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.