the oil/gas reserves and employing and training Kuwait nationals. In return, they will be entitled to recover their expenditure, receive an annual rate of return allowance, receive a service fee per barrel of oil recovered and also receive an incentive allowance in order to promote achievement of targets and increases in oil reserves. 10

In Iran, the scenario is very different. The 1979 revolution followed by the eight year war with Iraq from 1980 coupled with a US-led economic and arms embargo has crippled the Iranian economy. Though Iran claimed that sanctions imposed under the Iran-Libya Sanctions Act (ILSA) 11 had not affected its economy, according to many analysts, the sanctions have cost Iran over $2 billion in foreign exchange receipts in the first year itself, thanks mainly to the termination of sales to US-owned companies, and having to sell oil at a lower price. Many foreign financial institutions were also hesitant about lending to Iran because of the sanctions. As a result, Iran faced, a foreign exchange crunch, which in turn, forced it to cut down on imports, including badly needed industrial equipment and materials needed to enhance production, in both the hydrocarbon and other sectors. The decline in oil export earnings, coupled with a decline in the rial’s value, has made Iran fall back on its debt repalyments, which increased by $640 million by June 1998. Tehran also has ato contend with a trade deficit as well as a decline in international reserves, suggesting a worsening economic situation and a bleak outlook for the future unless oil prices begin to revive. The present grim economic scenario can only exacerbate an already tense domestic political situation, where a power struggle seems to be on between the conservatives currently holding power in the Majlis and the moderates who back President Khatami, who came to power promising a better economic and social environment to the increasingly young Iranian populace. 12

Despite attempts to strengthen its non-oil sector as well increase revenues from the same, Iran remains dependent on its oil revenue for 40 per cent of its overall government revenues. Therefore, falling oil prices have had a profound effect on its economy. In fact, Tehran claims that it loses $1 billion with every $1 drop in the price of oil. 13 On the other hand, to expand or even maintain oil production at its present rate, Iran needs to buy millions of dollars worth of equipment to replace old drilling and other machinery. Hitherto, Iran used to buy the equipment from the US, but after the sanctions, it not only had to look for other sources, but also needed to attack foreign investments into its oil industry, as the National Iran Oil Company (NIOC) does not have the funds or the technology to go it alone. Though Iran had acceded to the production cuts imposed by OPEC in March 1998, it desperately needs to increase its oil revenues. As a result, it finds itself at loggerheads with other OPEC members, especially Saudi Arabia and Kuwait on the baseline it should determine for its 305,000 b/d cutback obligation under the agreement. This has developed into a serious obstacle in the way of any further OPEC output reductions needed to improve oil prices. Iran insists that it produces 3.925 million b/d—while OPEC claims that according to its secondary sources, Iran’s production does not exceed 3.623 million b/d—and should, therefore, be allowed to produce 3.62 million b/d, which OPEC claims is its current production anyway and would, therefore, not entail any cuts. To resolve this current stalemate, Crown Prince Abdullah and King Fahd will be meeting Iran’s President Khatami in mid-March to try and work out a compromise. Both countries realise that it is imperative that a solution be found to improve the dismal oil price scenario, but given the current state of Iran’s economy, Tehran, more than the other Gulf states, needs to find a solution to resolve the crisis like situation that is fast developing in the country.

To encourage international oil companies to invest in its oil industry, Iran has announced the opening of its energy sector to foreign investment and has offered attractive terms like increased protection from nationalisation and easier profit repatriation. This strategy has met with some success. Despite US displeasure, European firms, led by the French, have signed deals to develop Iran’s vast oil and more recently its large gas reserves. To facilitate this, in 1997, Iran passed legislation allowing foreign companies a presence in the country—in fact, Iranian officials have said that foreign partners would be allowed to wn up to 99 per cent of some joint projects as well as offering lucrative offshore as well as onshore energy deals to foreign companies. 14 At the same time, Iran has been trying to present its case as the best transit route for Caspian oil and gas resources, and has tried to promote swap deals as a better alternative to laying expensive pipelines through hostile territory. Though it has come up against expected US hostility, it has managed to attract the attention of many oil companies, including US companies, and a decision in this respect is expected soon.

