5 Fundamental Facts About The Middle East & Oil

Bonus fact: gasoline is really just exploding dinosaurs

Who doesn't love cheap gasoline? Besides oil companies, North Dakota, and the overall global economy, nobody! The past year has seen a remarkable decline in oil prices, to the point where a drive from coast to coast can cost under $200. This has been great for the average consumer, but the global economy seems to be struggling to enjoy the benefits of a cheap car ride. Everyone knows the Middle East plays a big part in the petroleum trade (it's even become a classic and slightly racist TV trope!), but few understand exactly how this relationship works. Here are five major ways the Middle East and the global oil trade collide.

Wadiya Think Of My Fake Country?

It's All About The Petrodollars

One of the biggest changes to the global oil market occurred in the early 1970s, when Richard Nixon convinced the Organization of Petroleum Exporting Countries (OPEC) to permanently measure its supply of oil in American dollars.  Prior to that, oil was quoted in whatever currency it was being traded in (dollars, yen, rupees, Galleons...).  This created a huge demand for American dollars since now everyone suddenly had to start trading in dollars to get any oil!  This gave America quite a bit of control over the petroleum market, even though America could not gain OPEC status at the time.  Other oil-rich countries like Venezuela and Iran want to switch to the Euro, but it's unlikely the U.S. will allow that to happen anytime soon.

Thanks Dick!

Even if Europe suddenly decides it wants to trade oil in its (controversial yet Greece-approved) currency, it is unlikely much would change because....

Saudi Arabia Calls Most Of The Shots

Ok, this one is a slight exaggeration.  Saudi Arabia does not have the (near) complete stranglehold on the global petroleum market that it used to, but the Kingdom's power in influencing global oil prices should not be underestimated.  Historically, Saudi Arabia has acted as a "swing producer."  No, this doesn't mean the Saudis are dancing to jazz music or swapping companions for a night (both of which are probably illegal in the Kingdom anyway).  Swing producer refers to the ability of Saudi Arabia to raise or lower the price of global oil at will simply by adjusting its own production levels.  The other Persian Gulf oil states (Kuwait, Qatar, Bahrain, and the U.A.E.) can also help influence prices, but Saudi Arabia's 13% market share and ability to produce at least 12 million barrels per day means it is still a strong player.  The 1973 Oil Embargo, triggered by Saudi Arabia, is a harsh reminder of that.

Thanks Faisal!

Now before you grab your pitchforks and start getting angry at Saudi Arabia, remember that the role of swing producer has actually helped stabilize the market on several occasions.  During the Iran-Iraq war (when Iran and Iraq decided to massacre each other for almost ten years), Saudi Arabia compensated for the loss of both Iran and Iraq's oil supplies (since that was basically the first thing to get bombed) by raising its own production substantially.  This helped prevent a major oil catastrophe just as the United States and Europe were recovering from in 1970s oil shock.

Saudi's share of the oil market has declined in recent decades, so it isn't quite the global price fixer that it used to be.  This might be why the Kingdom has been flooding the market with cheap oil to keep prices down.  This strategy helps eliminate the Kingdom's competition (Russia, North Dakota's emerging oil market...), but also has the drawback of creating massive budget deficits.  Most of Saudi Arabia's power is based on its oil wealth, so you can rest assured that the Kingdom will begin trying to raise prices long before it gets into any serious trouble with its people.

Now THAT'S a welfare state!

Oh yeah, and there is one other potential oil producer Saudi Arabia is looking to undercut.

 

Iran Is Re-Entering The Global Oil Market

Few Middle East rivalries are more dramatic than that of Saudi Arabia and Iran.  We just covered this in detail in a couple previous posts, but relations have been pretty tough between these two since the 1979 Revolution.  Since then, the Kingdom and the Islamic Republic have been arguing continuously over which nation better represents Islam (hint: it's neither).  The hostile relations enjoyed by both countries (which has way more to do with regional power than just religion) is currently playing out in the global oil market as well.

I know that you're a a false prophet, but what am I?!

The recent deal struck over Iran's nuclear development program has also opened up Iran to begin selling petroleum to Europe again.  Previously, Iran had primarily been selling to Asian countries (China, India, Japan).  The lifting of many sanctions now means that Iran can sell directly to European markets, which some estimate can climb as high as 4 million barrels per day.  This is one reason oil prices have been falling so hard these past few weeks.  The escalating tensions between Saudi Arabia and Iran will probably continue to create uneasiness in the oil market for quite some time (setting fire to Saudi embassies and executing Iranian-backed protesters tend to leave a bad impression).  But fortunately, the United States will be somewhat sheltered from this instability because...

