Month: September 2013

Economic Warfare? A conversation with James R. Norman

In 2013 I spoke with James R. Norman, author of “The Oil Card: Global Economic Warfare in the 21st Century”

What did Kissinger mean when he said “control oil and you control nations?”

In 1970 Kissinger reportedly stated: “Control oil and you control nations; control food and you control the people.”  Then, and now, it is clear that no modern industrial/technological society or state can function without plentiful and affordable liquid motor fuel.  That means oil.  At the same time, resource-rich exporter nations may depend for their life-blood on the revenues from oil sales.  Controlling oil thus becomes a key leverage point affecting both the buyers and the sellers globally.  You need not own the stuff: just control the resources in the sense of a game of “keep-away.” Russia needs to export oil.  China needs to import it.  The US is an importer, but buys oil mainly from neighbors and allies whom it would be obligated to support in any case (Mexico, Saudi Arabia, Canada). In that regard, it is important to realize that Saudi Arabia marches in lockstep with US geopolitical and security agendas.  The US is also more able to afford its oil imports than most other buyers, as a share of its GDP.  Thus, the US is mostly indifferent to the price of oil, whereas its main geopolitical rivals, Russia and China, are critically dependent on oil pricing and availability.   A similar dynamic occurs with food, in which the US is self-sufficient and mostly indifferent to world prices and availability, unlike its rivals.

How was oil used as a weapon during the Cold War?

There is now a clear and documented record showing the Reagan Administration used oil pricing as an integral part of its economic warfare campaign against the Soviet Union.  By leaning on the Saudis and the oil majors to step up production, by restricting US oil consumption and by flooding the newly opened “paper” oil market for oil futures, The US quite successfully drove down oil prices in the 1980s and held them at severely depressed levels for more than a decade. It was a multi-pronged effort at global market manipulation and perception management that achieved remarkable success, albeit at significant cost and with collateral damage to Western oil interests. Post-soviet economic analysts have rightly attributed the resulting collapse in Soviet hard-currency income from oil exports as the single most important factor (among others, of course) in the ultimate failure and disintegration of the USSR after 1991.  Toward the end, Soviet foreign borrowings from Western governments to buy wheat to feed its people roughly approximated the cumulative loss of oil and natural gas export revenues in the 1980s, and came with strings attached which effectively precluded the use of military force by the Soviets to put down the Eastern Europe uprisings that spelled disintegration of the Soviet bloc.

Do high oil prices over the past decade have strategic implications?

Since 1998, world crude oil prices have seen a dramatic and sustained surge completely out of proportion to physical supply and demand fundamentals.  Despite more than ample world production and inventories, markets have been ramped up and sustained at irrationally high levels by a massive influx of what amounts to speculative and “investment” dollars into US and other world oil futures markets.  These fund flows, unchecked by regulators, now dwarf the physical oil markets. Physical oil output has also been restrained, despite high prices, by remarkable OPEC (particularly Saudi) discipline and restricted oil investment by the Western international majors.  Crucially, a 2003 market-allocation pact between top exporters Saudi Arabia and Russia has also served to restrain physical oil volumes and boost prices.

All of this coincides with a sea-change in relations between the US and the People’s Republic of China from “strategic partners” to strategic rivals, if not outright adversaries. While superficially one might think the US shoots itself in the foot by encouraging high oil prices, the reality is that the US can be viewed as a net “long” on oil if you include its close friends and allies. The US pays what amount to wholesale prices for cheap crude grades close to home and turns it into high-value products. China, on the other hand, has to buy from strangers, pays top dollar for the best grades, expends twice the US share of GDP for oil imports, ships its oil half way around the world in other people’s tankers through waters dominated by the US and its allies and turns the crude into relatively low-value products including fuel oil for power plants.  In short, high oil prices give the US a cold while China gets pneumonia.

Why did the United States invade Iraq in 2003?