The UAE, worried about its depleting oil reserves and the repercussions, has since the 1980s quietly continued to support investment and participation of foreign private oil companies in their upstream sector, and was rewarded by expanded production capacity. It was followed by Qatar in the late 1980s-early 1990s and it too benefited from production expansion. However, like its neighbour Oman, Qatar has for some time now been concentrating on developing its much larger natural gas resources, and Energy and Industry Minister Abdullah al-Attiyah highlighted Qatar’s strategy to become a global leader in the liquified natural gas (LNG) business and be the premier pipeline gas supplier in the Gulf region. 15

Oman, a non-OPEC oil producer, too, has had to contend with fast depleting oil production, and, therefore, was one of the first Gulf states to initiate a wide ranging privatisation programme to attract private and foreign investment. In fact, it promulgated an investment law to allow foreign nationals to own as much as 100 per cent of any “project which contributed to the development of the national economy.” 16 Over the past three years, it has signed around nine exploration and production sharing contracts with foreign oil companies for acreage covering the whole country, as well as developing its downstream industry, including forming joint ventures with other countries for setting up refineries. It has also invested in oil exploration projects in third countries, including the Caspian Basin. In fact, Oman, along with Kazakhstan and Russia was one of the three original participants of the Caspian Pipeline Consortium (CPC) project, though with the entry of new partners, its stake was reduced considerably. However, Oman has got gas reserves which are estimated at around 25 trillion cubic feet (750 billion cubic metres), and its officials are optimistic about more gas discoveries in the future. Many of the recent projects are gas-based contracts, and foreign investors have been attracted by the willingness of the Omani government to offer production-sharing terms for natural gas and condensate as well as for crude oil. 17

Perhaps the greatest danger to continued depression in oil prices will come from the resumption of Iraqi crude sales in the international market Iraq’s economy was in shambles within a few months after the UN imposed sanctions after its invasion of Kuwait in August 1990. The ban on oil sales, Iraq’s main commodity, deprived the economy of more than $20 billion a year in revenue, while depreciation of the dinar and rising prices put even necessities such as food and medicine out of reach for poor Iraqis. From 1995 onwards, Iraq has been trying to tell the world that the development of its immense oil resources should not be ignored for political reasons and has called upon foreign oil companies to participate in its development programme once the sanctions were lifted, offering attractive production sharing deals, joint ventures or service contracts. At the time, Iraq’s proven oil resources were estimated to be 112 billion barrels while gas reserves were estimated at 3,000 billion cubic metres. Probable and possible oil and gas reserves were placed at 214 billion barrels and 160 trillion cubic feet respectively, but according to the then Oil Minister Moin Safa Hadi Jawad al-Habubi, after the sanctions are lifted, initial production would be around 2 million b/d, which could be increased by a further 500,000 b/d “within a few weeks.” He also said that Iraq had plans to expand its oil production capacity to 6 million b/d within 5 to 8 years, as it had some 33 discovered and appraised oil fields with production capacity of 4.65 million b/d earmarked for development. 18

In May 1996, Iraq technically accepted a UN plan which allowed it to sell $2 billion worth of oil for an initial 180-day period with the revenue primarily being used to buy humanitarian supplies of food and medicine, and in December with the Kirkuk-Yumartalik pipeline becoming operational, the last technical snag to export of oil was removed, and Iraq was allowed to pump 650,000 b/d of oil for export. However, the entire proceeds from the sale of oil would not go towards the purchase of food and medicine as a share of the proceeds would go into an escrow account from which compensation was to be paid to those who suffered losses on account of Iraq’s invasion of Kuwait in 1990. A part of the funds was also expected to pay the costs of the UN Special Commission (UNSCOM), which was mandated to dismantle Iraq’s stockpiles of weapons of mass destructon (WMD), and, according to some estimates, the funds eventually available for food and other humanitarian supplies was less than half the funds raised by oil sales. Also, besids the stocks of food and medicines, the Iraqis were also obliged to pay the cost of repairing the medical infrastructure which has been badly damaged through the 5-year embargo. 19

Meanwhile, foreign, mainly European and Russian firms, as well as some Indian companies like Reliance Industries and Oil and Natural Gas Commission (ONGC), have been waiting eagerly for the sanctions to be lifted against Iraq so that they can invest in the lucrative Iraqi upstream oil sector. Despite the political risk, they cannot afford to be left out of deals with a country which holds the second largest oil reserves in the world and a government which is ready to offer them discovered and undeveloped giant oilfields. Though many international firms have had talks with Iraqi oil authorities since mid-1991, and despite the fact that some development and operation agreements have been signed, the status of the country’s upstream projects remains uncertain as the US continues to block any chances of a permanent lifting of the sanctions.

