January 5, 1999
No Funeral for OPEC Just
Yet
By RON CHERNOW
ven as cruise missiles
rained down on Iraq in mid-December, oil prices scarcely budged from their severely
depressed levels of about $11 a barrel. In the past, Middle East tension inevitably spooked
the oil markets, provoking panic buying. This time, the December price slump presented us
with a stunning paradox: we had waged war against Saddam Hussein precisely to safeguard
the Persian Gulf oil fields, yet the market's blase reaction to the fighting seemed to
underscore the marginal status of Mideast oil in the global economy.
Is our apprehension about Iraq's threat to Arabian oil now sadly anachronistic? In a
world brimming with oil -- and with the Organization of Petroleum Exporting Countries
providing only 40 percent of it -- should we finally stop fretting about the Middle East?
In fact, it would be both foolish and premature to gloat over OPEC's demise. A
retrospective glance at the oil industry last year suggests that, far from being liberated
from Mideast oil, we may be sliding into a dangerous new
era of dependence on the Arab sheikdoms.
In the 1970's, OPEC was the fearsome bogyman of Western politics,
able to quadruple prices and impose a punitive embargo on the United States. The resulting
shortage riled many economies, provoking rampant inflation, sluggish growth and plummeting
stock markets. Sober analysts predicted that oil might fetch $100 a barrel by century's end.
In the 1990's, we have seen the movie running in reverse as squabbling OPEC members have
failed to curb a glut that has slashed oil prices to their lowest inflation-adjusted levels
in a quarter century. The breathtaking price tumble has helped to tame inflation, spur
economic growth and buoy stocks. Commentators now deride the once haughty OPEC as a sorry
relic, rent by blatant cheating and factional feuds. In a world flooded with oil, it has
seemed to surrender its formidable powers to the marketplace.
Some factors that have humbled OPEC -- including the sharp contraction in Asian oil
demand and
balmy weather in North America -- are passing phenomena. The great and most lasting threat
to the cartel is the technological revolution that has transformed the oil business. Back
in 1972, the Club of Rome, sounding the apocalyptic note so voguish at the time, warned
that world reserves might be exhausted in a little more than a generation. What its analysts
failed to foresee was the amazing ability of technology to take a finite resource and convert
it into something seemingly infinite.
Long a low-tech backwater, the oil industry during the past decade has become an exotic
showplace of futuristic technologies. Producers can now find and produce oil with exceptional
precision and at lower costs than was ever dreamed possible. Special sensors create
three-dimensional maps
of deep geological formations. Producers can drill horizontally for long
distances, extracting oil trapped beneath towns. With computers guiding drill bits for miles underground, producers have resurrected numberless
old fields long thought depleted.
The upshot of such innovation is that analysts have radically revised their sense of
the earth's oil-bearing potential. Supplies today are dictated not by the amount discovered
but by what can be profitably produced at a given price. In Texas, Oklahoma and elsewhere,
a new breed of independent oil producer has extended the lives of small, aging fields. Their
so-called stripper wells produce 10 barrels or less per day. This might sound insignificant,
but they have been furnishing America with about as much oil as imports from Saudi Arabia
have.
Unfortunately, the strippers are now reeling from a crisis that may prove fatal.
They typically break even when oil is in the $12-to-$15-a-barrel range, but as prices have
fallen below that barrier they have suffered a disaster. Small companies are going
bankrupt almost daily, and thousands of wells are being capped
in the continental United States. The
oil service industry is another casualty, with only about half of its available
rigs searching for oil off American shores. Even our giant energy companies are
curtailing exploration budgets, and this will simply deepen American dependence on
foreign oil.
Bolstered by their networks of refineries and gas stations and their
strength in petrochemicals, the big oil companies haven't been as vulnerable as
their smaller brethren. Yet the spate of recent megamergers shows
that their plight, too, has grown precarious. In early December, the Exxon-Mobil
merger reunited the two largest pieces of the Standard Oil trust dismantled by the Supreme
Court in 1911. Antitrust concerns about the combination have been misplaced: the new
colossus will refine less than 14 percent of American oil, compared with nearly 90
percent for Standard Oil.
The merger testifies as much to the partners' weakness as to their strength.
When John D. Rockefeller formed Standard Oil in 1870, he aimed to consolidate refiners
into a giant
cartel that could contain falling prices. In contrast, the Exxon-Mobil
and BP-Amoco deals demonstrate that even the biggest companies now
accept lower prices as a fait accompli and can sustain their profitability
only through stringent cost-cutting and consolidation.
The real predicament shadowing the Exxon-Mobil merger resides with
the State Department, not with the
Justice Department. Exxon has enjoyed the luxury of inexpensive oil
from Alaska and other domestic fields but must now replace these
bountiful fields with more expensive oil from abroad. In the past 20 years,
no giant new American fields have been discovered to rival the Texas
strikes of the early 1900's or 1930's or Alaska in the late 1960's. Because
Mobil has lacked a strong base in
domestic oil and has been more aggressive in tapping frontiers abroad,
it was an attractive partner for Exxon. The major oil companies are too
large to bother with tiny stripper wells at home, which means that their
future exploration will be largely in
the third world. And Big Oil will turn
inescapably to the Middle East as the
last place left with huge, cheap reserves.
