I agree -- but only if geopolitical factors go absolutely right. But the balance of probability has to be for a rise, not a fall in oil prices, with a corresponding further strain on the world economy.
The key player is -- of course -- Saudi Arabia. The kingdom in 2001 has been pumping slightly more than its quota of 7.8 million barrels per day, out of a total OPEC output of around 25 million barrels per day. Thus Saudi Arabia represents just over more than 30 percent of OPEC oil production, which in turn is around 40 percent of world oil production. Saudi Arabian output thus represents about 12 percent of world oil output.
The second largest OPEC producer is Iran, which averages about 3.8 million barrels per day, just less than half Saudi Arabia's output.
But Saudi Arabia is not an isolated entity. If Saudi Arabia were to get into severe political difficulties, there would be severe knock-on effects on the other kingdoms of the Arabian penninsula: Qatar, the United Arab Emirates and Kuwait. All these countries are small, share the peninsula with their larger Saudi neighbor, and are ruled by traditional monarchies, which can be expected to suffer in the event the Saudi monarchy is destabilized.
These countries' oil production in 2001 totaled an additional 5.0 million barrels per day. Thus a destabilization of Saudi Arabia would affect about 12.8 million barrels per day of OPEC production, just over half total OPEC output and about 20 percent of world output.
In addition to representing about half of OPEC production, these countries represent at least half OPEC oil reserves, which are about 77 percent of the world total, according to the U.S. Department of Energy. Thus they are twice as important in terms of reserves as they are in terms of production. They also represent about 60 percent of OPEC's spare capacity -- OPEC's spare capacity in the event these producers were lost would be less than 2 million barrels per day, far from sufficient to take up the slack in world demand.
The Saudi monarchy has been the principal guarantor of world oil supplies since the oil crisis of 1973, and the only reliable such guarantor (other than the gradually increasing world share of non-OPEC production) since the Shah of Iran fell in 1978. To assist the Saudi monarchy in this role, they have used considerable resources of both U.S. and British military power and intelligence capability.
This has paid off: Saudi Arabia has showed itself a beacon of stability in the region, and in times of difficulty such as the Gulf War has proved a reliable supporter of the West.
The structure of the Saudi monarchy, however, makes it doubtful that this Saudi role can be sustained in the long run. Since the death of Ibn Saud, the founder of modern Saudi Arabia, in 1953, Saudi Arabia has been ruled by four of his 41 sons in succession, King Saud, King Faisal (assassinated in 1975), King Khalid and King Fahd (since 1982.) Prince Abdullah, the heir to the throne, is also a son of Ibn Saud, as is the second heir Prince Sultan.
Guys, at some stage you have to go to the next generation. King Fahd is 80 and sick, Prince Abdullah is 78 and Prince Sultan is 73. At the very least, a generational transition in the House of Saud is long overdue.
The generational question explains pretty well what has happened in Saudi Arabia since 1973. King Fahd, as the leading figure under the later years of King Faisal and King Khalid, was a youthful reformer, putting in place policies that allowed Saudi Arabia to take advantage of its immense oil wealth and the royal family to remain firmly in control. Western companies were expropriated, and oil production brought firmly under control of the Saudi authorities, while technical assistance arrangements and marketing agreements negotiated by the Saudi oil minister (from 1962 to 1986) Sheikh Yamani ensured that Saudi Arabia was regarded as the most reliable, as well as the largest supplier of Western oil. A generous social welfare system provided reasonable living standards for the Saudi people as a whole, while large infrastructure projects, particularly in petrochemicals, were undertaken to increase the Saudi share of the petrodollar and to a limited extent reduce its absolute dependence on crude oil production.
After 1982, it never went seriously wrong, but it began to wind down. The oil price stayed close to 1979-81 levels until the mid '80's, but dropped precipitously in 1985-86, to half its previous level, from which, in real terms it has never recovered (the peak of $32 per barrel reached last year is equivalent to only half that amount in 1980 dollars.)
Sheikh Yamani retired, or was forced out, in 1986, since when the Saudis have never had the dominance of the oil market they had under him, is spite of their premier producer position. Infrastructure projects were cancelled for lack of money, so the development of the Saudi economy beyond its oil base never happened. The social welfare system made menial jobs unattractive for Saudi nationals, so a foreign (but mainly Islamic) proletariat was imported to undertake them.
The most important problems since 1982 have been corruption among the Saudi elite and religious fanaticism among the Saudi populace and the foreign proletariat.
The Saudi royal family suffers from the problem that there are now 6,000 of them. For a Marcos or a Suharto, a Swiss bank account totaling in the billions of dollars seemed adequate wealth, so their kleptocracies were to an extent limited (although less so in Suharto's case once his children tried to prove themselves industrial titans). But in Saudi Arabia there are simply too many kleptocratic mouths to feed. Consequently, corruption, which in the 1970's was a modest and acceptable part of a booming economy, has since 1982 grown to encompass the Saudi economy as a whole, greatly reducing its efficiency and impoverishing (at least compared to the wealth they had been led to expect) the mass of the Saudi people.
