A new dynamic for the Middle East

Maybe it’s time to try something new. And maybe it’s already starting.

Last week the New York Times reported:

In the first major oil deal Iraq has made with a foreign country since 2003, the Iraqi government and the China National Petroleum Corporation have signed a contract in Beijing that could be worth up to $3 billion, Iraqi officials said Thursday.

Under the new contract, which must still be approved by Iraq’s cabinet, the Chinese company will provide technical advisers, oil workers and equipment to help develop the Ahdab oil field southeast of Baghdad, according to Assim Jihad, a spokesman for Iraq’s Oil Ministry. If the deal is approved, work could begin on the oil field within a few months, Mr. Jihad said.

And today the Guardian confirms that the deal was approved by Iraq’s cabinet.

There are some Americans who regard expanding Chinese global influence with fear and suspicion. But I maintain that stability and prosperity for Iraq and the broader Middle East should be the primary U.S. objective at the moment. Although China of course has its own reasons to be interested in the region, those interests are undermined by terrorism and regional instability just as much as ours. And precisely because China is a distinct power with separate interests from the U.S., its status as a more neutral third party leaves it in a position to assist in restoring stability to Iraq and the region in ways that the U.S. cannot. The perception that the purpose of toppling Saddam Hussein was to benefit U.S. oil companies greatly undermines our capacity to bring peace to the region. One way the U.S. can signal that our goal is instead regional stability is by embracing a larger role for China in Iraq and the Middle East.

Some may ask, What good does it do Americans if Iraqi oil gets shipped to China? The answer is, it is a global market for oil, and apart from quality differences you would pay pretty much the same price whether you buy the product in New York, Rotterdam or Singapore. That price depends on the total quantity produced globally and the total quantity consumed globally. More global production means a lower price, and which country consumes which oil is of little practical significance. It matters very little for the price that U.S. consumers pay whether the assistance for Iraqi oil production comes from CNPC or ExxonMobil or whether the oil is sold to the U.S. or to the Chinese. But it matters a great deal for the price that American consumers pay for oil whether the Iraqi oil is produced or is not produced.

Others may worry that higher oil production today just leaves the world with less of this depletable resource for the future. But to this I would counter that the transition to a world when global oil production no longer increases each year will raise some tremendous geopolitical stresses. The more stability and cooperation we can have as we enter that phase, the better off we will be.

You’ve heard it said, “What’s good for General Motors is good for the U.S.” But I say, “what’s good for Iraq and China is good for the U.S.”



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28 thoughts on “A new dynamic for the Middle East

  1. j

    Sir, You say that total world production of oil, independently of whose companies are extracting the stuff, is the significant point. May be, but for America it is not so good that its main economic rival is enjoying the benefits of the Iraq war. The perception that the purpose of toppling Saddam Hussein was to benefit U.S. oil companies greatly undermines our capacity to bring peace to the region. A je-ne-se-quoi is wrong here. May be I did expect that post-Saddam Iraq would be open to American companies.

  2. Babinich

    JDH says

    “But I say, “‘what’s good for Iraq and China is good for the U.S.’”

    I agree with you.

    Keep saying this and maybe, just maybe, it will stick.

    JDH,

    In your opinion, do you feel that the Chinese will sit on their hands if they see their investment challenged by random acts of violence?

  3. DickF

    Professor,
    This is one of the best posts you have written. It is easy to get lost in calculations when the truth is that we are in a global economy and as John Kennedy said, “A rising tide lifts all boats.”

  4. aaron

    I’d also add that keeping oil in the ground is a fools game. Given that current prices are the best indicator of future prices, there’s equal upside and downside risk. However, there’s no way to borrow on the value of oil kept in the ground, so we’d all be giving up the income and the and compounding growth generated by the wealth. Actually this would still be true even if they could borrow on the value of the oil in the ground.

  5. Bruce Hall

    Does anyone else find it slightly incongruent that so many see the benefits of “a rising tide lifts all boats” while supporting the U.S. government’s policy of restricting domestic oil and natural gas resources? Apparently, as long as the tide of oil comes from elsewhere, we are happy to have our boats float higher.

