After Iraq : Oil and Geopolitics

It is an understatement to say the aftermath of the war in Iraq is proving to be a difficult period.

It is an understatement to say the aftermath of the war in Iraq is proving to be a difficult period.  World media attention is focused on anti-American demonstrations and the failure of the American military to establish civil order.  Diplomats and commentators debate and opine on how, and by whom, a stable government, an orderly social system and a functioning economy should be established in Iraq; as well as what actions the United States will take regarding other Middle Eastern countries and North Korea.   

At this point, it is obvious the follow-up process will not be a smooth one and the result will probably not be the orderly, federal democratic system envisioned by the Bush Administration-at least not until after a long period of turmoil and conflict.  Oil fields and facilities were damaged much less than was expected before the war.  A return of production to supply the domestic Iraqi oil market may take only a few months.  A return to significant volumes of oil exports, however, will need to overcome several political and legal-as well as operational and investment-obstacles. As such, Iraq may not realize its potential as a source of large increased supplies of oil to a growing world market for several years, if at all.   

For several decades, the United States , as a matter of its own enlightened self-interest, has undertaken to establish and maintain security of oil supply for all the world's economies.  Any serious consideration of energy or foreign policy must recognize that now, and for the foreseeable future, oil represents the life's blood of the international economic order. Despite the delusions of anti-globalization protestors and street demonstrators, the secure supply and low price of oil not only allow wealthy countries to prosper but also define the margin in poor countries as to whether people eat or go hungry, have the medicines they need or send their children to school.  

The Iraq affair highlighted a coincidental development in international economics.  Combined with the strike in Venezuela and political unrest in Nigeria , it showed the world's discretionary surplus oil productive capability is much less than had been previously estimated.  As world economies resume normal growth with accompanying increases in oil demand, the world is likely to be faced, for the first time, with oil-supply shortages and persistent upward pressure on prices over the next several years. 

Oil prices have declined since the end of the war due to the return of Iraqi and Venezuelan production and a seasonal spring demand slump, but this price drop should not induce a false complacency regarding supplies.  A prolonged trend of increasing prices would severely restrain economic recovery in the United States, Europe and Japan .     

Oil shortages would be particularly disruptive to stability in Asia , the area of fastest economic and oil demand growth.  Japan is still in a prolonged depression and barely avoiding financial collapse.  China has been an oil importer since 1993, while India has always been dependent on imports.  Both are rapidly industrializing.  China continues to modernize its military and is already laying claim to large areas of the South China Sea and its potential oil and gas resources.  The need for oil supplies without American guarantees of free access and stability will only increase China's temptation to solve its energy needs by force.  Since the U.S. lost its Philippine bases, piracy has become one of the fastest-growing industries in Southeast Asia.  China also borders Russia and Central Asian countries with large oil and gas resources and could become belligerent about access to those supplies.  

Indonesia, the only OPEC producer in Asia, has been disintegrating since the Bre-X gold mining fraud was exposed in 1997. It is now under its fourth government in 5 years, the middle class has been wiped out, investment has stopped, and religious strife and civil disorder are increasing with no improvement in sight.  Amid the rising discontent and disintegration, Islamic terrorist groups are becoming aggressive.  Indonesia is the world's largest Islamic country and is strategically located; over one-third of the world's sea-borne commerce passes through Indonesian waters.  The combination of a sick Japan, an expansionistic China and an unstable Indonesia mixed with oil shortages is an excellent recipe for future conflict and instability.  

But the oil industry is not responding to the prospect of impending shortages.  Capital budgets are not increasing and worldwide drilling and exploration activity is down.  Oil prices are too volatile.  Projects that require investments of billions of dollars that require years to be repaid at low rates of return are not attracting capital.  In addition, after 20 years of severe cost-cutting, oil companies are without research laboratories, experienced staffs or young engineers trained in petroleum engineering.  

Another coincidental aspect of the Iraq affair was that it came just when Russia's president had reached out to the United States, supporting its war on terrorism and establishing a rapport with the American administration. France, who passed Italy as the largest purchaser of Russian crude and thus has become the largest source of foreign income to Russia, and Germany, the largest foreign investor in Russia, used their clout successfully to elicit Russian support for an anti-Iraq-war position.  

France is trying for a realignment of world power with typical and obvious French tactics--to ally France with Germany to control the European Union and, with such a large economic block, attract Russia into an alliance.  A combination of united European economies with Russian resources would establish an economic and political block to rival, and possibly displace, the United States.