Cracking the Oil Cartel

Oil prices fell six percent the Friday before last on the news that Hugo Chávez, the outspoken and charismatic leader of Venezuela, had been deposed in a military coup. However, political instability in the world’s fourth-largest oil producer might be expected to decrease the flow of oil and cause prices to rise. Indeed, politically motivated strikes have hurt oil production in Venezuela, South America’s only member of the Organization of Petroleum Exporting Countries (OPEC) in the past few months. One of the major factors in Chávez’s two-day fall from power was the work stoppages and strikes plaguing the state-run oil company, Petroleos de Venezuela.

Why did oil prices drop on Chávez’s ouster? (And rise once again when he was borne back to the presidential palace by a popular uprising Sunday?) The short answer is that Chavez has not hesitated in the past few years to kowtow to OPEC in keeping oil production down and prices high. The OPEC oil cartel—which includes Venezuela and rogue states such as Libya, Iraq and Iran—sets quotas for its member states to manipulate the market and keep oil revenues as high as possible. Because it takes only one major oil producer breaking ranks and increasing output to send prices plunging, the world market is very sensitive to the political situation in oil producing states. The guardian of the cartel’s well being is Saudi Arabia, a state the U.S. inexplicably calls an ally, whose ruling family has chosen not to own up to the country’s complicity in promoting global terrorism. Owing to its significant spare capacity, Saudi Arabia can endure prolongs price slumps much more easily than other oil producers.

Despite the Saudi advantage, Venezuela tried unsuccessfully to challenge Saudi dominance of the world oil market in the 1990s, exceeding its OPEC quota of 2.3 million barrels per day (MBD) and attempting to rapidly increase production. The Saudis increased their own output by 1 MBD and caused the price of oil to collapse in 1998, causing Venezuela to give up and return to its quota.

However, another challenger is emerging in the international oil market and it may unseat the Saudis—and change the entire calculus of American interests in the Middle East. Russia and the former Soviet republics have large oil reserves that are only now being developed by major oil companies. The Soviet Union extracted 12.5 MBD at its height. Since then, the oil fields of Russia and the USSR’s successor states have been hampered by corruption and mismanagement. However, as oil industry analysts Edward L. Morse and James Richard argue in the latest issue of Foreign Affairs, Russia may once again produce enormous quantities of oil. They argue that Russia will eventually be able to win any price war that it enters with the Saudis and the Russian oil extraction operations are likely to be more flexible because they are not controlled by a stifling central government. For all these reasons, Russia is likely to be reluctant to allow a prince in Riyadh dictate its oil production levels. Venezuela and Russia could provide a serious counter-balance to the power of Middle-Eastern oil.

Indeed, if Russia and the former Soviet republics are able to hobble the OPEC cartel and smash Saudi dominance, American interests in the Middle East would be the first to benefit. Not only would the despotic House of Saud likely lose power, the ability of dictators such as Iraqi President Sadam Hussein to produce weapons of mass destruction would be seriously degraded. The Saudi monarchy is already contending with a young and restive populace that sees little opportunity in a sclerotic oil-based economy. Without a steady flow of oil money, the totalitarian governments in the Middle East would be forced to reform themselves or risk popular revolt. The recent anti-Israel demonstrations in countries such as Egypt and Jordan have shaken the leaders of those countries and shown just how fragile their grip on power is. Without oil dollars flowing into the national treasury, the governments will have to give their people the freedom to create wealth that can be taxed.

Last Thursday, the New York Times wrote about a new oil field in Kazakhstan on the front of its world business section. After years of delays due to financial difficulties and corruption, Kazakhstan is making a serious bid with its Karachaganak oil field to break into the international market. With Iraq halting petroleum exports to protest Israel’s war against Arab terrorism and the rest of the Arab world urging the U.S. not to invade Iraq and end Hussein’s murderous regime, the conditions are good for a serious challenge to OPEC and the authoritarian governments it keeps in power. Russia and the former Soviet republics are the best candidates to make that challenge. Venezuela’s experience shows that challenging the Saudis is possible.

Vice President Dick Cheney visited Arab countries a few weeks ago to gain support for an attack on Iraq. He was told, however, that the road to Baghdad leads through Jerusalem and only peace with Israel would allow Arab nations to agree to an American attack. Although that advice may be true now, to ensure the long-term interests of the U.S. in the Middle East, Cheney should call up his oil-industry buddies and tell them to jump into the Russian oil market. For the road to Baghdad might just lead through Karachaganak.

Jonathan H. Esensten ’04, a Crimson editor, is a biochemical sciences concentrator in Lowell House.