Friday, July 30, 2004

Profits of Instability

A couple of days ago, I wrote a post claiming that the instability in Iraq has allowed Russia to charge between $15 to $30 billion dollars more this year for their oil production than they would have been able to charge in a traditional environment where there is no security or risk premium due to terrorism. Russia is not the only large oil exporter who has been collecting windfall profits. Saudi Arabia produces more oil than Russia and its government's finances are even more heavily dependent on oil exports than the Russian government. The Saudi budget was based on very pessimistic assumptions that oil would be priced at or below $20 per barrel. These projections led to governmental deficits for as far as the eye could see. However, in this new higher priced world, the Saudi government is loosing the spickets on the pumps while also enjoying massive windfall profits that have created surpluses and additional social spending monies for as far as the eye can see. This same story applies for the economies of the entire Persian Gulf, excluding to some degree Bahrain, and most of the rest of the member nations of OPEC. OPEC is composed of countries that are heavily dependent on oil revenue for their hard currency base.

This presents an interesting dilmena for all of the major oil exporters which are not part of NATO or NAFTA; stability in Iraq and in the Middle East in general is a contiunuum of choices, and the extremes on both ends have extremely expensive payoffs. Extreme levels of stability in Iraq will cost the Russians between fifteen and thirty billion dollars a year, and the Saudis even more money ($17-$35 billion is my best guess). Complete instability such as an Al-Queda led or inspired series of coups starting with the Saudi Royal family and moving down the line of Emirate will cost the current stakeholders their lives and fortunes. Somewhere in between are less dire consequences and therefore more desired states of being. This continuum of instability and its resultant payoff matrix leads to some very mixed incentives that we see acted upon every day.

Right now there seems to be a relative truce between the Saudi government and Al-Queda on not attacking the pipeline infrastructure. This is not because Al-Queda does not have the capability to attack the infrastructure or to penetrate security. The last major AQ operation which led to the death of approximately twenty oil field workers could have just been as easily an attack on the pumping stations and pipelines. The Iraqi insurgency has shown how soft these networks are when the bang-men are competent. Yet AQ has not attacked these targets and the attackers are able to escape the Saudi response. This is an interesting truce and it shows that a tolerable level of instability exists, as long as the actual physical infrastructure of wealth creation is not destroyed.

Yet at the same time, the Saudi government know that this truce could expire or break down at any time. They need the backing of the United States to maintain power over a very restive population. This has led to proposals to have a Muslim peacekeeping force enter Iraq. However no Saudi troops are available for this force, and the most support it will get is a nice smile and a friendly wave as it disembarks at Dhahran and Kuwait City. The Saudi government knows that this diplomatic piece of shit gives them some cover with the US government, which is desperately seeking to make the occpation multilateral for both political and practical reasons (some else can get shot.) But they also know that the Saudi National Guard is not large enough or competent enough to do anything worthwhile in Iraq while any committment is certain to bring mass riots into the streets of Riyadh. So fig leafs are offered towards moving up the stability ladder, while no real change will occur.

This same game and same basic set of payoffs are being calculated and played by all of the non-industrialized oil-exporters. Some level of instability is extremely profitable to them, especially an instability that so far has not resulted in the destruction of any actual production or export ability. The importance of this realization is simple; the incentive to cooperate with the United States is low for these countries, and if Iraq and the rest of the Middle East begins to stabilize, there is some direct economic incentive beyond the clear national security incentive that Iran possesses, to help the insurgents in Iraq. Help is not on the way.

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