  6. michael gordon

    1) Right now, China’s foreign policy behavior isn’t aggressive and threatening, in contrast to two oil-rich countries, Russia and Iran. Both would be basket-case economies without the democratic industrial countries being dependent on international oil and natural gas imports.
    2) We can go further. Without oil-revenue — which Saddam Hussein’s government was able to draw on for its own programs, including WMD R&D and stockpiles at least up to the mid- or late-1990s — his regime would have been no threat to his neighbors, let alone major US security, economic, and foreign policy interests in the Middle East.
    Note what I’m saying carefully. We did not intervene in Iraq either in 1991 or 2003 solely for reasons of oil resources and our dependence on them, or at least the Middle East supplies . . . OPEC, a huge global cartel that controls oil ouput for export in global markets, as far as supplies and prices go. But Iraq’s oil resources that funded Saddam’s regime — yes, even in the era of food-for-medicine sanctions in the 1990s — were a necessary condition of our occupation in 2003, as was our war in 1991 over Kuwait.
    3) The EU’s marked dependence, especially Germany’s on Russian oil and natural gas imports — about a third of their energy imports overall — encourages appeasement of a country, Russia, that has grown aggressive and threatening to its neighbors once more.
    Without its oil and gas resources, Russia would be a pitiful country economically, and Putin wouldn’t be so popular at home — obviously.
    4) Iran’s aggressive nuclear arms program would be essentially non-existent without huge oil exports, even if its people live a wretched life.
    5) In the long run, China’s economy — whose fast growth now will slow down as its GDP increases — is showing what free-market economists should worry about: namely, only 40% of its GDP are for the benefit of its people. The rest are intended to fuel its national ambitions of grandeur and influence.
    Will this change in the future? Will the orgy of self-indulgent enrichment by China’s CP elites and members lead them to abdicate their monopoly of political power voluntarily?
    When has such an abdication ever occurred in world history, whether in China or elsewhere.
    6) Economists, to put it bluntly — I have a Ph.D. in both economics and political science (the profession I practiced at UCSB for 40 years until my retirement recently) — have no way by their training for dealing with these security and foreign policy spillovers, nor analyzing why certain countries like Imperial Germany and Imperial Japan in the past were not concerned primarily with the well-being of their citizens as they cultivated the statist-capitalisms.
    ….
    Michael Gordon, AKA, the buggy professor

  7. aaron

    Bruce, yes. Like I suggest, it’s foolish.
    Companies could plausibly gain from high profits in the short term by keeping production below capacity and could pressure goverments to allow more production capability in the medium, but past the medium term it should get very scary. Might be profitable in the short term, but don’t be the last to turn the pumps on.

  8. GNP

    This contract with the Chinese is a vote of confidence on the part of the Chinese in an emerging, more stable Iraq. It should please thoughtful Americans on both sides of the Iraqi war issue.

    US foreign policy in the past has had the unanticipated consequence of contributing to keeping many barrels of light sweet high-grade crude oil in the ground in several Mid-East oil exporters: Libya, Iran and Iraq, and to a lesser extent in Kuwait and Syria.

    Past conflicts with Libya have been largely resolved; technologically-advanced, well-capitalized multinational oil&gas companies have returned in droves; security issues in Kuwait have been resolved at an enormous cost to US taxpayers; progress remains to be made with the other countries though a growing sense of political realism in Israel is cause for some optimism.

    Americans wishing to weaken the resurgent Russian bear and a defiant Persia should seriously consider announcing a schedule of Nordic-level excise taxes on gasoline and diesel. Such a credible commitment to using fiscal policy to further encourage energy conservation and enhanced effiency would bring oil prices crashing down below US$70/barrel faster than any other available mechanism short of global recession. It is perhaps the only tax on the horizon that could easily pay for itself many times over in restored domestic wealth and enhanced security.

  9. oops

    is this really “something new”? or is it just a sign that the iraqi government has finally grown up enough to start negotiating oil contracts?

  10. David Rogde

    What’s left out of the equation is that not only is there oil in the ground, there’s blood in the ground, and it’s American blood. Therefore the equation seems to lack the balance necessary to arrive at a correct answer, especially for the American families of those whose blood is in the Iraqi ground. Unless you consider the shared sacrifice (less than one half of one percent) to be negligible.
    I don’t.

  11. GK

    I agree. China buying a lot of oil from Iraq is good for America, because :
    1) China now has a vested interest in Iraq’s stability.
    2) China is less dependent on Iran for oil.
    3) China loses if Iran blocks shipments from the Persian Gulf.
    4) Money flows into Iraq, helping development.
    1, 2, and 3 are part of the reason Iran is a bit quieter now.
    Frankly, the best way to solve many problems in the world today is for the US to ensure that China’s interests align with our own. This is one example.

