A Different Failure of Intelligence

August 17, 2004

By Nikolas Gvosdev

Pundits continue to debate the question of "intelligence failure" as it relates to the terrorist attacks of 9/11 and the existence of weapons of mass destruction in Iraq.

But an intelligence failure of a different sort has not received a great deal of attention. This concerns global energy markets. With the oil price now hovering around $47 per barrel – more than $20 higher than even the acceptable price band laid down by OPEC – the question must be posed: was this outcome foreseeable?

This is a different point than saying it was foreordained. But the job of economic analysts and policymakers is to be prepared for all eventualities.

In The National Interest's winter 2003/04 energy supplement, I myself noted some trends that suggested rising global demand:

“China is buying up more oil on the world markets – imports for 2003 are up by 30 percent from last year, and imports as a whole are expected to double ... by 2010. ... While China has seen its rate of oil consumption skyrocket over the last decade (by 109 percent), it is not the only hungry consumer. During the same period South Korea's usage increased by 78 percent. By 2010, India is expected to be the world's fourth largest consumer of oil” (www.inthenationalinterest.com/Articles/Vol2Issue49/Vol2Issue49Energy-Gvosdev.html).

And consider this warning, from February 12, 2003, from Dr. Charles Kohlhaas, prior to the Iraq war:

“Oil inventories are at record low levels.  OPEC has admitted its surplus capacity is down to about 2 to 4 percent of world demand levels and it cannot make up for supply shortages caused by a disruption of Iraqi production in addition to the Venezuelan shutdown.  Non-OPEC producers are already producing at capacity.  Even if we squeeze through these near-term shortages, the surplus capacity will disappear in less than 3 years with normal demand growth in recovering economies causing long-term upward pressure on oil prices which will stifle that same growth” (emphasis added by ITNI, www.inthenationalinterest.com/Articles/vol2issue6/vol2issue6kohlhaaspfv.html).

And we know that not only has normal demand, particularly in East Asia, been on the rise, but that China and India, in particular, are also purchasing oil for their own stockpiles and reserves.

There should have been a reasonable expectation, therefore, that supplies would be tight and this would lead to price increases. Moreover, why would Saudi Arabia and other oil producers be expected to take actions to lower their incomes from increased revenues? Consider what Robin West said at the October 4, 2001 symposium that formed the basis of the special issue of The National Interest ("The Terror"):

“We estimate that the break-even point for Saudi Arabia ... to run the country, which is 90 percent dependent on oil revenues – is about $21 a barrel ... we may no longer be right to assume that any Saudi regime would feel obliged to sell a lot of oil.”

In other words, Saudi interests – the interests of the world's largest oil exporter – may not coincide with U.S. interests – the world's largest importer. So to assume that Saudi Arabia will "pull our chestnuts out of the fire" out of the goodness of its heart is folly. Saudi Arabia may have an interest in preventing the oil price from going so high that importing nations cannot afford to purchase large amounts of oil and move to rationing – but there is no reason to believe that they would want the oil price to artificially fall to the mid-$20 range if they can reasonably expect importers to pay a price of $40 per barrel.

All of this could have been anticipated. And it raises the question of what the purpose of the Strategic Petroleum Reserve is. If, three years ago, one noted that oil prices would be over $45 per barrel, I think nearly every expert would have said this would have qualified as the proverbial "rainy day" for which the reserve was created – and begun to move more oil out to market.

But even this is a short-term solution. Even if prices drop to some extent in the months ahead, it is unlikely that the halcyon days of oil at $16 per barrel are anywhere in sight. Now, more than ever, a concerted, credible and serious energy strategy is needed.

This is our wake-up call. Time to go to work.

Nikolas K. Gvosdev is editor of In the National Interest.