The Real Reason for Invading Iraq Jude Wanniski August 28, 2002

In a word, oil. At least this is the new rationale in circulation. How can the Superpower of the Planet prevent the Arab world, with control of most of the world oil reserves, from using oil as a weapon? The September issue of Commentary, the publication of the American Jewish Committee, has an article by the former CIA Director, R. James Woolsey, "Defeating the Oil Weapon." The article is mostly nonsense, as Woolsey was the least intelligent of the intelligence chiefs we have had. He has been a sidekick of Richard Perle`s for almost 30 years, which is the only reason he got the CIA job in the early days of the Clinton administration. Woolsey`s main idea, besides ethanol and smaller SUVs, is that the United States should become the "swing" oil producer, even though we have only 3% of the world oil reserves. We can do this, he says, by doubling the size of the Strategic Petroleum Reserve to a billion barrels, selling out of that inventory when the price is high and filling it up again when the price is low!! Buy low, sell high!! Woolsey even argues Uncle Sam can make money!! 

The reason Woolsey writes for Commentary is that Israel is where the oil weapon would be deployed. The damned Arabs would threaten to withhold from production if we invaded Iraq, so let us invade Iraq and get control of its 115 billion barrels of reserves, the second highest in the world after Saudi Arabia`s 265 billion. With this rationale, the arguments being raised by the critics of invasion like Brent Scowcroft seem less important. Yes, the costs of oil will go up for awhile, while the war is in progress, but once it is over and Saddam Hussein is gone and Iraqis are dancing in the streets, our friendly Baghdad government will be able to manage our "gas station" while we keep American troops stationed there indefinitely, to protect the friendly Baghdad government from the natives. In other words, we do not need an "exit strategy," because we have no intention of leaving. 

Now the real reason there is a true problem in the world oil industry is that we are not on a gold standard. There never was an "oil weapon" as long as the dollar/gold price was constant, which permitted the world markets to invest marginal capital where the economics could be reckoned with a fixed unit of account. There was always enough oil and gas to meet demand because the people who comprise "the oil industry" did not have to expand too fast during an inflation and did not have to contract furiously in a deflation. When the price of gold began falling in November 1996, it was a clear signal at least to Polyconomics that the price of oil would soon decline. Of course, the world oil industry has been struggling to expand reserves in recent years, with the biggest blows coming since 1997 when it became unprofitable for any capital to be dedicated to developing new reserves. It will be a long time before the world can dig itself out of this ditch, and it is not likely to happen with a floating unit of account. The dollar/gold price must be fixed, asap, so the world can adjust capital flows so the market can buy low and sell high, not the government.

Earlier this week I asked George Yates, former president of the Independent Petroleum Association of America for his take on the oil markets. He is "very concerned that controlling significant oil reserves has become part of the justification for a war with Iraq."  Those who make the argument, he says, tend to know nothing about the oil markets or the process of finding and producing it. "They view OPEC as an evil to be overcome and oil to be a right rather than a resource." He has always argued that OPEC has performed the necessary function of maintaining essential over-capacity, although sometimes "gracelessly." 

In the short term, Yates says the markets are tied to "how the Saudis use (or choose not to use) their current excess capacity," which is assumed to be around 3million barrels of oil per day (MBOD). There may be another 2 - 3 MBOD in a few other OPEC countries, he thinks, although that is harder to verify. He notes that because roughly 2MBOD of excess capacity is needed for the distribution system to work smoothly, "that`s not a lot of excess capacity during a period of restrained economic growth." Prices in the short-term will be driven by a decision to produce more or not to produce more. He says: "I don`t have any idea which course will be chosen but, as you know, there has been press speculation that the Saudis may want to make a statement to GW by sitting on their hands."

In the longer term -- keeping in mind that information about OPEC oil reserves, decline rates, as well as inventories is very poor -- the situation is even more disturbing. "There seems to be more and more evidence that several giant fields have peaked and are starting down the depletion slope. If this is a trend (and is to be expected at some time because of the age of these fields) it is significant because there are so few giant fields (over 500 MBO of producible reserves) and, until recently, they supplied the bulk of our daily production. This is the cheapest oil around and will have to be replaced by oil from smaller traps at higher cost." This is why he is wary about the gold/oil correlation at 15:1 going forward. Yates also worries about the natural gas picture in the period ahead, as the electric power grid increasingly relies on gas for generation, but production is falling behind for a variety of reasons involving government." He expects a supply pinch in the next 18 months even with benign weather.

What distresses me most in the near, near term is the potential for a crippling baseball strike, which is even easier to see as a problem of the monetary deflation, although nobody seems to see it but me. I have been warning since 1997 that the baseball owners were buying trouble by making long-term contracts with high-priced players on the reasonable supposition that monetary inflation would continue at a compounding rate of three or four percent a year. This would mean the fans would be expected to pay more for tickets, hot dogs and beer, and advertisers would pay more for spots to reach them on tv and radio. Instead, the deflation has cut in the other direction, first coming out of the stock market and disposable wealth, then out of incomes with massive layoffs that mean 100% pay cuts, and businesses slashing back on ad budgets. The "price" of franchises continues to climb as new billionaires seem willing to pay more to own teams, but there seems to be only four of the three dozen or so teams that are genuinely in the black, and the deflation is still bearing down on wages and prices. Soon the Yankees will be alone, one supposes, in subsidizing the rest of the teams. And then there will be none. 

Do we have to go to war with Iraq and have major league baseball go down the drain before Sir Alan Greenspan admits he goofed? Or will someone explain all this to the two oil guys in the White House, George W. Bush and Richard Cheney. The Vice President does not know especially much about the baseball strike, but maybe a light bulb might go off over the President`s head (before he invades Iraq). After all, not long ago he was one of the owners of the last place Texas Rangers.