The United States Isn't That Dependent On Middle East Oil.....But Asia Is

Quick, where does the United States get most of its imported oil?  It's not Saudi Arabia, but it is another barren wasteland with extreme temperatures and funny hats.  It's Canada!  That's right, America imports roughly 37% of its oil from the land of hockey and maple syrup (and poutine).  Even at the height of the American-Saudi oil trade, the U.S. only imported about 35% of its oil from the Kingdom.  Now, only about 20% of American oil imports come from the Persian Gulf. We also produce nearly 9 million barrels internally, and may soon begin exporting our own oil to foreign markets.  All this means that the United States is mostly prepared to handle a Road Warrior type situation where Saudi and Iran try their luck in the oil market Thunderdome.

Two Countries Enter, One Country Leaves!

So America might be able to weather this (strictly hypothetical) crisis, but Asia will have a much harder time.  As alluded to before, China, India, and Japan import a massive amount of their oil from the Persian Gulf countries.  After many countries in the United States and Europe began diversifying away from Persian Gulf (read: Arab) oil for reasons such as economic dependence, relations with Israel), Saudi and Iran began looking towards Asian markets as future long-term buyers.  Since Asia's economic power is now directly tied to the Middle East, the region will remain extremely important even as its relative power in the global oil market starts to decline.  But what happens when we run out of oil, you say?

There's No Such Thing As "Peak Oil"

Nearly every year we hear the same doomsday scenarios about how the world is only 100, 50, or 10 years away from completely running out of oil.  These people probably own stock in renewable energy companies because the simple truth is that "peak oil" (this idea that we have already exhausted or will soon exhaust the majority of oil supplies) doesn't really exist.  Most of the time, when people talk about peak oil, they are referring to oil reserves that are both proven and accessible (after all, much of the world's known oil is just too hard to get at).  To be sure, the era of super cheap and easy to extract oil is starting to fade, but there are still hundreds of billions of barrels of oil which can still be recovered to turn a profit.

These estimates of the end of global oil forget that the petroleum industry is evolving over time.  Like a combustible energy T-Rex, petroleum technology continues to adapt to its surroundings, finding new and more ingenious ways of extracting oil.  Only a couple decades ago, oil from shale and tar sands was all but excluded from consideration.  As this technology is developed, it drives down the cost of extracting hard to reach oil.  In another couple years, drilling and extraction technology can easily open up new oilfields which were previously considered impossible or too costly to mine.

And yet this still happens!

The real threat to the global oil market is, of course, renewable energy.  Hydroelectric, solar, and nuclear power is far cleaner, more sustainable, and (sometimes) more efficient.  As we continue to innovate, even more efficient and sustainable energy production methods will slowly replace fossil fuels as the world's primary energy supply.  Though every nation will be changed by this, perhaps no region will feel these effects more than the Middle East.  If countries like Saudi Arabia and Iran do not take care to diversify their economies (like the U.A.E. has done), they will be left behind in the global economy. Fortunately for now, who wants to invest in renewable energy when gas is so cheap!

Time to buy a Hummer!  This won't be a bad decision in five years.

What Is America's Strategy In Iran?

"It is imperative as a matter of fundamental principles of diplomacy of multilateral relations, and frankly of wielding the great power of potentially going to war, that you exhaust all the diplomatic possibilities before you ask young men and women to put their lives on the line." -John Kerry

Secretary of State John Kerry & Iran Foreign Affairs Minister Mohammad Javad Zarif

When a group of student militants seized the American embassy in Iran during the Revolution of 1979, everyone knew that American-Iranian relations would never be the same.  Iran's revolution, sparked in part by the actions of Iran's brutal (and American-backed) Shah Mohammad Reza Pahlavi, resulted in the complete upending of the balance of power in the Middle East.  Iran perceived itself as surrounded by new enemies, and its aggressive actions in the following years helped ensure that became true.  Now, after decades of sanctions and isolation, Implementation Day has arrived in Iran.  A critical part of the recent international agreement surrounding Iran's nuclear development program, Implementation Day saw the lifting of many (but not all) trade sanctions against Iran.  Though controversial, this is part of a long strategy by the current administration to slowly bring about change in Iran.  This week, we investigate the long-term strategy for American-Iranian relations.