There has never been a reasonable explanation given by the US for leading its invasion and occupation of Iraq in 2003. I argue that is because the real reason could not be spoken of plainly: The need to preempt hostile foreign (Chinese) occupation of key Iraq oil fields as soon as UN sanctions against Iraq were slated to expire in late 2003.  The Saddam Hussein regime had crossed a critical line in the sand when it granted equity ownership rights to vast undeveloped in-ground oil reserves to Chinese state-controlled oil companies in return for development funding and a revenue share.  More such deals were in line to be signed, creating the potential for a broad client-state relationship between Iraq and the PRC akin to what China had achieved in The Sudan.  Since at least 1980, the US has had in place the so-called “Carter Doctrine,” which states the US will regard any effort by an outside power to gain control of Persian Gulf region oil reserves as a direct threat to the US national interest, to be met if necessary by the use of military force.  To avoid a direct military confrontation with the PRC, the GW Bush Administration was obliged to act before large numbers of Chinese nationals could be installed in Iraq and the oil deals finalized.

Is the promulgation of the Peak Oil theory in the interests of the oil majors?

It is notable that none of the international oil majors has ever endorsed the essential tenets of “peak oil.”  They know better.  The earth’s crust still has vast unexplored potential for recoverable hydrocarbons.  That potential just keeps improving with better technology and rising prices.  The primary problem the oil industry has always faced, ever since the first well was drilled, is NOT how to get oil out of the ground.  Rather, the economic challenge is to keep enough of it IN THE GROUND so as not to trash the price structure.  Historically, the oil majors have thus tended to encourage relatively modest crude oil pricing – high enough to make a good margin but low enough to discourage over-production by higher-cost independents.  The current very high-price world oil regime is thus a challenge to the cartel and oil majors aiming to avoid a glut of production.  Thus, you see oil-related capital spending by the oil majors being held to historically very low ratios of cash flow, significant production restraint in Russia and throughout OPEC. Oil-exporting countries that attempt to cash in on the windfall and over-produce can expect to be beset by engineered civil unrest, “terror” incidents and other destabilizing forces.

http://www.post-gazette.com/image/2013/12/20/oil-derrick-bakken.jpg

If oil prices are determined by supply and demand, by conventional market forces, then your thesis of the oil price as a strategic weapon falls apart. Could you reconcile these two perspectives?

Of course oil pricing is affected by many factors.  At the margin, day-to-day supply and demand fundamentals, including currency rates, can certainly have a market impact, up and down. But these influences are usually small.  The key element is the underlying macro environment for oil pricing and especially the flow of funds into the futures markets, where oil and gas prices really are set.  Since 1998 US financial regulators have allowed an unchecked torrent of essentially speculative, non-oil-industry investment money to flood into the futures market, skewing prices wildly upward. It is not credible to suggest the regulators did not see this coming, or could do nothing about it.  They have always had ample power to rein in such flows and in fact are mandated by law to make futures markets behave in a way that reflects underlying physical supply and demand.  Their utter failure to do that job is, to me, the proverbial “dog that didn’t bark,” confirming a government-level bias toward higher oil pricing for national security purposes.

To what extent the mystery funds used to drive up the market come from accounts directly controlled by government or national security elements (including the US Treasury and Federal Reserve) is impossible to know.  But it need not be large.  Once the market gets a sense which way the wind is blowing, large pools of private capital readily jump in to do the heavy lifting. Left to its own, oil pricing would tend to gravitate toward the marginal cost of supply.  That currently is probably in the range of about $20/bbl, where it has hovered for decades. Instead, US light sweet crude trades around $90/bbl and North Sea Brent at around $120, despite the fact Bent is of inferior quality and historically traded at a discount.  Brent, however, is the primary benchmark used in pricing Persian Gulf crude for sale to the Far East (ie: China).

Mr Norman, thank you for your time.

Jim Norman is a veteran business journalist and energy reporter. He is currently a contributing writer for McGraw-Hill’s Platts Oilgram News, where he was a senior writer for 10 years before retiring in mid-2007. He has also been a senior editor at Forbes magazine and for 10 years was at BusinessWeek, where he was Houston bureau chief in the mid-1980s. Prior to that, he won an AP award for investigative reporting (on an oil and gas scam) while a reporter for the Ann Arbor News in his home state of Michigan. He lives in New York City.

At Platts, Norman has been noted for his coverage of oil industry finance, economics, deal-making and chicanery. His “prophetic press reports,” as early as 1998, were cited by Paul Volcker’s UN Independent Inquiry Committee for laying bare the likelihood of kickbacks and money laundering involving the Iraq Oil-For-Food program. His critical analysis of Enron accounting and governance in mid-2001 helped trigger the SEC investigation which led to Enron’s downfall.

His latest book “The Oil Card” can be found on Amazon.com