War and the Oil Price Cycle

Saturday, February 13th, 2016

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Conflicts in the Middle East, including the Syrian civil war and the rise of ISIS, are raising serious new risks to regional oil facilities, making them both strategic assets and spoils of war.

Oil has shaped international conflict for many decades. According to one estimate, between 25% to 50% of interstate wars between 1973 and 2012 have oil-related linkages. Still, the cyclical nature of oil’s contribution to global conflict is not well understood. Not only are oil prices cyclical, but the geopolitics of oil is linked inexorably to the same boom and bust price cycle. Military adventurism, proxy wars and regional pathologies in the Middle East expand and contract with the ebb and flow of massive petro-dollar accumulations and recycling related to the oil price cycle. The massive inflow of petro-dollar revenues when oil prices are high create disposable income that can be easily dispensed on regional arms races, especially since oil consuming countries like the United States and Europe are incentivized to increase arms sales to solve oil import-related trade deficits. Then as oil prices recede following the impacts of prolonged high prices, which stimulate new supplies and slowing demand through economic slowdown, substitution and conservation, social and political problems in the region reemerge. Regional governments have less resources to spend on restive populations who have become accustomed to generous hand-outs enabled by high oil prices. Job creation and visible social programs slow, dissatisfaction rises, and the consequences of economic down-cycles incite support for militants inside the borders of petro-states. Ensuing instability forces governments to use newly purchased arms, which ironically begins the cycle yet again by putting oil producing geography in the path of violence, leading to oil price spikes and disruption that drive the next boom and financing for replenishment of military equipment.

In this manner, the world experiences perpetuating repeating patterns of Middle East military conflict, followed by oil supply crises, and accompanying global financial instability. In effect, the Middle East resource curse has become globalized and the challenges this is currently presenting on humanitarian, security and economic fronts has become increasingly dangerous. We discuss this pattern at length in a new article in the Journal of International Affairs released today.

The arms race that accompanied the rise oil prices over the 2000s has been no exception and is now rendered all the more complicated than in the past by the violent participation of sub-national radicalized groups whose interests differ from regional governments and are less susceptible to diplomatic pressures or initiatives. In this emerging geopolitical context, the rise of sub-national groups and insurgencies like the Islamic State (IS) and Al-Qaeda is increasingly putting oil infrastructure at risk, laying the groundwork for a future oil crisis that may prove harder to solve than in the past. The violent protests in Saudi Arabia and Iran following the execution of Shia cleric Nimr El-Nimir by the Saudi government in early January not only further strained relations between Riyadh and Tehran but also included the firebombing of bus transportation used to take Saudi oil workers, many of whom are Shia, to the oil fields in the eastern province – a reminder that disruptions to oil operations can arise quickly and take unexpectedly different forms.

In ongoing conflict in Iraq, Syria, Libya and Yemen, Mideast oil and gas production capacity and surface facilities are increasingly being damaged in ways that will make them hard to repair, and export disruptions, once sporadic, are becoming a more permanent feature of the civil war landscape. The level of destroyed capacity is currently estimated at around 2 million b/d and rising. The longer regional Middle East conflicts fester, the more infrastructures could potentially become at risk.

And, there is an additional element to this oil and war story that links structurally with the oil boom and bust cycle. As oil prices recede and with it global oil demand in the aftermath of an oil price spike event or period, and as conflict in the Middle East accelerates, wealthy oil producers like Saudi Arabia, the United Arab Emirates and Kuwait are prone to use large oil production capacity as a strategic asset, flooding the market with increased supplies to lower prices to hurt geopolitical rivals. This price war strategy, notably present during the prolonged Soviet war in Afghanistan and the 8 year Iraq-Iran war, and now leading to speculation that oil prices might once again hit single digits, will lay the seeds for the future oil market uptick, by discouraging investment in future oil productive capacity when prices are extremely low. In the case of the 2000s, the combination of IS induced destruction of the oil sector in many locations around the Middle East, combined with expected losses in investment in other parts of the world like Canada’s oil sands and the Arctic due to current low oil prices, may be creating the conditions for a future oil supply crunch, with implications for U.S. policy.

The United States would, in light of these circumstances, unwise to dismantle its strategic petroleum reserve (SPR) as has been flirted with on Capitol Hill in light of rising U.S. domestic oil production. It would be similarly unwise for the United States to lose focus on the importance of conservation efforts in the transportation and buildings sectors which have both national security and climate benefits. Should a new oil disruption emerge in the coming years as might be expected in line with repetition of historical cycles, the U.S. will benefit strategically from its decision to lift the ban on oil exports.

Oil markets are expected to see increased volatility in 2016 and rumors that Russia is actively trying to broker a deal with the Organization of Petroleum Exporting Countries (OPEC) and other major oil producers briefly at the end of January halted a freefall in prices that characterized the first days of the year. The fate of any producer deal to stabilize the market may hinge, in great measure, on peace efforts to end the conflict in Syria – efforts that so far have proven very uphill.

As the United States continues to engage on resolving conflicts in Syria, Libya and beyond, it will need to consider the long term benefits of dealing more directly with resolving internal conflicts over distribution of resource income. Only by paving the way for long term solutions for the equitable division of oil revenues and integration of those revenues into national budgets in ways that brings economic prosperity to populations – as opposed to spending on military expenditure– will the region – and the world – be able to exit itself from this pattern of geopolitical conflict tied to the oil boom and bust cycle.

Amy Jaffe serves as Executive Director of Energy and Sustainability at the University of California, Davis, and a Global Fellow at the Woodrow Wilson International Center for Scholars. Jaffe is the chair of the Future of Oil and Gas at the World Economic Forum in Davos and is co-author of the book Oil, Dollars, Debt and Crises: The Global Curse of Black Gold. Formerly, Ms. Jaffe served as the founding director of the Baker Institute Energy Forum at Rice University.

Jareer Elass is a Washington, D.C.-based energy analyst with 25 years of experience in the industry, including as an oil journalist and editor. He is currently affiliated with AMJ Energy Consulting. Mr. Elass has served as an energy consultant and editor for the James A. Baker III Institute for Public Policy Energy Forum and as managing editor of Oil Navigator, an online energy consulting firm specializing in Middle East energy sector news and analysis. Mr. Elass worked for many years as an energy editor and reporter for Energy Intelligence Group oil publications, covering political and oil developments within the OPEC countries. Having spent his formative years growing up in the Saudi Aramco community of Dhahran, Saudi Arabia, Mr. Elass began his professional career working in the company’s public relations department.