Iraq's Oil Futures

Rosy scenario, Iraqi version, suddenly finds herself out of favor. Not so long ago, she was the belle of the postwar ball. With a bit of tweaking by highly skilled American technicians, and some money that could be generated by the sale of oil, Iraq’s industry would be restored to its pre-Saddam glory. Oil would flow in sufficient quantities to dampen the upward pressure on prices, new areas would be opened to foreign investors—well, American and British investors, anyway—and the stricken nation’s economy would float to prosperity on a sea of black gold.

That is not to be. Thamir Ghadhban, the U.S.-appointed head of Iraq’s oil ministry, told the World Economic Forum in Jordan last week that problems with power supply are forcing him to lower his year-end production target to 2.0 from 2.5 million barrels per day. With 500,000 barrels needed to fuel Iraq’s power plants and to make gasoline, diesel and kerosene for domestic use, and another 200,000 needed for reinjection to keep existing wells flowing, that leaves only a bit more than one million barrels per day available for export.

The OPEC cartel can easily make room for that volume of oil by cutting back its members’ output in order to maintain prices if market conditions require. So at least in the near-term any hopes American policymakers had that Iraq would provide relief from current $30 per barrel prices will have to be put on hold.

The long-term outlook is not much better. So far, coalition forces have been unable to prevent the sabotage of pipelines, power production facilities, or the theft of the vehicles used by oil-field workers to get to and from work. It is not unreasonable to assume that the security situation will improve. But that will remove only one of the many obstacles to the realization of the plans that the American administrator, Paul Bremer, has for the industry.

Bremer’s vision for the industry, indeed for Iraq’s economy, is worthy of Margaret Thatcher at her free-market best. He sees an economy in which state-owned and supported industries are starved of the subsidies that sustained them under the Saddam regime, in which domestic markets are open to free trade, and in which prices, exchange rates, and other variables are set by market forces. The oil industry would be operated for the benefit of the Iraqi people. And the new Iraq would set an example so irresistible that other Middle East oil producers would be forced to adopt the new model.

Why Bremer and Washington’s policymakers think that the seeds of free enterprise will bear fruit in the desert soil of Iraq is something of a mystery—a triumph of hope over experience. After all, no oil-producing country in the region has shown the slightest interest in such a model, the young protesters in Iran being a possible exception. As Fareed Zakaria points out in his new book (The Future of Freedom: Illiberal Democracy at Home and Abroad), countries are quite capable of using democratic tools such as free elections to impose draconian restrictions on individual freedom and to create economies that are centrally controlled.

To restructure Iraq’s oil industry so that it serves the interests of the Iraqi people and becomes a force for more competitively priced crude oil, the occupying powers will have to do more than require that oil revenues flow into some sort of trust fund to finance reconstruction and other good works. Occupation forces may stay in Iraq longer than Britain, America and their allies planned, but they can’t stay forever. When they leave, revenues from oil sales can be redirected by the new government into any uses that it chooses, including the construction of palaces for the new rulers, the financing of weapons programs, of the funding of anti-Israel terrorists.

American planners know that, and are now considering a two-pronged approach. First, the current monopoly producer will be broken up into several—five or six is the number most often heard. Then, shares in those companies will be distributed to the Iraqi people. The theory behind this approach is that any new government will find it difficult to renationalize the oil industry, and capture its revenues for the government, if it has to confiscate or otherwise acquire shares held by the majority of citizens.

This plan does, of course, have its weaknesses. Among other things, the power to tax involves the power to destroy, as the great American jurist John Marshall famously wrote almost two hundred years ago. An Iraqi government, freed of the supervision of coalition forces, might achieve by taxation what it could not achieve directly by takeover: it could redirect oil revenues to itself. After all, successive British governments have done just that, directing almost all of the revenue from the sale of petrol to the Treasury without owning any oil company shares.

Moreover, it now seems more rather than less likely that Iraq will reenlist in the OPEC cartel. For its part, OPEC has announced that it will welcome Iraq back with open arms as soon as it has an internationally recognized government. Whatever production Iraq can spare from domestic needs will then be exported pursuant to a cartel agreement that seeks to maintain prices at several multiples of those that would prevail in a competitive market.

The one ray of hope is that Iraq’s skilled technicians will ramp up production more rapidly than now seems likely, and that the nation’s need for cash will force it to violate OPEC quotas, pushing prices down. America and other consuming countries would benefit from cheaper oil, an economic stimulant equivalent to a tax cut, but with none of the long-term adverse effects on interest rates and investment that the Bush cuts are likely to produce.

Rosy Scenario would then return to center stage, perhaps on Bremer’s arm, to receive the plaudits of the free-enterprise set.

This article appeared in London’s Sunday Times on June 29, 2003.