Diatribes of Jay

This is a blog of essays on public policy. It shuns ideology and applies facts, logic and math to economic, social and political problems. It has a subject-matter index, a list of recent posts, and permalinks at the ends of posts. Comments are moderated and may take time to appear. Note: Profile updated 4/7/12

17 April 2016

Doha Oil, Nerve Gas, and Iran’s Nukes: Trusting your Rivals, and Russia’s Role

[For a short update on the failed Doha talks, click here. For an endnote on the long game, click here. For a recent post on the Dems’ Brooklyn debate, click here. ]

This weekend the petrostates are meeting at Doha, sans Iran. An intelligent alien watching them would be puzzled. Will they reach agreement to freeze oil production? And if not, why not? More important, why hadn’t they reached agreement long ago, so that the oil price slump they’ve been suffering for over a year never happened?

To any rational beings in their positions, agreement would be a no-brainer. They would just have to understand a basic principle of economics. It’s taught in every basic course in college and even in high schools. It’s called the “elasticity” of supply and demand.

As I’ve explained in detail elsewhere, oil is one of the most inelastic commodities known to economics. For most motor vehicles, it’s essential and has no real substitutes. At least the two closest things to substitutes—natural gas and electricity—are not yet widely used for that purpose. So, as for all inelastic commodities, small changes in global supply or demand produce nonlinear and outsized effects on price.

It’s not hard to do the numbers, at least with crude accuracy. Since its peak in 2013, oil has plunged from $111 a barrel to under $30, recovering to its present price of near $43. That’s a drop to present pricing of 61%. What caused it? A supply glut of less than 2 million barrels per day worldwide. That’s about 2% of the 93 million barrels consumed globally every day.

So a supply excess of less than 2% has caused a price drop of 61%, or over 70% at the trough. That’s inelasticity!

To have avoided their respective fiscal catastrophes, all the petrostates would have had to do was each decrease its own production by 2%. Then the oil income would have fallen by only 2%, due to the decrease in volume. Instead, by continuing to pump in manic rivalry, they created the surplus, collectively, and let prices fall enough to cut their income 61%.

Rational? Hardly. So why did they do something that, on its face and on the numbers, seems incredibly stupid? Why are they unable to do something easy and simple to enrich themselves?

Not surprisingly, the answer lies in the things that have made the difference between barbarity and civilization throughout human history: enmity and trust. The Saudis and Iranians hate each other, and the rest of the petrostates don’t trust each other. If they did, oil prices would again be at the highest level that the developed world could bear, just as they were when the Saudi Oil Ministry, through its control of OPEC, set oil prices to maximize their benefit to OPEC.

The Doha parties could easily circumvent the millennial Saudi-Persian, Sunni-Shiite hatred, at least in theory. No one thinks Iran can increase its production by much more than 0.8 million barrels per day, at least in the next year. So if the Saudis could repress their hate for Iran, just for a moment, they and the other petrostates could take up the slack—less than 1% of global demand—and raise prices back up to erase most or all of the 61% drop.

So why don’t Russia and the other petrostates gang up on the Saudis and make it happen? Here the answer shifts from enmity to trust. In order to agree, the Saudis and all the others have to trust each other to perform their parts of the production-limiting bargain. Self-evidently, they don’t.

Unlike the Saudi-Iranian enmity, the lack of trust among petrostates is not entirely irrational. The history of cartels is rife with cheating, and there’s really no good way to determine whether other petrostates are cheating.

Think about it. Recently the international community decided to restrict shipments of nuclear-useful material into North Korea. The only way they could do so (they apparently thought) was to allow stops and searches of ships going to North Korea. Otherwise, they didn’t think they could tell what’s a nuclear-useful cargo and what’s not.

Now oil tankers have a special profile, which satellites can see. A good satellite, along with good computers, can probably tell a tanker’s capacity, at least within 10% or so.

But a satellite can’t tell how full the tanker is. Nor can a single satellite tell where every tanker it sees is coming from or going to. It would take a whole-Earth-covering network of satellites, watching 24/7/365, to monitor global oil shipments effectively. The only nations that have that capacity are the EU, Russia and the US, plus maybe China.