  12. peatey

    Sure oil could be explained as fungible. Except it’s not exactly, because of varying distance of transportation (US will have to import more oil from farther abroad because Mexico export is declining) and risk of disruption of steady supply as well as price of transportation per mile(if the major lumpy production is claimed by China, then it’d likely take more number of smaller lumps to compensate by the US, less economies of scale in transporting by smaller tankers than from a VLCC from an Iraqi port).

  13. Anonymous

    Bruce Hall,
    If you were referring to me about opposing domestic drilling you haven’t read any of my posts on the subject. I would drill in my back yard if I thought it would give us more oil.

  14. realist

    So you say :”what’s good for Iraq and China is good for the U.S.” So it’s good that the U.S. has entangled itself economically with a brutal dictatorship named China so that we can enjoy the cheap goods they send us produced from their oppressed/exploited citizens. Is this how we define ourselves and our lives, as consumers willing to scour the globe for the best deal, no matter the sordid story behind it. We have now subjugated ourselves to China through the extreme leverage they hold over us with the $1.2 trillion in US assets they own and the huge trade deficit between our nations. They carry out their capitalistic dictatorship supported by US companies such as Google, Microsoft, and Yahoo who aid them in censorship and oppression. This is good for America and its citizens?

  15. Anon

    Professor,
    Agreed excellent post.
    The ONLY time that control of Oil Production becomes critical is at a time of war. In peace time, it is enough that there is a viable and working free market – suppliers sell to whoever it makes most sense to deal with.
    If Iraq can get a negotiate a deal from China (who is highly motivated to diversify supply and a latecomer to international oil expansion), then perhaps it will set royalty expectations so that American companies can be judged to “play fair” by the Iraqi leadership. Each deal will establish a precedence of “market rates” in royalties.
    A process not unlike the historical role played by Enrico Mattei, Head of ENI-AGIP, could be envisioned: a latecomer, being more desperate at securing deals, breaks ranks with “Le Sette Sorelle” and accepts less attractive terms (Iran, Egypt, Libya)
    It would appear that Game Theory comes into it again…

  16. lalaDude

    realist. China is dictatorship. But it is not as brutal as you think. It is much more benign than it was 30 years ago. I believe it will get much better gradually. It is kind of silly to think that China will deliberately mess with it’s biggest customer aka the US for no apparent reasons. It does not make any business sense to do so. It is much better for the US to think China is a friend and help make her think and behave like the US. If the interests are aligned, both can benefit from it.

  17. Gregor

    James, your larger point about the fungibility of oil is of course quite true. However, a good portion of global oil supply comes under price setting terms that are less than the free market price. The kinds of deals the China is striking in places like Africa and potentially Iraq will exert at the very least a lagged effect on the price they pay, in a rising price market. In other words, they will actually be first in line for this oil. In a flat market the next user will pay the same. But in a rising market, the next user will have to pay more, because the auction phase will begin, to use an imperfect phrase, “after” China gets its share.
    Over time, the price China pays in the aggregate may not be substantially different than what open auction buyers will pay. However, the security of the supply in these deals is an embedded discount, imo, that China wouldn’t bother trying to seek–unless it was worth something.
    And it is. There is value there.

  18. michael gordon

    1) Just wondering: those who think that China’s current economic development is largely benign — not to mention that our growing interdependence is in our national interest over the long run — might answer how it is that an economy with 1.4 billion people that has 8-fold since 1979 (according to official Chinese stats) devotes only 40% to national consumption.
    The US devotes 69% of its GDP to consumption. The average in West Europe is only slightly lower: roughly 63-65%. (The McKinsey Global Institute carried out a comparative study of capital productivity in the US, Japan, and Germany in the mid-1990s, across 5 major industries. It found that US capital investments were about 40% more efficient than in the other two countries: hence less need for the same percentage of capital investment in the US compared to the other two countries.)
    ……
    2) So where is the rest of the 60% of the fast-growing GDP going?
    It can’t just be capital investment. Is it going to infra-structure development? If so, why are dams, roads, ports, train systems, airports, streets, and telecommunications not better? Is it going to environmental needs, cleaning up the huge air, water, and land pollution in the country? Or to education? Or to retrofitting the shoddy and dangerous buildings erected in a craze of construction without concern for safety or environment needs? Or to medical care? Or social security?
    …..
    3) It seems hard for Americans, especially economists, to grasp that the Chinese leadership isn’t directly concerned with the standards of living of their people.
    Other motives and goals seem to be uppermost in the minds of the CP elites, themselves busy in an orgy of self-aggrandizement and enrichment.
    And why, then — given how they are flourishing — are some of the posters here certain that as China develops more, its leaders will open up democratically, show more concern for the environment, infrastructure, consumption, education, and social needs of their people, and not use their growing national resources for their own nationalist and personal goals?