This Tends To Send A Bad Message

First of all, what are these sanctions anyway?  Basically, sanctions are large international agreements which tend to be directed towards specific nations.  In the case of Iran, these agreements are designed to prevent Iran from having access to the oil trade, stop certain officials from engaging in international banking, and block Iranian access to American made aircraft for commercial use.  Iran has also had substantial resources and assets frozen in international banks, meaning that Iran is likely to receive between $55 and $100 billion dollars in the coming months.  Though not all sanctions have been lifted (and most American businesses still cannot conduct affairs with Iran), Iran is set to receive a substantial boost from this development.  In all, Implementation Day means that Iran will effectively rejoin the international community as a participating member.

Also Carpets, They Can Trade Carpets Again!

Implementation Day has been directly connected to the negotiations of Iran's nuclear development program.  The major points of this have been reviewed several times on this blog, but what are the long term implications for the non-military strategy of preventing Iran from developing a nuclear weapon?  Essentially, the United States is seeking to change Iran's behavior by opening up the country rather than keeping it closed off and isolated.  The basic theory behind this is that as Iranians become more exposed to the outside world, they will want to take a greater part in it.  As the nation and its people become more dependent (and connected with) the outside world, they will be less likely to accept their government pursuing policies which threaten this relationship.  In short, either the Iranian government would have to abandon its pursuit of nuclear weapons entirely, or its people would eventually try to change their government.

Of course, this Liberal International Order (everyone trades with each other and holds hands) is somewhat idealistic.  But this has worked to generally prevent large scale conflict and promote international cooperation for decades.  Known as the Economic Peace Theory (or McDonald's Peace Theory if you are hungry enough), this idea states that countries with strong economic ties (and a McDonald's) very rarely go to war with each other.  Countries can still have substantial disagreements, but economic partners simply have too much to lose to risk going to war with each other.  In short, by opening Iran up to international markets and global influence, the West is looking to change Iranian behavior through persuasion and positive reinforcement (as opposed to the coercion of bombs and sanctions). 

The Great Peacekeeper Of Our Time

Will this strategy work?  Right now it is too early in the process to tell.  However, there are promising signs that Iran is looking to start a new chapter in its international relations.  Iran has a very large youth population (nearly 60% are under the age of 30), and these people are often far less enamored with the establishment than previous generations have been.  They hold a much more positive opinion of the United States and are typically less enthusiastic about Iran's radically religious government.  Still, Iran's clerics and the Revolutionary Guard force hold a lot of power in government.  Protests like the 2009 Green Revolution (which disputed the re-election of president Ahmadinejad) have been a sign in this favor of this direction, but it will take time (and the involvement of global influence) for substantial changes to occur.

Green Revolution Protests

Most people in Washington (except those very closely connected to Iran's regional enemies) want the same thing: a friendly and stable Iran, but they differ on the best approach to this.  Some want to bring about change through coercive force (more sanctions, bombing, further isolation), but this strategy has produced few meaningful results in several decades (and does little to improve relations).  We have seen the failure of this strategy in places like Iraq in 2003.  Military strikes would only set Iran's nuclear tech development back a few years.  It would also likely enrage the population and further convince Iran's leaders that the world is out to destroy them.  In order to bring about permanent change, the nation (and its people) itself needs to reform.  This only happens by demonstrating both the benefits of cooperation in the international system (sanctions relief, participation in the global economy) and the consequences of rebuking this system (isolation and sanctions).  Participation in the international system is usually very alluring to both governments and the average citizen.  Opening up Iranian markets in a responsible way is the best way to help reform the country in the long term.

TL;DR: Give Iran McDonald's, not bombs.

The Saudi-Iranian Rivalry In Context

"Diplomacy is fundamentally working with people, bringing people together to deal with difficult issues." - John Roos, former U.S. Ambassador to Japan

Can't We All Just Get Along?   (probably not)

Tensions have spiked in recent days between two of the Middle East's dominant powers: Saudi Arabia and Iran.  When Saudi Arabia executed a prominent Shia cleric named Nimr al-Nimr (along with 46 others) last week for peacefully protesting the government's discrimination against its Shia population, many Iranians responded by setting fire to the Saudi embassy in Tehran, Iran.  And in response to the torching of its embassy, Saudi Arabia formally severed diplomatic ties to Iran (Bahrain and Sudan, being close allies, also followed suit).  This is essentially the international relations equivalent to giving a country the silent treatment.  But this behavior between the two countries is hardly new.  As we will examine this week, the Saudi-Iranian rivalry goes back much longer than just the past couple of years.