All but Russia are non-petrostates, unlikely to slit their own price throats by monitoring a cartel for the petrostates. In addition, any state capable of such monitoring probably would have to divert significant spy-satellite capacity from more sensitive and important military operations.

So Russia holds the key, as it has in two other recent international accords. Russia avoided US direct involvement in Syria’s civil war by agreeing to force its client and vassal Assad to divest himself of nerve gas, and by monitoring the divestment. Later, Russia helped forge the Iranian nuclear accord by leaning on its client state Iran and agreeing to extract Iran’s nuclear material, transparently and verifiably, according to the accord. In other words, Russia used its might, technology and influence to allow the US and international community to trust and verify compliance with diplomatic agreements.

The results were notable. First, nerve gas left Syria without deeper US involvement in the Syrian civil war, without risking direct military confrontation between the US and Russia, and without possible inadvertent dispersion of nerve gas in air or drone strikes. Second, our species avoided, for the moment, another possible war in Iran, in which super-nuclear powers Russia and the US could also have come into direct conflict.

Say what you will about Vladimir Putin. He is a dangerous man, willing to press every advantage and risk chaos and vast suffering to do so. But he’s far from stupid. He appears to be cleverer at diplomacy than he is at awkward military action, as in Eastern Ukraine and Syria now. Likely he understands the “art of the deal” far better than pathetic Donald Trump.

So will Putin make the difference at Doha? Will he commit Russia’s spy satellites and intelligence apparatus to verifying compliance with a production-limiting agreement, so that petrostates can balance supply and demand and raise prices?

There are lots of unknowns. We don’t know whether Russia’s spy satellites can do the job, at least without diverting themselves from military applications. We don’t know whether Russian intelligence can do the job, which requires global 24/7/365 monitoring. We don’t know whether Russia will be willing to devote the necessary resources or, even if it will, whether the Saudis and other petrostates will trust Russia. After all, the Saudis mistrust Russia (as Iran’s adamant backer) almost as much as they hate Iran.

But if Putin can bridge the trust gap and enforce an agreement at Doha, we will be back in the pre-Crash oil regime. Then Saudi Arabia, as leader of OPEC, cleverly set global oil prices just high enough to squeeze the developed world hard without strangling it. If the developed world wants to avoid economic subjection to petrostates, it’s going to have to start working harder on fracking for oil and using fracked gas as a substitute for oil in light vehicles. And it’s going to have to get much more serious about electric cars and making nuclear power safe.

Endnote on the long game

The foregoing analysis applies in the short-to-medium term. Whenever (if ever) the petrostates get their act together, the price of oil will rise to the point at which the economies of developed-nation buyers begin to stagnate or decline. Then it will stay there.

It could begin this weekend at Doha. It could happen next year. Or it could fail to happen until oil starts to run out.

Based on 2013 global reserve and consumption figures, global oil will run out anywhere from 2031 to 2056. That would be in the lifetimes of children living today. Universal fracking might extend oil reserves another twenty or thirty years. But today’s children’s children will almost certainly see the global exhaustion of oil. There are only so many liquified, ten-million-year-old dead trees in the Earth’s crust where we can reach them.

After a short period of extraordinary revenue (from exorbitant low-supply prices pre-exhaustion), the petrostates’ economic power will evaporate. The whole world will be proud owner of a gigantic stranded and obsolete infrastructure: oil wells, derricks, refineries, tankers, and cars, trucks, buses, trains, planes and construction equipment that run on oil. Our successors will convert some of it to other energy sources—such as natural gas, before it runs out, likely a generation later. But much of that infrastructure will get abandoned or recycled as scrap.

During this interim period, as oil production begins to decline irrevocably, the multinationals and nations that provide substitutes for oil (and oil-burning vehicles and equipment) will control the world’s economy. They will invent, make and sell such things as renewable-energy sources, smart grids (including localized ones), storage batteries, and safe nuclear power plants. They will own the industries of the late twenty-first century and beyond.

The whole developed world is joining the electric-car craze today. So it’s unlikely that any single nation or vendor will “corner the market,” except perhaps with a breakthrough unforeseeable today.