    4) By the way, how many of you know that China’s GDP shrank 40% last year?
    A trick? Only slightly. It shrank 40% in PPP terms, the World Bank suddenly discovering hundreds of millions of poor Chinese exactly as it did in the early 1990s. More concretely, the World Bank specialists on the Chinese economy found that its price levels were actually much closer to the American levels than they thought.
    ……
    5) Just wondering too. Since oil wealth has fueled Russian nationalism and aggressive behavior, just as it has Iran’s nuclear weapons programs — and Saudi Arabia’s Wahhabi-driven propaganda of a radical Islamist sort world-wide — why, over time, China’s growing concerns for energy, natural resources, arid land, and the like will be benign for the rest of the world too?
    …..
    I cannot myself be certain in answering these latter questions. I do know that it is, in my view, fairly sloppy economics to concentrate on narrow cost/benefit considerations in trade and investment and technology transfers without considering wider foreign policy and security concerns . . . all spillovers that need to be brought in to the “partial analysis” of economic modeling.
    And if any of you are convinced by your answers — China will become more democratic, more cooperative, more benign diplomatically and militarily — would you be in favor of lifting any US restrictions on transferring advanced weapons technologies to the Chinese?
    ……
    Michael Gordon, AKA, the buggy professor

  19. realist

    Anon,
    Constant Surveillance and censorship, imprisonment and torture, repression and death – they all are the same whether you talk of now or 30 years ago. Capitalism is just a means for the dictatorship to gain more power and expansion. You sound like a businessman who would just prefer to stick to the profit motive and close your eyes to these other issues.

  20. DickF

    michael gordon,
    1. This is why China is growing at such a rapid rate. It is not accurate to compare Chinas domestic consumption with the west. Compare Chinas domestic consumption today to China 20 years ago.
    2. Why cant it just be capital investment? China had, and still has, a huge infrastructure challenge, but the infrastructure is significantly better than 20 years ago.
    3. Your description of the Chinese political leadership sounds like the US. Of course the leaders fill their pockets first. That is true of 99.999% of those in government in any country.
    Also, dont get the cart before the horse. China is not open because it is flourishing; it is flourishing because it is more open. Yes, they could have another “Cultural Revolution” and take the country back to the Dark Ages, but that is highly doubtful. The leadership and the people have tasted prosperity.
    4. China is going through growing pains but as they continue to understand that their labor force is perhaps their greatest capital asset they will continue to grow faster than the world average. Chinese leaders are listening to the right people and the results are obvious.
    5. Chinas need for energy will make it a world player and competitor. If the industrialized countries want to keep their position in the financial order they better learn to open up their markets and their commerce to innovation through free markets or they will find themselves catering to the Chinese in the future.
    You question about transferring sensitive data to China is nonsense. Just because we see China moving in a direction that will continue to allow its economy to grow does not mean that we accept everything about China. This is the wrong question. The right question is if we attempt to isolate a China that is more open today than it was yesterday will THAT change those things we do not like?
    Economic freedom begets personal freedom. It should be obvious that you cannot have one without the other. The Chinese are slowly learning this. It is something the US congress seems to be unlearning.

  21. Brian

    I have a question that’s only slightly off topic. It’s safe to assume the run-up in oil prices (and other commodities) has led to increased investment in production capacity by oil-producing countries and corporations. The expected return on investment would be contingent on the higher price and that investment may or may not be fuel by increasing debt.
    So the question is, if oil prices continue to fall, is there a determinable point below which these countries face the trap of their returns being insufficient for servicing their debt? For example, Brazil has been investing in more deep water drilling, which requires oil prices to stay fairly high to be profitable. Canada’s tar sands are another example. Could it be that the most recent price surge occurred too quickly to effect decisions? Or could there have been some ‘irrational exuberance’ which would cause problems down the line?
    I bring this up because the issue of capacity over-development has had significant consequences on the world economy in the past for precisely this reason.

  22. GNP

    Brian: You raise some excellent points. Industry folks and stock market valuations have generally been pricing in expectations of US$80 to US$100/barrel oil over the medium term. I expect oil to settle in the US$65 to US$80/barrel range before going higher, and I suspect that I am not alone.

