HOW MUCH TO FEAR FROM O.P.E.C.?
ARROW, KENNETH
HOW MUCH TO FEAR FROM O.P.E.C.? KENNETH ARROW The concentration of oil reserves in Saudi Arabia and the small Persian Gulf s h e i k d o m s , coupled to the emergence of OPEC as an...
...Hence, the whole oil weapon is contingent for its effectiveness on continued support of the anti-Israeli front by Saudi Arabia, Kuwait and others...
...I observe only that, on the one hand, Saudi Arabia has virtually no real Kenneth J. Arrow is University Professor in Economics at Harvard and former president of the American Economic Association...
...c) Investment and ownership: The funds that are not used by the Arab states for purchases will be invested...
...This issue is distinct from the general economic problems of the Western world, although the latter certainly feed back on Israeli security as well...
...It is not held by the "confrontation states," Egypt and Syria, nor by the Soviet Union, and a fortiori, not by the Palestinians, no matter by whom represented...
...Finally, if the cartel breaks down, or if it is sustained only by a significant reduction on Saudi Arabian output, the resources flowing to the Persian Gulf countries will decline over time—the more so if demand is reduced and alternative sources of energy expanded...
...To avoid this, there may be a considerable use of intermediaries...
...Free mobility of resources between the two sectors will keep profit margins equal...
...Present prices will surely elicit more oil even from the heavily exploited domestic United States fields...
...But in some sense the length of the war is determined by the Arabs...
...it is certainly limited in its capacity for tactical use of either oil supply or oil revenues...
...All previous commodity cartels have collapsed, and the reasons are easy to understand: If prices are high, then each member of the cartel has an incentive to increase production—but the aggregate increased output can only be sold at lower prices...
...Libya can indeed use whatever power it has with little constraint from domestic needs or foreign ties, but by itself it is not large enough to matter...
...The cartel has a leader who controls prices but pays for his leadership by being the one to take on himself the burden of restricting output...
...Further, Iraq has real need for its limited oil revenues for development purposes...
...The Embargo Suppose an Arab-Israeli war breaks out, or there is some other development which produces a state of alarm...
...I here sketch first some alternative scenarios for the future of the oil market, and then consider the two main weapons supplied by oil to the Persian Gulf countries: the use of economic power, and the embargo...
...Certainly, in this decade, no country, not even the United States, will have achieved independence from Arab oil supplies (except possibly in scenario [3...
...The point here is simply that Saudi Arabia is wealthy, regardless of the reason for its wealth, and so are the small sheikdoms...
...Certainly Iran, Venezuela, and Nigeria, at least, have shown every evidence of wanting to sell as much as possible at the present prices...
...selling Israel out might not be too much of a price, if its own gains were to compensate it for the loss of an effective enemy of the Arab countries...
...The strong sense of Arab identity, sharpened by the conflict with Israel, would, however, make it difficult for the Arab states to accept Iranian leadership...
...Pure economic theory would tend to play down this effect...
...Even marching through Damascus and Cairo would not have ended the war, if the Egyptians and Syrians did not allow it to (remember Moscow in 1812...
...KENNETH ARROW The concentration of oil reserves in Saudi Arabia and the small Persian Gulf s h e i k d o m s , coupled to the emergence of OPEC as an effective cartel, clearly affect the political and military prospects of Israel over the near future—that is, until new energy developments elsewhere reduce the importance of mid-East oil...
...The role has usually proved to be unprofitable...
...There is one offsetting factor...
...The last scenario has precedent in a number of past domestic cartels in the United States, such as steel, and doubtless elsewhere...
...There will unquestionably be a reduction in energy usage, at least compared with what it would otherwise have been, and we will also witness the development of alternative sources of energy—coal, nuclear power, and possibly synthetic crudes from shale and tar sands...
...The Possible Futures of the Oil Market Many experts have expressed the view that the oil cartel must inevitably break up...
...There will be exploratory activity in the South China Sea and in Mainland China and the Soviet Union as well...
...But ownership can be used for power, particularly when the exercise of the power is not very costly...
...Algeria, in any case more remote and detached, is in a similar position to Iraq and is also constrained by its relations with France...
...On the other hand, the incentive to maintain cartel discipline is pretty clear...
...In addition, a cartel rarely encompasses the whole supply, and supply sources outside the cartel, although they may have been small initially, have a strong incentive to expand...
...for most contingencies, the oil weapon is not likely to add very much to the purely military situation...
...2) The cartel will collapse in a welter of cheating and mutual recrimination...
...Both these factors can easily be observed in the oil case...
...On balance, my own best guess, at least for the short run, is for the third scenario—but there can be no certainty in these matters...
...and no doubt the North Sea, the Alaska North Slope and the Outer Continental Shelf, among others, will be contributing much more...
...Do Egypt and Syria really depend on economic support from the Persian Gulf countries...
...We can imagine General Motors half-owned by Arabs and refusing to sell to Israel, or at least, making sales more difficult...
...Finally, I will raise some dismal possibilities about the role of Iran which do not seem to have been remarked in discussion so far...
...In the first case, the West will undoubtedly have taken some kind of conservation measures, and in the third it will be deriving its oil from other countries...
...Further, oil moves in heavily centralized channels, and control can be exercised by agreement of a few governments rather than many individual sellers...
...would now be effectively cut off from oil, and this might well be a fatal military blow...
...Only over years of unresolved tension, therefore, would it be possible for Iran to become recognized as the inevitable leader in the Persian Gulf...
