Postwar OPEC Will Be 'Kinder, Gentler'

PRIOR to the invasion of Kuwait, the Organization of Petroleum Exporting Countries lacked the discipline needed to achieve its oil production and pricing targets. A post-Saddam OPEC could be a far different story. Soon after the invasion of Kuwait, the world seemed to be headed toward a repeat of the 1970s oil crisis, with prices shooting upward and Iraq in control of 20 percent of world oil reserves. Baghdad seemed on the verge of becoming the dominant force in OPEC, capable of enforcing its wishes through the cartel.

In fact, the post-Saddam OPEC may in fact turn into a "gentler and kinder" cartel than anyone might have foreseen. Forces from the United States, Britain, and possibly other allies that remain in the region after the crisis is over will effectively become de facto enforcers of the wishes of members of the Gulf Organization of Petroleum Exporting Countries (GOPEC).

This group is smaller, six oil producers as opposed to OPEC's 13. Since the members (Saudi Arabia, Kuwait, Qatar, the United Arab Emirates (UAE), Oman, and Bahrain) share a common political as well as economic agenda, oil pricing and production strategies are more likely to emanate from Riyadh than from OPEC headquarters in Vienna. This may turn out to be the basis of a "new world oil order."

A common characteristic of the members of GOPEC - particularly the dominant producers, Saudi Arabia, Kuwait, and the UAE - is the coupling of vast oil resources with a small population. For this group, the "haves," natural-resource economics dictates an oil strategy based on a stable-prices path designed to keep at bay threats from marginal oil producers as well as from oil substitutes.

To maintain a stable market for their oil for years to come, GOPEC will ensure a shock-free world oil market by adjusting its production to meet the required demand. This approach was evident in the Saudi response to oil-price fluctuations right after the invasion of Kuwait. After all, these oil producers have substantial investments in the West and are not likely to do anything to jeopardize them.

The oil shocks of 1974 and 1978 showed clearly that the thirst for oil is not limitless. Once the demand "shock" takes hold, oil producers may very well have to scramble to sell every barrel of oil in the world market. This is precisely what former Saudi oil minister Sheikh Yamani called "short-term thinking."

A STRATEGY of oil-price stability, however, is clearly contrary to the interests of the poor members of OPEC, the "have-nots." This fact underlay the invasion of Kuwait by Iraq, which claimed that Kuwait's policy of overproduction was tantamount to an economic war. Prior to the invasion, Kuwait and the UAE were producing above the quotas allocated by OPEC, a fact well documented by the industry press at the time.

The "have-not" oil producers also share common characteristics. They tend to have larger populations and a smaller resource bases (with the exception of Iraq). They also face a significant debt burden, which makes them insist on higher oil prices now rather than at some time in the future. Therein lies the problem for OPEC.

In the past, OPEC meetings often turned into long haggling sessions over who can produce what and at what price. The Gulf oil producers tended to compromise for the sake of the group unity, but also because of fear of antagonizing their brethren within the cartel. Now, with a probable Western/Arab force staying behind in the region, the "haves" will essentially dictate the future course of the cartel.

In fact, one wonders if the Gulf oil producers will retain their membership in OPEC at all.

At the last meeting of OPEC prior to the invasion of Kuwait, the Kuwaiti oil minister observed that eight or nine oil producers factored themselves out the decisionmaking process of OPEC. Even before the invasion and occupation of Kuwait, therefore, the world oil market was already moving towards de facto control by the few rich Gulf oil producers of GOPEC.

A characteristic of the world oil industry in the past decade has been the extent to which some oil producers have acquired interests in foreign oil refineries and gas stations. This process is referred to as vertical integration, similar to the structure of the world oil industry that prevailed in much of the 1950s and '60s among the major oil companies.

Kuwait has been a leader, among oil-producing countries, in venturing beyond its own borders to buy refining and distributing capacity. It owns an extensive network of filling stations in Europe under the catchy Q8 logo and has a substantial equity in "downstream" operations. Outside the Gulf, Venezuela has also been a big player. In 1988 Saudi Arabia ventured into this investment arena with a 50 percent stake in Texaco. Recently, the Saudis invested in South Korea for the same purpose, and they are no doubt eyeing other markets to guarantee an outlet for their country's huge eight to 10 million-barrel-a-day capacity.

Vertical integration means that the interests of the producers and the consumers finally converge. This obviously leads to a certain stability in world oil prices, since the producers who now are part owners of Western refineries - and in some cases distribution networks - inevitably find themselves responding to market signals generated in the consuming countries.

Kuwait was able to sustain itself financially after the Iraqi invasion thanks to extensive investments overseas - oil facilities being only one of them. If anything, the Kuwaiti example will no doubt be quickly emulated by the other Gulf oil producers.

This will dictate a faster depletion of oil reserves, since the risk of future crises will make the Gulf oil producers prefer current to future oil production, with the proceeds invested overseas. A barrel of oil extracted and invested today is preferable to one left in the ground on the hope of a higher price in the future.

The result could be increased investment in the West and an outflow of capital from the region. The process of vertical integration will be enhanced as more oil producers scramble to enlarge their equity investments in downstream operations overseas.

KUWAIT'S need to rebuild its economy is another factor supporting higher oil production rates. Its $100 billion of foreign assets notwithstanding, the country still needs to finance part of the reconstruction from current oil production. Saudi Arabia, too, will be in need of money. Recently, it borrowed $3.5 billion from international financial markets.

Finally, Iraq, regardless of the leadership it ends up with, will also need to rebuild its war-torn economy. Add Iran, Algeria, and all the oil producers in debt, and you get a potential oil glut of gigantic proportions.

The impact of this "new world oil order" on the US economy and the US balance of payments should be positive, since oil imports have constituted a large part of the trade deficit. The consequences may not be so kind to the US oil patch, however. Lower oil prices will discourage domestic oil production and adversely affect the economies of the oil states.

This may push some in Congress to call for an oil import fee to protect the oil states and achieve long-awaited energy independence from the Gulf.

But such a move would be shortsighted. It would amount to subjecting the American economy to a home-grown, artificial oil shock that would adversely affect US competitiveness overseas. Even the US Department of Energy study concurs. Since the US will likely remain in the Gulf region for some time to come, and will incur a cost for doing so, it would be foolish to drain US domestic oil reserves in order to avoid using cheaper Gulf oil.

Rather, the US should encourage the process of vertical integration, since this trend will lead to a more stable world oil market that will benefit not only the US, but all oil-importing nations and poor, less-developed countries as well.