First of all, this is about much more than just the Sunni-Shia religious divide in Islam.  Though Saudi Arabia likes to proclaim itself as the champion of Sunni Islam and Iran does the same for Shia Islam, many Muslims do not look to these regional powers as the embodiment of religious piety.  This dispute has much more to do with the dynamics of nation-state power.  Both countries have large amounts of wealth, resources, and regional power.  Given their very close proximity, it is understandable that the interests of these two nations would inevitably clash.  Like France and Britain before the First World War, Saudi Arabia and Iran are looking to be the uncontested leaders of the region.  However, things weren't always so dramatic across the Persian Gulf.

For part of the 1960s and 1970s, Iran and Saudi Arabia had modestly friendly relations.  During this time, Iran was ruled by the American-backed Shah Mohammad Reza Pahlavi.  Both nations enjoyed very favorable relations with the United States and even cooperated on a few regional issues.  However, as with so many things in the Middle East, this fundamentally changed following the 1979 Revolution in Iran.  The new (and extremely fundamentalist) regime was radically opposed to Saudi Arabia (and the United States as well), and relations quickly fell apart as the revolution continued to intensify in Iran.

Iranian Revolution: Ruining Everyone's Plans Since 1979

These problems were magnified greatly during the outbreak of the Iran-Iraq war in 1980.  Iraq (being a fellow Sunni nation) enjoyed billions of dollars in monetary and weapons support from Saudi Arabia in its vicious war with Iran.  Iran threatened retaliation against Saudi Arabia multiple times (and even laid mines throughout the Persian Gulf to destroy Saudi tanker ships).  Incidents like the killing of over 400 Shia Muslims during a demonstration at the 1987 Hajj in Mecca didn't help the situation either.  Though their mutual condemnation of Iraq's invasion of Kuwait in 1990 helped improve relations somewhat, Saudi Arabia and Iran never fully regained the cooperation they once enjoyed. 

Eight Years Of War and Hundreds Of Thousands Of Casualties Later, Almost Nothing Changed

Today, the Iran-Saudi Arabia rivalry is reaching another critical low point.  In Yemen, Saudi Arabia has been directly targeting the Shia Houthi rebels who took over much of the country last year.  These rebels, though not complete puppets of the Iranian government, still enjoy a substantial amount of support from Iran in its effort to create a friendly Shia government in Yemen.  The two are also at odds in Syria and Iraq.  Though both nations claim to be against ISIS, they each support a different faction in the region and are both looking to install weak (and friendly) governments so each can further their own influence in the region.

So what does this all mean for the future of the Middle East?  It is difficult to say this early if the severing of diplomatic ties is a temporary reaction to recent events or a long-term signal of extremely strained relations.  Still, many are worried that this issue could derail the (lukewarm) support these two nations have provided for diplomatic efforts to resolve regional crises like those in Yemen, Syria, and Iraq.  Further complicating things, Saudi Arabia has also expressed concerns about the recent deal surrounding Iran's nuclear research program.  But it should be noted that this has less to do with the fear of Iran obtaining a weapon (since the deal makes that extremely difficult within the next fifteen years), and instead has much more to do with the regional power Iran can gain through the lifting of trade sanctions.  But all of this doesn't mean Saudi Arabia and Iran are on the brink of war by any means.  Though each will continue to subvert the influence of the other, both nations know that full-scale war usually creates more problems than it solves.

We All Know How Annoying Trade Sanctions Can Be

In all, Saudi and Iranian relations have hit a recent low point, but this is hardly a new development.  The behavior of each nation means that we are still very far apart from seeing a cooling of tensions or the establishment of friendly relations.  So long as Saudi Arabia continues to export its radical Salafi ideologies to subvert Iran, and so long as Iran's government remains packed with radicals and hardliners, the situation will likely continue to deteriorate.  The difficulty will be in reminding both nations that the other isn't going to go away anytime soon, and convincing each nation to abandon their radical agendas for regional power.  Without this, lasting peace and stability is impossible.  Perhaps the United States can play a role in resolving this, but we ought to be careful not to get dragged too far down into the maelstrom of the Saudi-Iranian conflict. 

TL;DR: Saudi Arabia and Iran have vastly different interests in the Middle East.  This conflict is escalating, but is unlikely to break out into armed aggression.