While OPEC today accounts for
only 40 percent of world production, it
possesses 75 percent of known reserves. And its Persian Gulf members can drain these
vast reservoirs for less than $2 a barrel. By contrast,
it costs the super-efficient Exxon an estimated $7 to produce a barrel of
domestic oil and more than $10 a
barrel for foreign oil. Given the dramatic cost advantage enjoyed by Saudi Arabia and
its neighbors over foreign oil companies and non-OPEC
producers, OPEC may be on the
threshold of a new hegemony.
Now that crude prices have sagged
to such low levels, each further dollar
decline will bankrupt more high-cost
competitors and widen the Arabs'
market share. Might OPEC deliberately boost production and drive down
prices to single digits to recapture
control of the oil market?
It seems unlikely that it would do so
by design. In the short run, this risky
strategy would rob it of too much
revenue before it won the compensating gain in market share.
But if the United States slipped into
recession, intensifying the glut and
pushing oil down to, say, $5 a barrel,
the Persian Gulf states would be back
in full control. Production and exploration budgets would be sharply reduced outside the
Middle East as
prices fell below the cost of extracting oil elsewhere.
During the anti-American frenzy of
the 1970's, the Arab states nationalized their oil companies, chasing out
the large Western companies that had
operated their fields in the early postwar years. In response, big oil companies have turned to places that are
geographically remote and politically
volatile. The countries rich in new oil
and gas deposits -- including Nigeria,
Angola, Indonesia, Russia, Azerbaijan, Kazakhstan, Turkmenistan and
Colombia -- are also places steeped in
corruption, poverty and violence. The
acrimonious dispute over the pipeline
route that will carry oil from Baku in
Azerbaijan to Western markets illustrates the extreme geopolitical hazards that await American policy makers in the next century. Guaranteeing
oil supplies will create security problems that may make the Middle East
seem a peaceful oasis in comparison.
As chance would have it, the Arab
oil states are about to forge an alliance with the Western companies 20
years after most of them lost their
concessions in the region. On Sept. 25,
a Saudi crown prince presided over a
one-hour "tea party" to explore possible cooperation with chief executives
from seven American companies.
Prominent among the chieftains was
Lucio Noto, the chairman of Mobil.
Analysts have speculated that one
motive for the Exxon-Mobil merger
was to combine Mobil's Saudi connections with Exxon's capital to strengthen its bargaining position with the
desert kingdom.
Why would Saudi Arabia court
American investment at a moment of
patent weakness for Big Oil? The
Saudis have watched jealously as
Mexico and Venezuela have angled to
supplant them as the foremost supplier to the United States, the largest oil
consumer. Not only is Saudi Arabia
loath to cede the American market
with Asia in recession, but it wishes to
retain the Defense Department security umbrella that accompanied its
former status as America's largest oil exporter.
The Mideast oil states would also
like to profit from the new technologies patented by American companies and to enlist their worldwide
refining and marketing apparatus to
sell oil. It was partly in the hope of
providing expensive services, including exploration and pipeline building,
to producers in the Middle East that
BP merged with Amoco and Exxon
with Mobil to form a critical mass of
capital and expertise. Faced with the
extreme risks and production costs in
new areas like the Caspian Sea, the
American oil companies will be powerfully attracted by any new partnership offered by the Arab states. Iran,
Algeria and the United Arab Emirates have already formed joint ventures with foreign companies.
All of the foregoing suggests that if
oil prices stay low -- and that isn't
certain, especially if Asia revives --
the oil industry of the early 21st century may well
resemble that of the 1960's more than that of the 1990's.
Far from being extricated from the
morass of Mideast politics, we may
only grow more entangled.
The low prices of recent years have
produced an extraordinary complacency about energy policy. Profligate
Americans have turned to sports utility vehicles, light trucks and other old-fashioned gas guzzlers. At the time of
the Arab embargo in 1973, the United
States produced 9.2 million barrels of
oil a day; last year we managed only
6.4 million barrels. Yet nobody talks
anymore about our perilous reliance
on foreign oil. In fact, energy policy is
so seldom discussed in Washington
these days that the term has acquired
a quaint ring. By focusing solely on
deterring Iraqi aggression over the
past eight years, we have been diverted from the concern over secure energy supplies that prompted both the
gulf war and the recent air strikes in
the first place.
It may be naïve to assume that
anybody in our sex-obsessed
capital will care about things
as banal as energy conservation, fuel efficiency and the
like. But the alternative is to be
forever menaced by the future Saddam Husseins who will undoubtedly
emerge to challenge the American
presence in the Middle East's oil
fields.
Ron Chernow is the author of "Titan: The Life of John D. Rockefeller Sr."