commentary

(Albany Times-Union)

January 6, 2003

Iraqi Oil and the Global Economy

by James T. Bartis

If Saddam Hussein is ousted as leader of Iraq, the United States will face critical decisions about the future of the world's second-largest oil reserves. Should the United States support greatly increased Iraqi oil production? Or should America protect the status quo of artificially high oil prices?

The choice the United States makes will have profound repercussions far into the future, because Iraq holds 112 billion barrels of proven reserves of crude oil -- more than five times the size of U.S. reserves.

For decades, the United States has appeared satisfied with the status quo of high oil prices more than $20 per barrel in today's dollars, rather than prices in the $8 to $12 per barrel range, which is where they would be today under a free market. The Organization of Petroleum Exporting Countries drives oil prices artificially high by keeping the supply of oil artificially low.

U.N. sanctions against Iraq are a key factor in holding down worldwide oil production and keeping oil prices high. Because of the sanctions, Iraq produces fewer than 2.5 million barrels of oil a day -- far below what that country's huge oil resource base can sustain.

If Iraq is defeated in a war with the United States and allied nations, Iraq will need funds to rebuild. Oil exports are the obvious answer. Within 5 to 10 years, a combination of high pay-off investment and sound management could enable Iraq's oil fields to produce more than 10 million barrels of oil per day -- more than four times the current level.

Pumping millions of additional barrels of oil into the world market everyday would cause world oil prices to plummet. It is very unlikely that key OPEC members would agree to cut their own oil income by accepting significant cuts in their production. OPEC could plunge into a death spiral.

Under a free market, oil prices would probably fall to between $8 and $12 per barrel over the next 10 years -- down dramatically from today's price of about $25 per barrel. At current prices, the United States is sending about $90 billion per year to OPEC members and other oil exporting countries. Globally, about $350 billion per year moves from oil importers to oil exporters. With free-market oil prices, these huge transfers of wealth would drop by at least half and possibly as much as two-thirds.

A major decrease in petroleum prices would boost U.S. and global economic activity. Home heating oil prices would drop by at least a third. Gasoline prices would drop to less than $1 a gallon. As a result, people and business in the United States and throughout the world would spend far less for fuel. From an economic perspective, the United States and many nations around the world would clearly win.

But the U.S. government needs to weigh the clear benefits of a boost in global economic growth against three potential dangers: crippling American energy producers; reducing energy conservation efforts at home and abroad; destabilizing the Middle East by sharply reducing oil earnings in the region.

On the domestic energy front, lower oil prices would hurt the oil and gas-producing states of Alaska, Louisiana, Oklahoma, Texas and Wyoming by making it uneconomical to produce as much petroleum and to explore for some new supplies of petroleum.

We can expect that independent oil producers in the United States would argue for a tax on imported oil while leaving domestic production untaxed. This proposal has been raised frequently during the past 25 years and has been rejected by all sides of the economic and political spectrum. Basically, an import-only tax amounts to a subsidy of U.S. oil producers and results in premature depletion of our domestic oil reserves.

On the environmental front, one of the benefits of high energy prices is that they encourage energy conservation, resulting in less damage to the environment from fuel production and combustion. This happened during the 1980s, when energy prices were high. Just the opposite occurred during the 1990s when prices were relatively low.

If OPEC loses its power to set energy prices, energy use will almost surely increase absent other measures. This problem is especially important in view of the growing international consensus regarding the relationship between fossil fuel use and global climate change. As a result, lower oil prices might spark a renewed effort for across-the-board energy taxes to encourage reduced energy use and lower emissions of greenhouse gases.

As for the Middle East, most of OPEC's production is coming from nations bordering the Persian Gulf, which are currently pulling in about $500 million a day from oil exports. Some of these countries -- such as Kuwait, the United Arab Emirates and Qatar -- have small populations and could prosper even with much lower oil prices. However, Saudi Arabia -- with a population of more than 23 million -- would sorely feel the loss in oil revenues because it is the dominant producer in OPEC. The combined impact of lower prices and reduced sales (at least in the short term) could devastate the Saudi economy and destabilize the government.

As we look at the real prospect of overthrowing Saddam, U.S. leaders need to keep in mind the profound effects their actions taken in the months ahead can have for decades to come on the world's governments, businesses and environment. America's challenge is to formulate an energy policy that promotes long-term political stability and economic growth while minimizing the negative effects of lower oil prices.


James T. Bartis is a policy analyst with the RAND Corp., a nonprofit public policy analysis institution. He worked in the U.S. Department of Energy during the Carter and Reagan administrations.

This commentary originally appeared in Albany Times-Union on January 6, 2003. Commentary gives RAND researchers a platform to convey insights based on their professional expertise and often on their peer-reviewed research and analysis.