    I’m reading estimates of the marginal cost of oil ranging from US$60 to US$80. Indeed some projects will be delayed if the price of oil falls below that rough threshold. It is hard to fix an exact number because industry costs have escalated so dramatically in recent years, and consequently should subside with lower output prices.

    Over-building, and the resulting boom ‘n bust phenomena are common features of the resource business. The better managed companies will do fine. Rich exporters like Canada or Norway will do fine, though some in Alberta will get egg on their faces if and when some oilsands projects are halted. Poorly diversified poor-country oil exporters toiling under the burden of the Resource Curse will suffer, especially their poorest citizens.

    OPEC will once again demonstrate that it cannot stop oil prices sliding to the downside just like the paper cartel lost control of prices to the upside in the past year.

    In the longer run, the relative price of oil is going higher but your guess is as good as mine with respect to the exact time frame.

  23. bartman

    Constant Surveillance and censorship, imprisonment and torture, repression and death
    Yes. It’s good that we have none of these things ion the West.

  24. Anon

    Absolutely, as Naomi Klein has pointed out quite well in her “Disaster Capitalism” book…all is Hunky Dory in the West…Sure!

  25. realist

    “Be careful what you wish for”….so said Joe Clark, founder and CIO of FEG, on CNBC yesterday. He says that input costs for oil exploration/extraction don’t disappear with lowering oil prices. For oil extraction from the Canadian oil sands, the input cost is close to $70 per barrel and for deep water Gulf oil, it’s around $95. The most recent estimate from the Canadian Association of Petroleum Producers (CAPP) puts the cost for oil sand extraction at $75 to $90.
    Extracting petroleum from the oil sands requires a massive amount of energy and water to separate the petroleum from the sand, rock, and other substances. ?They?re moving four tonnes of the stuff to extract a single barrel from the oil sands,? says Simon Dyer, director of the oil sands program at an environmental think tank called the Pembina Institute, ?two tonnes of overburden and two tonnes of the oil sands itself just to get one barrel.? The extraction process uses 2 to 4 ? barrels of water for each barrel of oil produced, according to the Pembina Institute. Production from Alberta’s oil sands climbed to an average 1.32 million barrels a day last year, a 5 percent rise over 2006 and could get to 3.2 million per day by 2017, the province’s energy regulator said recently.
    Concerning deep water Gulf oil, it can take years to construct a new offshore rig. That includes the time it takes to collect the skyrocketing input costs for piping, metals, deep-sea drilling, and labor. You can’t just flick a switch and turn on a new rig. It takes time. Offshore rigs – where the daily lease rates are still soaring – remain in a net supply deficit. A supply shortage for classes of offshore rigs capable of drilling in up to 10,000 feet of water means that the daily rate that operators pay to rent a high-end, deep-water drilling rig is now $500,000 to $550,000. That?s up from a day rate of $450,000 to $500,000 a year ago-and more than double the price per day on the spot market just three years ago, according to ODS-Petrodata Consulting & Research. ExxonMobilOil, PetroChina, and other oil exploration companies should expect the extended up-cycle in day rates to rent these rigs to continue unabated. Declining yields from mature, onshore energy fields coupled with increasing natural gas and oil prices is driving the demand for global drilling activity in deep-water provinces, pushing fleet utilization rates for high-end rig counts close to 100 percent, too. Exploration and production costs in the first-quarter Y/Y at ExxonMobil, Royal Dutch Shell, and BP, rose 30 percent to $5.8 billion, 39 percent to 7.4 billion, and 59 percent to $10.0 billion, respectively. The U.S. Gulf Coast accounts for about 25 percent of domestic oil production and 15 percent of natural gas output, according to the MMS.

  26. realist

    The British have a way with words:
    “We ordinary British have no reason to trust the assurances of our own political classes or those who have a financial interest in currying favour with the Chinese dictatorship. Our own leaders betray us with no compunction so would the Chinese be in the least interested in what
    we think?”

  27. GNP

    realist: All true, but perspective is needed. Fleet utilization rates for various drilling and service rigs bounce up and down worse than a crack-head’s fickle moods. Input capacity utilization rates and fees charged customers will drop sharply as output prices drop. Experienced o&g patch investors and traders anticipate this; sell into the heat, and then wait for equity values to sharply drop. The volatily reflects serious information and ‘co-ordination issues’.

    That is why it is kinda sad when populist ideologues like Alaskan governor Sarah Palin get to determine hydrocarbon resource policies such as sliding tax rates. I’ll bet that she has no understanding of the secular risks that exploration and production outfits as well as service companies face.

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