The End of OPEC

Forty years after the Arab oil embargo, new technologies are dramatically reshaping the geopolitics of the Middle East.

BY AMY MYERS JAFFE, ED MORSE

October 18, 2013- "FP"-  Forty years have passed since the Arab oil embargo went into effect on Oct. 16, 1973, triggering a period of incredible change and turmoil. After the United States provided support to Israel during the Yom Kippur War, a cartel of developing-world countries (via the Organization of the Petroleum Exporting Countries, or OPEC) banned the sale of their oil to Israel's allies and thereby set in motion geopolitical circumstances that eventually allowed them to wrest control over global oil production and pricing from the giant international oil companies -- ushering in an era of significantly higher oil prices. The event was hailed at the time as the first major victory of "Third World" powers to bring the West to its knees. Designed in part to bring Arab populations their due after decades of colonialism, the embargo opened the floodgates for an unprecedented transfer of wealth out of America and Europe to the Middle East. Overnight, the largest segment of the global economy, the oil market, became politicized as never before in history.

But four decades later, the shoe may finally be on the other foot. Now, on the 40th anniversary of the 1973 embargo, the United States has a historic opportunity to lead a counterrevolution against the energy world created by OPEC as innovation in the U.S. energy industry looks poised to end the decades-long, precarious "dependence on foreign oil." Washington should seize the opportunity and push to democratize energy globally, just as its Silicon Valley giants have democratized information. 

In the run-up to 1973, two-thirds of global ownership of oil moved from the private sector of American and European companies to public-sector national oil companies. Rather than let the forces of supply and demand determine prices, post-1973, the lowest-cost oil producers, such as Saudi Arabia, Iraq, and Iran, artificially shut production and discouraged capital investment, creating a lasting wedge of rents or financial profitability that market conditions never warranted. (Today, oil prices in real terms are more than four times higher than in 1972.) A massive industrial restructuring occurred over the course of a half-decade, as state-owned enterprises, with limited project-management skills and bloated workforces, surpassed the oil majors like Chevron and Shell in both capitalization and size. 

The 1970s witnessed a profound and unprecedented transfer of wealth to the Middle East that continues to have significant repercussions today -- from democracy movements to terrorism to civil wars. The region's leaders failed to set up long-term mechanisms to distribute the benefits of that wealth transfer broadly to their populations and to establish an equitable stake in governance of resource proceeds that would have brought a newfound stability to the region. Instead, they bought lavishly, gilding their palaces and buying fleets of luxury autos. For decades, they squandered the opportunity to use oil wealth to modernize their societies and train their populations for future global economic competition. The result -- unfolding not just in the Middle East but in other oil-producing countries as well -- is a crisis of governance that is itself triggering a round of oil-supply disruptions. 

Massive petrodollar inflows brought with them a new political paradigm of "rentier" patronage, characterized by financial excesses, corruption, repression, and billions of dollars in accumulated weapons purchases. Populations of oil-producing states, for the most part, are little better off today than in 1973. Many of the countries have been war-ravaged or riven by sectarian hatreds. And, even with decades of relatively high oil prices and associated worker remittances, most countries of the Middle East still see modest GDP per capita, below $30,000 person on a purchasing-power-parity basis. 

Deep income inequality means that much of the region's population is in fact still living in poverty, even in places like Saudi Arabia. So it should be no surprise that 40 years after the 1973 embargo, citizens of the region are rising up against those who squandered their futures. Tired of waiting for the day when rising oil revenues would somehow magically bring back the promise of prosperity, youth are taking to the streets; port and oil workers are mounting strikes; and jihadists are taking up arms to end the oil curse once and for all. Their frustrations do not unfold in a vacuum. High oil prices associated with all this unrest is propelling energy investment elsewhere to great success. Energy efficiency is also getting a boost, shrinking the long-term market for Middle East oil. The upshot will be that it will be harder and harder over time for Arab rulers to count on oil money to keep them in power. And that has a trickle-down effect to the populations they've been keeping quiescent with handouts for decades. 

Ironically, just when political revolutions were gaining momentum across the Middle East, a different kind of revolution was emerging that looks likely to bring a new epoch of dislocation and distortion to prevailing oil and gas structures. This second energy revolution is also ameliorating the impact of the first. 

Since January 2011, at the dawn of the rebellions against dictatorial governments in North Africa, the amount of oil "offline" or being blocked from production by either domestic turmoil (in Iraq, Nigeria, Sudan, Syria, Yemen) or international sanctions (in Iran) has generally been above 2 million barrels per day (m b/d), four times the average level of supply outages before the so-called Arab Spring. Then Libya erupted once again this past summer, taking another 1.2 m b/d, or more, offline. But the impact of these disruptions has been relatively mild, given that over the same period, production in North America, the heartland of the three revolutionary changes in unconventional hydrocarbon production (shale, deep water, and oil sands), has grown by more than 2.5 m b/d. And more is on the way. 

Growth in renewable energy has also been significant in recent years in the United States and beyond, and rising fossil fuel costs and strong government intervention have created new market opportunities. World biofuels production has doubled to over 1.2 m b/d since 2006, but wind power has grown in oil-equivalent terms from 1 m b/d to 2 m b/d since 2008 (and is accelerating at about a 20 percent annualized clip). Solar power, meanwhile, grew from 20,000 b/d of oil-equivalent energy in 2008 to 400,000 b/d last year. 

But the impact of all this change in the energy world will go far beyond just replacing continuing Arab Spring outages. Unconventional oil and gas and the clean-tech booms are spawning a host of new, smaller oil and gas exploration companies committed to innovation and willing to take on risk. They have no stake in the multibillion-dollar megaproject world of the international majors and national oil companies, and as such, they have fewer concerns about sustaining high profits from giant assets found decades ago. They are enabling the United States the opportunity to take a lead in changing the way energy is bought and sold -- not just in the United States, but globally. 

