The Happy Arab News Service

Monday, January 22, 2007

Oil Misconceptions

This post is an after-thought of my conversation with Lirun. You can read the whole of it here. The debate started after I said that a move to low carbon economy will devastate the Middle East economically and plunge the region into chaos. Among several comments that we exchanged during this conservation the first one by Lirun in particular called my attention:

dude.. you under-estimate the tycoons of our region.. while we were sleeping they have been very diligent to store their nuts for the winters in the green pastures of europe..

any european change of direction will be well coordinated with arab money..

furthermore.. once solar farms take off.. guess where will be best to locate them.. some good empty arab desert with some good old israeli know-how.. we'll be energy magnates in no time..

the middle east isnt done with the energy trade just yet..

I regularly encounter misconceptions regarding oil, green energy and its potential effect on the Middle East. Lirun's comments contain a few of them and to reply to each and any of these misconceptions will take probably several posts. So I will relate here to only one of them and this is that the Middle East can reestablish itself economically as a trader in solar energy.

This misconception is based on another one - that the Gulf region grew prosperous as an energy trader, by selling oil. This is plainly wrong. To think that energy trading made the Gulf Arabs prosperous is to greatly overestimate the Arabs in general and the Gulf Arabs in particular. In general it's impossible to avoid overestimating Arabs. I am doing it all the time myself even though i have usually nothing good to say about them. So I don't blame people for committing this mistake, but Israelis should have it very clear that the prosperity of the Gulf Arabs has nothing to do with their managerial excellence or technical expertise. The Arabs don't prosper because they extract and sell their oil but because they are part of the cartel called OPEC in which the Gulf countries led by the Saudis have a decisive voice.

I have no idea at which profit margins the Arabs are selling their oil but it is sure out of any proportion to the actual costs. It is generally considered that the Saudi fields can still be profitable at $5-6 per barrel (not the state which will go bust immediately). This means that the ratio of profits to costs is above 10 to 1. So it is not oil as such that keeps the Arab/Muslim world on its feet but the manipulation of oil price by the OPEC cartel. The Arabs simply take advantage of the fact that unlike corn one cannot grow oil at will where one wants.

From the Gulf oil money flows to all corners of the Arab/Muslim world via different channels. One of these are remittances sent home by gastarbeiters to their home countries. Dozens and hundreds of thousands of Muslims from all parts of the Muslim world work in the Gulf and the money they send home accounts in some countries for from 1/4 to 1/3 of all currency inflows.

There are more ways for the oil money to get out of the Gulf. The Lebanese economy for example is based squarely on tourism from the Gulf. Each year the Khalidgees leave a few billions of dollars in Lebanon as tourists, many of them buying homes and yachts in Lebanon. The Saudis invest heavily in the Lebanese infrastructure but once again this is because this infrastructure serves tourists from the same Gulf.

Syria is reported to have up to 1/3 of its revenues coming from Lebanon. Apart from that bit of oil the Syrians sell themselves, another 1/3 of their revenues comes once again from the same Gulf region. And this is more or less the model of the economic development in the Middle East and to a lesser degree in the rest of the Muslim world. The Gulf states sell oil and their oil wealth then trickles in direct or indirect ways to the rest of the Arab/Muslim world. The fact that most of the Arab/Muslim world still didn't fall apart is because they are all feeding in one or another way from the Gulf region. Our region is very close to the Gulf region and so the Arab countries around us grew to be particularly dependent on the prosperity of the Gulf.

The OPEC can manipulate the price of oil in several ways but the most basic of them is that the Saudis and others are simply in no rush to develop their fields or to sell their oil for a lower price to push competitors out of the market. They know that they are seating atop of the world's biggest reserves and the rest of the world can hardly go elsewhere because the Arabs co-opted some other big producers like Venezuela and Mexico.

In fact in some cases to claim that the Arabs/Muslims manipulate the price of oil is really to think too much of them. Iran for example is projected to stop being an oil exporter at the beginning of the next decade. But this has nothing to do with OPEC cartel trying to inflate the price of oil by creating shortages. The oil production in Iran is declining because of years of chronic under-investment. And another reason is macro-economic mismanagement. Inside Iran the price of oil is kept intentionally low as part of populistic economic policies. This encourages domestic oil consumption at such a scale that it undermines the position of the country as an oil exporter.

In short it's not energy trading that made the Gulf Arabs prosperous. It's not for the fact that the Arabs have lots of oil, that the Gulf region is what it is. Otherwise i will have to acknowledge that there is at least one thing that the Arabs can do properly. But this is not the case at all. The economic backbone of the Arab/Muslim world is based on a combination of OPEC's cartel practices and overall economic and technological backwardness. It's one of those rare cases when the Arabs' backwardness play into their hands. It would be more correct to say that the Arabs grew rich not by trading energy but rather by intentionally or unintentionally not trading it.

At one point after i explain why the solar industry won't establish itself in Saudi Arabia, Lirun asks:

dont you think saudi arabia would be cheaper?

This is precisely the point. Because that means that the Saudis will attract some foreign investors, like us for example, and will start competing on the world market by price. Such a situation will be roughly equivalent today to the Saudis opening their oil fields for foreign companies. The multinationals will come with their technology and will try to produce as much oil as possible. The price of oil will go down pushing out of the market other competitors since many currently active oil fields will stop being profitable if the price of oil goes below $10-15.

This would be considered a huge achievement in a normal country. But the Saudis are not a normal country. They are an Arab country. The Saudi budget will be wiped out with dozens of thousands of gastarbeiters being sent back home for lack of employment. This will start a chain reaction across the region that will reverberate all over the Arab/Muslim world. It will be an economic collapse on a regional and even wider scale. And the main reason is because the Arabs didn't grow prosperous by competing at the energy market, but by expanding profit margins through direct or indirect price manipulation. Solar energy may be more expensive than oil but its because it's economically less efficient. In terms of profit margins none of the green energies will ever resemble oil even remotely.

But it is on these insane profit margins of today's oil market that the Arab/Muslim world survives economically. Even if some of green energies become as economically efficient as oil, the competition will immediately drive the prices down since unlike oil nobody has a monopoly on sunlight. That's why even in a highly improbable case of most of the world's solar plants being located in the Gulf this will fail reproduce the oil effect.

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