A changing oil market

On a recent visit to London, I had the opportunity to meet Dr Leonidas Drollas, the right-hand man to Sheikh Zaki Yamani, the former oil minister of Saudi Arabia and a prime mover behind OPEC, at the Center for Global Energy Studies (CGES). Drollas is a graduate of the London School of Economics and the first econometrician to be hired by BP at its London headquarters. He became scientific director of the newly established CGES in 1989. He is nowadays considered one of the great oil market analysts and his answers are quite illuminating and shed light on many questions that concern the public. A weakened OPEC The war in Iraq is raging. However, despite the gloomy predictions, oil prices have declined. What is going on? Even though the price of oil has slightly recovered – after a sharp drop at the beginning of hostilities – as a result of reduced production in Nigeria and because of the greater resistance encountered by the allied forces in Iraq, its general trend after March 10 has been a downward one. The price of oil fell by $8 per barrel, or 23 percent, in less than 10 days after March 10. This was an unexpected development. In 1991, during the last Gulf war, the price of oil declined straight after the beginning of hostilities and very few people expected that prices would decline earlier than that in the present conflict. That this happened is due to the market’s positive fundamentals. The lack of oil production in Venezuela, which was the result of a strike in December 2002, led nine of OPEC’s 11 members – except Venezuela and Iraq – to raise production to compensate for the events in Venezuela. This meant that oil that took five days to reach the United States was replaced by oil from the Middle East, which takes an average of 42 days to reach the East Coast of the USA. It is this oil that is now turning up at the East Coast’s refineries, expanding US reserves and relieving upward pressure on prices. The second factor that contributed to the recent decline in oil prices was the arrival of warmer weather. The period from November to February was colder than usual. This has led people to reduce consumption by more than usual. Higher available quantities, combined with smaller seasonal demand, lead to a rise in global reserves and lower prices. Do you foresee Iraq returning to OPEC after the end of hostilities? Provided that Iraq has a new government by summer, it is very difficult to foresee this government wanting to rejoin OPEC functions so early. OPEC means quotas and limitations in oil production, while Iraq will need to have maximum freedom of movement. It will need to restore its production infrastructure and to revise the legal status and organization of its oil industry. But, above all, it will need money, a lot of money, since oil can ensure the revenues it will desperately need. Moreover, Iraq will claim that OPEC has dominated the market completely since the invasion of Kuwait in August 1990 and that it is time to leave Iraqi oil production unimpeded. My estimate is that Iraq will return to OPEC but that it won’t rejoin the quota system for quite a while. Do you think the United States has a plan to undermine, and ultimately dismantle, OPEC? I really believe there is no such plan. However, in recent years, we have seen a significant deviation in the priorities of US foreign policy, including a different stance toward OPEC. Before September 11, the three pillars of US policy in the Middle East were ensuring safe oil supply routes, guaranteeing the existence and independence of Israel, and supporting Saudi Arabia and other regimes friendly to the United States, such as Egypt and Jordan. The first and third pillars meant that the US overlooked the «democratic deficit» in many countries and did not actively oppose the wishes of many of these states to create conditions of high oil prices through OPEC. Moreover, it was estimated that OPEC’s positions and efforts to control supply and increase prices were good for the market. This explains [former US President] George Bush’s visit to Saudi Arabia in 1986, when he was vice president, to convince King Fahd to help push prices up. But, after the tragedy on September 11, 2001, the United States’ priorities have changed. The war against terrorism has become priority No. 1 and confronting the pariah states is second in the list. This means that the USA’s unconditional support of some Middle East regimes can no longer be taken for granted. As a result, the USA appears less willing to accept high oil prices in order to prop up the authoritarian governments in the area. The old Middle Eastern paradigm of oil nationalism, state repression, high defense budgets and lack of respect of human rights has become anathema to US policymakers. OPEC appears as an increasingly anachronistic institution, and maybe, along with the old model of economic and political development, it has outlived its usefulness. Dilemmas for the industry in Iraq in the post-Saddam Hussein era On March 14, Sheikh Ahmed Zaki Yamani held a high-level conference in London to discuss the situation in international oil markets relative to the situation in Iraq. What was the spirit pervading that meeting? Were there any conclusions drawn by the participants? The general spirit of the participants was one of suspense and alert ahead of the start of hostilities in Iraq. The Iraqis attending the conference were convinced that the war was not going to be easy and that Turkey’s presence in northern Iraq would create problems for the allied forces. Sheikh Yamani himself feared that an attack with chemical weapons against military units and even neighboring countries by a desperate regime was very likely and warned of the likelihood of high oil prices if this happened. Many speakers expressed the opinion that winning peace was as important as winning the war and that Iraq should not be obliged to pay for war reparations. There was also a great deal of discussion about the post-Saddam Iraqi oil industry, with some favoring the continuation of a state monopoly, while others favored a partial or total privatization of production and reserves. One of the main conclusions was that it will take much more time and a lot more money to rebuild Iraq than people believe. Can you describe the operations of the CGES? How important are they relative to international developments in the energy sector? The center is an independent think tank and is, therefore, in a position to study, analyze and comment on important energy issues without being obliged to satisfy one party or another. It has also acquired a reputation for detailed and, quite often, original research, especially on oil price forecasts. Thirteen years ago, the center pioneered the idea that oil prices are influenced by factors relative to reserves. As a result, it has developed specialized models on the behavior of reserves and prices. CGES has also conducted econometric studies on oil demand issues and has developed models on the international trade of natural gas, tanker fares, oil prices and risk offset strategies in the global market. One of the center’s tenets is that the speculated link between the rise in the planet’s temperature and the burning of hydrocarbon fuels has not yet been proved and that the integral application of the Kyoto Protocol would negatively affect most economies without reason. The center’s work is diffused among its regular publications, special studies and four international conferences it organizes annually on crucial energy issues. What are your specific duties in the center? How can you describe your collaboration with Sheikh Yamani? I am the center’s deputy executive director and chief economist. I oversee its daily operations and am responsible for all its regular publications. Moreover, I contribute articles and studies and represent the center at many international conferences and other events. I also work closely with the center’s chairman, Sheikh Yamani, and the executive director, Dr Fadhil Chalabi. (1) Costis Stambolis is director of Delos Communications.