However, if the sanctions are lifted and Iraq is allowed to freely export oil, it would create an upheaval for world petroleum markets and consequently Gulf oil politics since Saddam Hussein’s invasion of Kuwait. In 1998, when the Iraq oil-for food programme was expanded to allow Baghdad to increase its sales $5.2 billion worth of oil, ot contributed to a large extent to the present glut in world supplies, even though Iraq is unable expand production to meet the target thanks to lack of drilling equipment, spare parts and damage to its oil fields which it has been unable to repair, as well as depressed prices which allows for increased output. Now with Washington poised to pass legislation allowing sale of spare parts for the Iraqi oil industry, there is danger of Iraq resuming its pre-1990 oil production target of 3.2 million b/d and further inundating the already glutted international oil market.

 

Potential Threats to Gulf Oil Security

Possible threats to production and supply of energy, both non-military and military, from the Persian Gulf region exist. In fact, over the last two decades, ever since the 1973 oil crisis, with the expansion of non-OPEC production, especially from the North Sea, these Gulf states have had to see their hold over the international oil industry diminishing. Today, though the high-cost oil-producing European countries have barely 6 per cent of global reserves, more than three-quarters of total worldwide investments are spent here, with comparatively little investment being targetted in the region. Since the collapse of the Soviet empire, the Caspian Sea Basin states of the former Soviet Union (FSU) have become the focus of Western governments and their oil companies as they try to develop the region as an important alternative to Persian Gulf energy resources.

Also, since the oil crisis, the oil-dependent industrialised countries have been trying to develop technologies aimed at conserving energy and have been successful to large extent, thereby decreasing their energy imports over the years to a large extent. The environment lobby has also been coming down heavily on a lot of countries responsible for large scale global pollution, forcing many governments to adopt laws and implement energy taxes which have had an effect on reducing oil consumption to a large extent. At the same time, huge sums are being deployed in developing alternatives surces of energy, including natural gas and coal, as well as harnessing solar, hydro and nuclear energy for meeting their requirements. Though these alternative sources of energy are nowhere near replacing oil in the near future, it may not be too long before research succeeds in finding a cheaper alternative to oil which is abundant and accptable to the green lobby as well. This, more than any other energy resource, would be responsible for forcing oil to take a backseat, ending its dominance over the energy industry.

However, probably the biggest threat to Gulf energy comes from internal political tensions that exists within the region, both amongst the states as well as domestic problems inside each of the individual states. Ever since the 1979 revolution in Iran heralded a new regime that was inimical to the West and especially the US, it was perceived by the US as well as many of the Western-friendly states of the region as a threat to their national security, intent on destabilising their governments and threatening oil supplies to the industrialised OECD countries. Since then and especially after the 1990-91 Gulf War which also saw Iraq being branded as a “rogue state” along with Iran, Sudan and Libya, the Gulf Arab states have launched themselves into an arms race which has been billion of dollars of oil money channelled into buying weapons from Western countries, (see Table 1) which none of these states has the manpower or expertise to use effectively, thereby making them dependent on an American security umbrella which has seen thousand of US troops being stationed on their soil. This in turn has had a two-pronged effect on these states. The arms buying sprees have depleted the states coffers, eating into funds which could have been spent on developing the non-oil sectors and other developmental schemes, and with a surge in the population growth and rising unemployment as more and more educated local youths find themselves unable to find jobs in a market that has been taken over by large expatriate communities, it makes for a possible crisis-like situation. Therefore, a simmering resentment against the rulers has been growing, firstly, for decreasing the social benefits and subsidies they were used to and, secondly, for allowing foreign soldiers to guard them against fellow Arabs and Muslims. Many analysts suggest that the weapons being stockpiled by the regimes are as much for their protection against their own people as against Iran or Iraq, especially since the rise and strengthening of the anti-government Islamic movements in many of these states.

Table 1. Military Expenditures in the Gulf: 1985-96
  US$ per capita   % of GDP
Country 1985 1995 1996   1985 1995 1996
Bahrain 494 477 476   3.5 5.4 5.5
Kuwait 1,444 2,418 2,218   9.1 14.1 12.9
Oman 1,841 1,073 955   20.8 17.1 15.6
Qatar 1,301 1,286 1,334   6.0 9.8 10.2
Saudi Arabia 2,125 1,082 1,030   19.6 13.8 12.8
UAE 1,993 820 830   7.6 5.1 5.2
Iran 435 46 49   36.0 4.8 5.0
Iraq 1,105 59 56   25.9 8.3 8.3
World 275 146 139   5.2 2.9 2.8
Source: International Institute for Strategic Studies, The Military Balance 1997/98 (New York: Oxford Univeristy Press, 1997), p. 294.