Prince Alwaleed bin Talal is doubtless a clever and generous man, as witnessed by his $10 million offer to the City of New York after Sept. 11.But his wealth, in terms of the cash amounts he has invested since 1990 in major Western companies such as Citigroup, is wholly unexplained, as he is the son of a relatively junior (and still living) progeny of Ibn Saud, so cannot have acquired his venture capital fund by mere inheritance.
Thus the royal family, which like the Pahlavi dynasty in Iran does not have centuries of legitimacy to back it (Ibn Saud emerged from his minor principality in 1921), has become highly unpopular among the Saudi people as a whole, let alone among the proletarianized foreign workforce.
The Saudi monarchy has compounded its difficulties by gratuitous folly in funding and encouraging fundamentalist Islam. In the 1970's, the ownership of the Muslim holy places Mecca and Medina was a source of great strength to the Saudi monarchy, both among its own people and among Islam as a whole. The fall of the Shah in 1978 demonstrated to the Saudi rulers that a national strategy of secularization risked a religious backlash; in 1980 the Ayatollah Khomeini appeared the wave of the future to rulers in the Middle East. Consequently, the Saudi rulers adopted the strategy of the lamented English King Ethelred the Unready; fearing fundamentalist Islam, they paid Danegeld (payoffs to Danish invaders) in attempt to buy its support. It didn't work for Ethelred, and it hasn't worked for the Saudi monarchy; Islamic fundamentalism has been greatly strengthened by Saudi royal patronage, while in the Islamic universities a generation of students has been trained for whom the United States is the Great Satan and the Saudi royals are Satan's tools.
The United States cannot in the long run defeat Islamic terrorism without bringing Islamic public opinion into a state of acceptance of Westernization. The Saudi-born Osama bin Laden and his al-Quaida can be defeated, at great cost, but it cannot be supposed that no successors would appear. With vigilance in security and a strong military effort directed at terrorism, the United States at least can limit its effect and prevent terrorists from destroying American civilization as a whole.
No such assurance is possible to the Saudi monarchy. Grown old and corrupt, hated by many of its people, and surrounded by the fundamentalist Islamic monster they have largely created, it would seem only a matter of time before the Saudi monarchy falls, presumably to be replaced by a theocracy along the Khomeini lines.
This is not necessarily fatal in the long run. In Iran, a measure of democratic representation was allowed once Khomeini died and the result has been both a political moderation of the country's Islamic fervor and an economic opening to the West. Sunday's announcement that Iran is pulling its advisors out of the Hezbollah camps in Lebanon is just one example of this. Twenty years after the monarchy's fall, therefore, Saudi Arabia, too may see a government with which the West can do business.
Twenty years is an extremely long time in the oil market. In the intervening period, if the Saudi monarchy falls and is replaced by radical Islam, Saudi oil output will no longer be reliable, either politically or technically, and the oil price must inevitably increase. If as is likely, radical Islam in Saudi Arabia spreads to Qatar, the U.A.E. and Kuwait, the market disruption will be still worse.
What can President Bush and the administration do about it?
They can try to prop up the Saudi monarchy, but if the disturbances grow too bad this may be both impossible and pointless -- a country in turmoil will be unable to act as a reliable last resort supplier of oil.
More positively, they can respond as quickly as possible to Iran's faint overtures of friendship and seek to rebuild the Iranian oil industry. At its peak under the Shah, Iran produced 6 million barrels per day; an increase from the current 3.8 million to that level, accompanied by a political détente with the Iranian government, would be a great help to world oil stability.
Other defenses against Saudi collapse would include drilling in the Arctic National Wildlife Refuge, which would replace only 10-15 percent of Saudi output, starting 2 years from when drilling begins, but every little helps.
It also may be necessary to strong-arm Mexico and Venezuela. Mexico should be pushed to privatize Pemex so its oil output can be prevented from what is otherwise an inevitable and rapid decline. Venezuela should be pressured to get rid of the hard-left anti-American president Hugo Chavez, who will otherwise seize any disruption in the oil market to maximize its damage to the U.S. and world economy.
As I said, if all goes well and the Saudi monarchy survives as a peaceable and reliable friend of the West, then indeed oil prices may drop gradually, perhaps to the $15-17 level as Ian Campbell suggested. But I would regard the probability of such a benign outcome as well under 50-50.
If the Saudi monarchy falls, as I expect, then expect huge disruption in the world oil markets, and prices to be driven to their 1979 peaks -- in oday's dollars, about $60-70 per barrel. Given the age of the Saudi rulers, this is likely to happen this side of 2005.
(The Bear's Lair is a weekly column which is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the last 10 years, the proportion of "sell" recommendations put out by Wall Street houses has declined from 9 percent of all research reports to 1 percent. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)