...Others can speak more knowledgeably to that...
...No doubt there is desire for some economic development, for luxury consumption, and, perhaps more important, for financing arms for other Arab states and even economic development in those states and in other Third World countries...
...Even economically, it might compensate itself by taking over Kuwait...
...The purpose of this background note is to analyze the potential of forces that are or might be hostile to Israel, and so to inform the decisions that face both Israel and us...
...at a time of crisis, the assets owned in the United States, at least, are subject to blocking and even confiscation...
...In 1972 he was awarded the Nobel Prize in Economic Science...
...The consuming countries are stockpiling oil and can stick it out for a while, but not for six months...
...it has little to do with the receipts, especially relative to the volume...
...These will inevitably mean the weakening of the cartel, but the precise quantitative effects are highly speculative...
...presumably the market would fragment in proportion to the purchases by Israel and the Arab countries...
...the governments that wish to expand output will realize the self-defeating nature of their aims...
...But it could do all these things, and do them well, even with distinctly lower revenues than are now in prospect...
...Imperial pretensions are costly, but that has not stopped other countries...
...b) Boycott: The income of the Arab countries is partly used for purchases, and these are the effective sanction for boycotts...
...To the extent that Israel is supplied by monopolistic firms that will have to make an all-ornone choice between the two markets, it will be in trouble...
...Public statements by economists about the mechanisms by which cartels disintegrate can be self-denying prophecies...
...At that point, an embargo could have been used with great effect, in order to make the United States cut off arms shipments and to bring pressure from Western Europe...
...Apart from the last, the view derived is more optimistic than I had expected...
...Might it not find it useful to ally itself with the antiIsraeli coalition, under some panIslamic banner...
...but then the power is also diluted...
...Not only would the economic power of the coalition be increased, but above all, the power of the embargo would be vastly expanded...
...Others will have to assess the effects on arms, but the assessment must ask whether, between their own resources and the generosity of the Soviet Union, Egypt or Syria would not be able to acquire enough arms anyway...
...Libya and Iraq do indeed have some significant reserves and output, but they are small compared with Saudi Arabia...
...There are three possibilities here: (1) The cartel will maintain discipline...
...First, an obvious point: whatever power is conveyed by command over oil reserves is held by Saudi Arabia and, to a lesser extent, by the small sheikdoms...
...The primary aim of such investments will no doubt be revenue...
...The oil-rich states will be torn between leaning on the Iranian strength for protection against outside powers, and especially against Arab radicalism, and their apprehension at being too close to such a powerful neighboring state...
...The only offsetting factor here is the possibility of military intervention...
...3) The cartel will retain high prices, because Saudi Arabia will take it on itself to cut output to the extent that others are increasing it...
...In particular, Israel itself If there were intervention, the wells could easily be sabotaged, and thereby kept out of production for nine months or so...
...Here I consider the first...
...Economic Power from Oil Revenues As I see it, the two major implications of Arab oil control for international political power are the economic power derived from the oil revenues and the threat of interrupting supplies in times of crisis...
...Israel, after completing the destruction of the Egyptian Third Army, would have had nowhere to go...
...Note that the embargo will be most effective if the second scenario, the breakdown of the cartel, has occurred, for then the Western countries will be most dependent on oil...
...But there is one factor, in this connection, which cannot be overlooked: if there were intervention, the wells could easily be sabotaged, and thereby kept out of production for nine months or so...
...Sooner or later, individual members of the cartel secretly start selling at lower prices, and eventually the whole cartel discipline collapses...
...even its religious and ideological interests seem confined to Jerusalem...
...The Arab states may again resort to an embargo...
...In the case at hand, the ability of Saudi Arabia to undertake such a leadership role is increased by the fact that it really has no compelling motive to maximize profits...
...indeed, they will surely do so unless there is a marked change in their anti-Israel attitude...
...There are, as I see it, three aspects of the use of wealth, (a) Political power: Economic power can always be translated into political power...
...If the war is short, the embargo will have little effect on Israel, though it may have much on Western Europe, Japan, and even the United States...
...Suppose that in 1973 the great powers had not intervened...
...they can neither make nor destroy an embargo, for example...
...It might make of Saudi Arabia a client state, which it would protect against revolutionary movements, at the price of accepting Iranian leadership...
...Iran clearly could expand against Iraq and a decrepit Pakistan and might well want the support or neutrality of the other Arab countries...
...powerful interests in powerful countries are not won over so easily, and weak interests really don't matter...
...Moreover, the limiting factor here surely seems to be a shortage of technically trained people rather than a shortage of cash for arms purchase...
...But suppose, instead, that it sees itself as a potential empire...
...Why would Iran behave in this way...
...I leave it to others more knowledgeable to assess the future of Saudi policy...
...Ownership also creates hostages...
...How would the Europeans take to that...
...How would the Europeans take to that...
...Wealth can be used to buy means of persuasion, whether they be propaganda bureaus, newspapers and other media, bribes (especially in Third World countries), promises of financial assistance to poor countries, or arms for the Arab confrontation states...
...interest, economic or other, in the matter...
...Much of this must be minor...
...Iran I have assumed above that Iran is basically interested in revenue, to the point where it may endanger the cartel...
...It is true that, as the years go on, the demand responses to high oil prices will become more important...
...but on the other hand, with its enormous revenues and absence of internal needs, indulging in anti-Israeli and anti-Semitic activities by use of money (rather than lives) may be an inexpensive self-indulgence...
Vol. 1 • June 1975 • No. 2