 

Besides Iran and Iraq, differences and border tensions also prevail among the other Gulf Cooperation Council (GCC) states. Since the political map of the region was drawn the two World Wars by the British, who were the dominant power in the region at the time, and to a large extent reflected the British response to the Saudi ruler, Ibn Saud’s attempt to expand his power and influence, vis-a-vis the other emirated. Hence, in 1992, the boundaries between Kuwait ad the Saudi province of Najd were drawn up, and the problem is yet to be resolved fully. Similarly, border disputes exist between Qatar and Saudi Arabia, which has led to armed skirmishes between the two in the 1990s, between Qatar and Bahrain over the islands of Hawar, Dibal and Jarada, which are rich in energy resources and between the UAE and Iran over the islands of Abu Musa, the Greater and Lesser Tunbs. Though none of these is expected to develop into full fledged war, they are a source of tension and prevent the building up of trust between the states to work towards a common goal. 20

Far more disruptive are internal domestic challenges, which have a greater chance of impacting on energy supplies. For instance, the Iranian revolution saw Iranian oil production dropping from 5.3 million b/d in 1978 to 1.6 million b/d in 1980. Therefore, if the domestic challenges to the regimes develop into real threats, they can disrupt oil supplies. All these regimes are autocratic and do not rule by popular mandate or with the help of democratic institutions. With the decrease in their oil wealth, and concurrently a drop in their luxurious lifestyles, the population in these states are clamouring for a larger say in the running of their countries and for greater accountability by their rulers.

Though some experts have cited the question of succession as a possible disruptive factor, the recent smooth transfer of power in Jordan, though laced with some drama at the last minute change in the succession, believes this. Most of these rulers have a clear line of succession charted out and unless there is a change in dynasty, chances of violent are remote. The only exception could be Oman, where the Sultan has no sons or even brothers. But even in Qatar, where in 1995, Hamad bin Khalifa al-Thani deposed his father while the latter was holidaying, there was no armed conflict, despite the former ruler challenging the deposition.

 

Conclusion

Though some analysts tend to paint a gloomy picture for the Gulf oil industry, there are others who say the current situation is a short-term phenomenon and predict a brighter future for Gulf oil in general and the countries of the region. Though oil prices may not reach the pre-1997 levels of $23/b, prices are bound to pick up once the international economic climate improves and specifically the Asian one, since the Asia-Pacific region was, and the South Asian is, projected to be, the largest consumers of energy in the future. In fact, according to a Ninth Plan document Indian indigenous oil reserves will last for only 11-12 years even if the production rate is only 30 per cent, which would mean that India will have to import all its oil in the future, mainly from the Persian Gulf states.

These states (the GCC states and Iran and Iraq) together own more than 65 per cent or two thirds of the world’s energy reserves (see Table 2).

Table 2. Persian Gulf States’ Share of World Oil Production 1970-2015
Year % Year %
1970 27.6 1995 25.9
1975 34.0 2000 29.0
1980 28.9 2005 33.4
1985 17.4 2010 37.2
1990 24.3 2015 41.5
Source: EIA, International Energy Outlook (Washington D.C: USGPO, 1997) p. 61; and International Petroleum Statistics Report (Washington D.C.: USPGO, August 1997)

 

More importantly, that these states have the lowest cost of production continues to be a source of comfort for them. According to the Saudi National Commercial Bank, the cost of developing a new field in the UAE is $6,000 per peak barrel of capacity compared to $10,000 in the North Sea, while an onshore well in Iraq and Saudi Arabia costs a mere $2,500. 21

However, in order to recapture their pre-1970s share of the oil market, these countries will have to change their policies, especially those pertaining to their upstream sector. Mehdi Varzi, editor of a recent study done by the London-based Dresdner Kleinwort Benson Research (DKBR), sees the convergence of a number of issues that will lead to the re-emergence of Gulf upstream activity. He says that the price of the benchmark Brent will remain at $13-15/b as opposed to the original forecast of $15-20/b, due to a number of market variables, forcing Gulf producers to seek access to international private capital and upstream technology just when the oil majors will need access to low cost, high volume oil with no exploration risk. With oil prices continuing to be depressed, oil companies are restricting investments in expensive upstream activity. There is thus going to be a movement of capital away from high-cost, non-OPEC production areas to the low-cost Middle East sectors, as they can offer the majors access to plentiful low-cost reserves and production. This may even provide OPEC the opportunity to regain the importance it once had by increasing its presence in the global oil scene. 22

Though the above is only a prediction, it may well be true as lower prices would mean that oil majors will need to find lower cost production areas, since higher cost areas, like the Caspian for example, may no longer be profitable to explore and extract oil. Therefore, though foreign access to the Gulf’s upstream sector has been limited, Iran’s recent decision to invite foreign participation in over 40 upstream development projects, and Kuwait implementing policies to partially open up the sector could be an indication that things are about to change.