The opposite is true of safe nuclear power plants. As far as I can tell, no one is seriously trying to develop them. Everyone is just trying to extend the life of the current unsafe designs and maybe make them marginally safer, with quick and dirty retrofits.

“Quick and dirty” are not words you ever want to hear about anything associated with nuclear power. Unfortunately, no one is seriously working on entirely new meltdown-proof designs, let alone liquid fluoride thorium reactors. So the nation, multinational or consortium that first invests the money to develop any of these will have a global monopoly, perhaps for the foreseeable future.

Wind, solar, tide, biomass and other renewable-energy sources, and the grids to accommodate them, will have a free-for-all, with Germany and its Energiewende enjoying a strong head start. These things will be the bases of late-twenty-first-century industry, along with nanotechnology, 3D printing, personalized medicine, private space travel, and “designer genes.”

So the search for alternative sources of energy and ways to use them is not just a passing fad. It’s not just about climate change, although it may help reduce the already-baked-in (pardon the pun) catastrophic change in the Planet on which we evolved. It’s a part of the global competition and progress that will take our species from burning exhaustible stuff (and polluting our thin atmosphere) into a sustainable future.

In that competition, those who continue to focus on exhaustible fossil fuels, with all their uncertain pricing, will realize the Prophecy of the Bible and Bob Dylan: “Those who are first now will later be last.” To avoid that sad fate, the Saudis are planning to sell part of Aramco and finance a “Public Investment Fund” to invest in this future. They may hate Iran enough to cut off their noses despite their faces on near-term oil pricing, but they are not stupid.

Update: Doha Talks Failed

By 3 pm Sunday (EST), April 17, the Doha oil talks had failed.

The Saudis stuck to their initial position, insisting they would not freeze their production unless all major oil producers involved did, including Iran. Iran had refused even to attend the talks, deeming any production freeze by it a “ridiculous” self-imposed renewal of sanctions.

So there was no basis for discussion. As it turned out, my suggestion that Russia might smooth the way by providing intelligence to enforce any agreement was sheer speculation. The talks never got to a stage where an offer of that sort might have been helpful.

It’s interesting to calculate the Saudis’ price for hating Iran. The talks’ failure is highly likely to drive oil prices still lower. But let’s start with the pre-talks price, $43 per barrel. (Since Iran produces only about 3 million barrels per day, its share of the cut would have been 3/93 = 3% of the whole cut. Saudi Arabia’s share of taking up Iran’s slack would have been about a tenth of that, or less than 1% of the cut.)

Saudi Arabia was looking to freeze its own production at about 10.4 million barrels per day. Let’s suppose that a 2% production cut by everyone would raise the price of oil back to $111, as at its peak in 2013. That’s ($111 - $43) x 10.4 million = $707 million per day—or nearly three quarters of a billion dollars per day worth of hate.

Of course, the Saudis might say it was all to uphold discipline among the cartel. And there’s some truth in that. The dominant player in a cartel often “disciplines” other members by temporarily lowering prices until they fall in line. But three-quarters of a billion dollars a day is a lot to pay for discipline, especially by a royal (and totalitarian) economy bleeding red ink.

The Saudis refusal to bargain potentially cost the Iranians $111 - $43 = $68 per barrel times their production of about 3 million barrels per day, or $204 million per day. The difference between what the Saudis failed to gain and what Iran failed to gain is $503 million, or half a billion dollars a day.

Iran’s recalcitrant position made as little economic sense. Had it acceded to a 2% production cut, it would have gotten 98% of the $204 million per day, or just about a clean $200 million per day. As the talks failed, its daily oil take will probably go down with the price of oil, which might drop all the way back to $30 per barrel. If that happens, Iran will not only forego about a $200 million increase, but will suffer a $39 million per day actual loss.

So there, my gentle readers, is the price of hate in the Middle East: nearly three-quarters of a billion dollars a day for Saudis and almost a quarter billion dollars a day for Iran. Neither seems so exorbitant a price when you compare Syria’s utter destruction. But I wonder what ordinary Saudi citizens, especially Shiites, and ordinary Iranians would think of it.



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