Energy innovation is taking many forms in the United States, creating major export opportunities and giving Washington the tools it needs to ensure that the conditions of a 1973-style oil embargo will not repeat themselves. The oil embargo was so devastating because strong economic growth throughout the 1960s had taken up the margin of spare oil-productive capacity in the United States and across the world, leaving the Middle East's oil producers with undue monopoly power. Similar razor-thin extra productive capacity left markets highly vulnerable in 2006 and 2007, when OPEC made contraseasonal cuts in output to increase prices, instead of considering the risks to global economic growth. But as oil and gas production from U.S. and Canadian shale formations rises, the ability of oil producers like Russia to use an "energy weapon" to gain extra benefits from consuming countries is diminishing. 

U.S.-led innovation in alternative fuels (including natural gas-vehicle fueling technology and electric vehicles), energy-efficiency technologies, battery storage, and smart-grid solutions, working together with and complementing the supply surge in unconventional oil and gas, should also change the face of demand, giving consumers around the world more freedom of choice. And as the United States becomes an energy exporter -- at competitive prices -- that should seal the deal. By providing ready alternatives to politicized energy supplies, the United States can use its influence to democratize global energy markets, much the way smartphone and social media technologies have ended the lock on information and communications by repressive governments and large multinational or state-run corporations. 

Abundant U.S. natural gas is just the first step. Booming domestic natural gas supplies have already displaced and defanged Russia's and Iran's grip on natural gas buyers. By significantly reducing American domestic requirements for imported liquefied natural gas (LNG), rising U.S. shale gas production has had the knock-on effect of increasing alternative LNG supplies to Europe, breaking down fixed pricing from entrenched monopolies. But this is just the beginning: Over the coming decade, the United States looks likely to overtake Russia and rival Qatar as a leading supplier of natural gas to international markets. 

The geopolitical role of U.S. natural gas surpluses in constraining Russia's ability to use its energy as a wedge between the United States and its European and Asian allies should strengthen over time, to the extent that Barack Obama's administration stays the course with approving the construction of LNG export terminals. American unconventional oil and gas plays from Texas to Pennsylvania are also generating new surpluses of natural gas liquids, which are increasingly exported as transportation fuel or petrochemical feedstock to Europe, Asia, and elsewhere -- reducing demand growth for oil from the Middle East. And U.S. crude oil exports might also be possible some day, strengthening America's lead in market-related pricing for kingpin crude oil, much the way rising North Sea production did in the 1980s. 

As an increasing number of companies and investors flock to North America to develop prolific unconventional resources, Middle East heavyweights like Saudi Arabia, Kuwait, and Iran are losing their lock on remaining exploitable reserves, reducing their ability to band together and create artificial shortages. Already, Mexico and Argentina are reading the tea leaves and reversing protectionist resource nationalism policies, instead pushing through reforms to attract capital investment to their doorsteps. 

Abundant U.S. natural gas is also spawning new American-designed engine and modular fueling station technologies to readily use natural gas as a fuel in trucks, trains, and ships, ending oil's monopoly in transport. Some 40 m b/d of the global 85 m b/d oil market is open for competition from natural gas -- in the form of compressed natural gas for cars and buses, and LNG for heavy-duty vehicles and marine transportation. We conservatively expect at least 2 m b/d of currently projected oil demand to cede to natural gas by 2020, further weakening perspectives on future global oil-demand growth and once again chipping away at Middle Eastern influence. 

American innovation and exports of energy supply and technology will open global energy markets to competitive investments and consumer choice. But Washington needs to embrace this choice by resisting the call to continue to ban energy exports to protect vested business interests or for resource nationalistic reasons. Indeed, we need to reverse the mindset of the oil embargo years -- a mindset of supply shortages and husbanding of resources -- and move back to a more traditional promotion of free markets. The energy sector has done this in the trade of petroleum products, where the United States is simultaneously the world's largest importer and exporter. The United States is heading in this same direction for trade in natural gas, whether by pipeline to Mexico and eastern Canada or the export of LNG. And it should move in the same direction with crude oil exports as pressures mount from growing surpluses midcontinent and on the U.S. Gulf Coast. 

The expanding wind and solar businesses in California and Texas are encouraging new complementary battery-storage options and smarter networks, laying the groundwork for greater consumer choice and control. The move to distributed energy, right now focused mainly on affluent customers who can afford private backup generation, may spread to broader applications. Some day soon, it will enable increased remote energy solutions for villages in sub-Saharan Africa or Southeast Asia.  

The U.S. government needs to support the reform of the electricity utilities to enable this transition, which will entail more-efficient technologies, locally produced and distributed generation, time-of-day pricing and peak-demand shaving. Such reforms are critical to the integration of renewable energy whose output varies widely over the course of a day. By leading the charge to these new energy technologies, the United States can fashion a global energy world more to its liking, where petropowers can no longer hold car owners hostage or turn off the heat and lights to millions of consumers to further geopolitical ends. 

Just as it was difficult to predict the impact of Apple computers on future global social trends, it may now seem hard to depict the exact time and place that America's unconventional resources and smart-grid innovation will democratize energy markets. But Apple did reset the way we think about computing and changed the world. Similarly, the dislocations currently unfolding in the energy sector are pointing to markets taking back pride of place over government control and consumer choice winning over supplier monopolies. The pace of change may be slow in coming at first, but eventually it will be no less stunning than Oct. 16, 1973, a day that sent shock waves into the global economy, the ripples of which are still visible today. 

©2013 The Foreign Policy Group