The report goes on to cite some primary reasons as to why the Gulf states will open up their upstream to private international investment: (1) the need for badly needed access to capital and technology; (2) political and strategic considerations—for instance, Kuwait’s fear of a revanchist Iraq; (3) ensuring easy access to foreign markets; and (4) “improving the image of Gulf oil.” However, for any of this to truly happen, there must be a serious reassessment of the “outdated” quota system followed by OPEC, which has been responsible for diverting hundreds of billions of dollars of investment into relatively high cost non-OPEC oil at its expense.

The report goes on to say that the Persian Gulf region faces a major challenge in the capacity is set to expand while future global oil demand is being undercut by oversupply. While demand projections have been high, OPEC reserves have been severely undershot, but if secondary and tertiary recovery methods were included in reserve estimations, as opposed to using mainly primary recovery, the area’s true reserve estimates would undoubtedly be many billions of barrels higher than currently reported. 23

However, though the Gulf states enjoy several advantages over their competitors, they cannot afford to sit back and let events dictate their course of action. To regain their former superior position in the international market, they must act now. Even if the South-East Asian countries come out of recession in the near future, their energy demand is unlikely to grow as rapidly or as large as before. The Gulf countries will have to depend more and more on market forces for sales, and can no longer afford to keep their industries insulated from outside forces. They must cartly on the pace of opening up their oil sectors to foreign participation before the competition gets too tough and other regions take over their market share. The countries of the Gulf region have definite advantages over their comeptitors in other areas but it is up to them to exploit the same.

 


Endnotes

*: Research Officer, The Institute for Defence Studies and Analyses.  Back.

Note 1: Observer of Business and Politics, February 18, 1999.  Back.

Note 2: Washington Post, December 20, 1998.  Back.

Note 3: Khaleej Times, December 12, 1998.  Back.

Note 4: Hooshang Amirahmadi, “Oil at the Turn of the Twenty First Century: Interplay of Market Forces and Politics,” Occasional Paper No, 5, The Emirates Centre for Strategic Studies and Research, 1996.  Back.

Note 5: Financial Times, December 30, 1998.  Back.

Note 6: Middle East International, November 13, 1998.  Back.

Note 7: Petroleum Intelligence Weekly, February 15, 1999.  Back.

Note 8: Ibid.  Back.

Note 9: Middle East Economic Survey, February 15, 1999.  Back.

Note 10: Middle East Economic Survey, December 7, 1998.  Back.

Note 11: On May 8, 1995, President Clinton placed a ban on US economic transactions with Iran, mainly to address European criticism that they were asked to sacrifice while American firms profited. But when Europe continued with its policies towards Iran, Senator Alfonso D’Amato’s reworked his Bill, which had originally been aimed at Iraq in 1989 followed by another series of Bills aimed at Iran and Libya, and this time it was accepted by the US Congress. on August 5, 1996, Clinton signed the Iran and Libya Sanctions Act, which authorities the US President to sanction foreign firms that invest in the development of Iran’s petroleum resources.  Back.

Note 12: Patrick Clawson, “US Sanctions on Iran,” Occasional Paper, No. 6, The Emirates Centre for Strategic Studies, 1997; Also see Middle East Economic Survey, February 8, 1999.  Back.

Note 13: Geoffrey Kemp, “The Persian Gulf Remains the Strategic Prize,” Survival, vol. 40, no. 4, Winter, 1998-99.  Back.

Note 14: Khaleej Times, November 13, 1997.  Back.

Note 15: Middle East Economic Survey, December 14, 1998.  Back.

Note 16: Middle East Economic Survey, March 30, 1998.  Back.

Note 17: Middle East Economic Survey, April 20, 1998.  Back.

Note 18: Khaleej Times, March 22, 1995.  Back.

Note 19: The Hindu, November 27, 1996.  Back.

Note 20: Gawdat Bahgat, “Oil Security: Potential Threats,” Contemporary Security Policy, vol. 19, no. 2, August 1998.  Back.

Note 21: Petroleum Economist, October 1996.  Back.

Note 22: Middle East Economic Survey, September 28, 1998.  Back.

Note 23: Ibid.  Back.