The Iraqi Wild Card in the OPEC Equation

WITH Baghdad, where the Organisation of Petroleum Exporting Countries (Opec) was born 43 years ago, now in the hands of American forces, the oil cartel faces a big new imponderable: its future. The 11-member grouping is now pondering its survival strategy in the face of the possibility that a revenue-hungry Iraq will flood the world market with crude. So what are the prospects for Opec's longevity?

For 50 years, multinational oil companies determined crude prices for the world and paid host countries pennies for a barrel after a Kirkuk discovery launched the Middle East oil story. Opec wrested that power in the 1970s. Artificial shortages arising from the Arab oil embargo and the Iranian Revolution propelled prices manifold to beyond US$35 before they stabilised.

Over the next 30 years, Opec's fortunes waxed and waned. The cartel enjoyed the best and the worst of times. The years 1973-74, 1980-81 and 2003 (so far) were high points for Opec, during which oil prices soared to US$35-40 a barrel. But during the mid 1980s and the late '90s (when Brent crude fell, at one point, below US$10 per barrel) were low watermarks for the cartel.

Saudi Arabia, with its huge spare capacity, has long held the group in line by balancing supply and demand, and non-Opec oil producers like Norway and Mexico have generally cooperated. When the threat of oversupply became serious in the mid '80s, for instance, Riyadh assumed the role of a 'swing producer' which saw its production plunge from 10 million barrels per day (bpd) to 2.3 million bpd by August 1985. However, it aggressively rebuilt its market share later.

Now, with US forces controlling Iraq - and likely to do so for some time yet - the dynamics of Opec are poised to change dramatically.

Blessed with the second largest oil reserves in the world, Iraq could potentially challenge the Saudi dominance of the cartel. Iraq's oil wells have been mostly unscathed by the war. Moreover, after many years in the wilderness under United Nations sanctions, Baghdad has signalled it will ramp up production.

Fresh funds and new technologies will be no problem under production-sharing agreements with Western oil companies, who are now more welcome in Iraq. Ahmed Chalabi, the leader of the Iraqi National Congress, who is slated for a key position in the new Iraq, has said Americans will play a big role in the Iraqi oil industry. There are even suggestions that the country should partly privatise its oil industry and float it on stock markets.

All this may point to unbridled oil production some time in the future. But whether Iraq will always play to the American tune when it comes to oil is debatable. Anyway, it would take many years before Iraq will hit its full production potential of 6 million to 8 million bpd - which requires an investment of up to US$40 billion. But it could, relatively easily, add a million barrels to its February production level of 2.5 million bpd in about three years.

How will all this play out for Opec? Since Baghdad has been excluded from the group quota since 1991, other members - mostly the Saudis, with an output of 9.5 million bpd - have shared the spoils. Now they would have to forgo some of their previous production and curb their tendency to bust quotas, for which some members are notorious. If Iraq maintains no controls on its production - a position advocated by the Iraqi opposition - that would exacerbate the problem for the cartel.

Since 1999, Opec has held oil prices in a tight range of US$22-28 to support an average price of US$25 for a basket of seven crudes. This marks the highest official selling prices that the group has managed to sustain since it priced benchmark Arab Light crude at US$34 in 1983. For several months, prices have even stayed above the top end of the range, affording producers occasional windfalls.

Even without the Iraq issue to contend with, the group is facing several internal and external challenges. Internally, it is faced with rising populations in producer countries, with the poorer members pressing for higher quotas. Externally, it contends with larger supplies from Russia and the Caspian countries, which are planning their own pipelines to supply key markets.

Recently, for instance, Moscow cleared a pipeline to Murmunsak on the Barents Sea to supply the US. Opec must also reckon with the larger oil-producing potential of Africa and Canada and even possibly new drilling in Alaska and the Gulf of Mexico.

Such huge incremental supplies apart, fuel switching and conservation have curtailed growth rates in oil demand. In Japan, the share of oil in total energy use has slumped by nearly 30 per cent since the 1970s, with industries switching to nuclear power and natural gas over the years. And thanks to increased energy efficiency, the US now consumes 40 per cent less energy to produce one dollar of GDP compared with the days of the Arab oil embargo.

Moreover, high prices as well as new deep-water drilling and enhanced oil recovery technologies have made investment in high-cost oil areas worthwhile. So much so that today, Opec is a shadow of its former self. From a peak of 32 million bpd in 1974, the total of its quotas stands at 24.5 million bpd now, compared with global demand of around 78 million bpd. Non-Opec producers account for roughly two-thirds of global production. The US gets more than half of its oil from outside Opec, even though its oil imports have jumped nearly 700 per cent since 1973.

Some analysts see all this as pointing to the demise of the last commodity cartel. But the question is whether Washington, which suffers from a severe image problem in the Arab world, would encourage a price collapse - which would knock high-cost producers out of business and create instability in the very countries that have supported the US in its war on Iraq. There is also the fact that the US is itself the third-largest oil producer in the world and has vast interests in the energy sector. It's not surprising that the US has supported a US$25 per barrel price.

Washington has also acknowledged that the Middle East, which holds two-thirds of the world's oil reserves and has the lowest cost of production, is indispensable to its future. 'In fact, we will encourage them to increase foreign investment to steadily expand supplies, and increase their own economic potential,' Alan Larson, undersecretary at the US State Department, said recently.

An Energy Information Administration, the statistical wing of the US Department of Energy, has forecast that for the next 25 years, the price of oil will be the current dollar equivalent of US$48 a barrel. Over that period, US oil demand is projected to rise 33 per cent, with an import content of 64 per cent.

Moreover, even if supply is increasing, demand is growing at a faster pace. Today, Opec's own extra oil production capacity is 76 per cent below what it was in the summer of 1990. Consumption, which is 15 per cent higher than in 1990, has outpaced the discovery of oil reserves: proven reserves are barely 2 per cent larger. Production from major fields like the North Sea, has begun to decline. Consumption is growing rapidly in China and India.

Global demand is projected to hit 112 million bpd by 2025, of which Opec will account for 60 million barrels.

Given this scenario, it would be premature to pronounce the demise of the cartel so soon.