War and the oil price cycle.

• Author: Jaffe, Amy Myers
• Position: Middle East and Africa

Complex rivalries for influence among regional powers, most notably between Saudi Arabia and Iran but also including Turkey, Qatar and the United Arab Emirates, are transforming the Middle East. As local borders and ruling institutions have become contested in the aftermath of the Iraq War and the Arab Spring, so has control of the region's major oil and gas facilities. Warring militias, the Islamic State of Iraq and Syria (ISIS), Al Qaeda and traditional governments are increasingly focusing on maintaining or gaining control of oil production and refining installations. Additionally, regional conflicts, now complicated by the active military involvement of Russia, have spilled over to affect global oil markets as Saudi Arabia and its Gulf allies, seeking to influence regional military and geopolitical outcomes, have initiated a market share war that has brought about a collapse in oil prices.

This paper examines how conflicts in the Middle East, including the Syrian civil war and the rise of ISIS, are shifting the geopolitics of oil. These conflicts are raising serious new risks to regional oil facilities, making them both strategic assets and spoils of war. Current diplomacy to resolve the conflict in Syria faces serious challenges. In addition to humanitarian grounds, it is imperative to find a durable solution in order to prevent the continued destruction of major regional oil and gas production and export facilities. The ongoing destruction of such infrastructure may represent a major challenge to global energy security in the three to five year timeframe.

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Oil has shaped international conflict for decades. According to one estimate, twenty-five to fifty percent of interstate wars between 1973 and 2012 had oil-related linkages. 1 But the cyclical nature of oil's contribution to global conflict is not well understood. Not only are oil prices cyclical, but the geopolitics of oil are linked inexorably to the same boom and bust price cycle.

Military adventurism, proxy wars and regional pathologies in the Middle East expand and contract with the ebb and flow of massive petrodollar accumulations related to the oil price cycle.

The massive inflow of petrodollar revenues when oil prices are high creates disposable incomes that can be easily dispensed on regional arms races, especially since oil consuming countries like the United States are incentivized to increase arms sales as a means of solving oil import related trade deficits. Besides transferring wealth from industrialized countries to oil producers in the Middle East and North African (MENA) region and Russia (and stimulating renewed drilling for oil and gas in North America), high global oil and natural gas prices also slow global economic growth and encourage energy conservation. This causes petroleum demand to slow globally, lowering oil prices. Social and political problems in the region reemerge as oil prices recede. Regional governments have fewer resources to spend on restive populations that have become accustomed to generous handouts enabled by high oil prices. Job creation and visible social programs slow, dissatisfaction rises, and the consequences of economic downturns incite support for militants. Ensuing instability forces governments to use newly purchased arms, which ironically begins the cycle yet again, as new conflicts disrupt oil supplies.

In this manner, the world experiences perpetuating patterns of military conflict, followed by oil supply crises, and accompanying global financial instability. In effect, the Middle East resource curse has become globalized. The challenges this is presenting on humanitarian, security and economic fronts have become increasingly dangerous. The arms race that has accompanied the rise of oil prices over the 2000s has been no exception and is now all the more complicated due to the violent participation of sub-national radicalized groups that are less susceptible to diplomatic pressures or initiatives. In this emerging geopolitical context, the rise of violent subnational groups like ISIS and Al-Qaeda are increasingly putting oil infrastructure at risk, laying the groundwork for a future oil crisis that may prove harder to solve than in the past.

As borders and ruling institutions have become contested, so has control of the region's major oil and gas facilities. Initially an outgrowth of disunity inside Iraq, the conflict over oil and gas facilities is now accelerating across ungoverned territories, with important long-term consequences for global energy markets. Mideast oil and gas production capacity, along with surface facilities, are increasingly being damaged in ways that will make them hard to repair. Export disruptions, which were once sporadic, are becoming a more permanent feature of the civil war landscape. The level of destroyed capacity is currently estimated at about 2 million b/d and rising. (2) The longer Mideast conflicts fester, the more that infrastructure could become at risk. There is an additional element to this oil and war story that links structurally with the oil boom and bust cycle.

As oil prices recede, along with a decreased demand for oil and accelerating regional conflict, wealthy oil producers such as Saudi Arabia, the United Arab Emirates, and Kuwait, are often tempted to use large oil production capacity as a strategic asset. They flood the market with increased supplies in order to lower prices, thereby hurting geopolitical rivals. This price war strategy, which was notably present during the prolonged Soviet war in Afghanistan and the eight year Iran-Iraq War, temporarily ameliorates the short run effects of war on surface export facilities through excessive production rates. In addition, it lays the seeds for the future uptick in the oil market, by discouraging investment in future oil productive capacity outside the Middle East when prices are extremely low. In the case of the 2000s, the destruction caused by ISIS on the oil sector in many locations around the Middle East, combined with expected losses in investment in other parts of the world (like Canada's oil sands and the Arctic due to current low oil prices), may be creating the conditions for a future oil supply crunch. This has major implications on U.S. policy.

This article asserts that the United State would be, in light of these circumstances in the Middle East, unwise to dismantle its Strategic Petroleum Reserve (SPR) as has been suggested on Capitol Hill. It would be similarly unwise for the United States to lose focus on the importance of conservation efforts in the transportation sector which has both national security and climate benefits. The United States would benefit strategically from a reevaluation of its ban on oil exports. Finally, the United States should place a greater emphasis on conflict resolution in troubled states. By resolving internal conflicts over the distribution of oil revenues, the United States can better pave the way for long-term solutions whereby those same revenues can be integrated into national budgets in ways that brings economic prosperity to populations instead of rising military expenditure.

WAR AND THE OIL CYCLE

Over the past four decades, oil prices have been governed by a combination of the real business cycle and the boom and bust investment cycles of oil exploration and production (E&P). As economies expand during upswings in the business cycle, oil demand rises in parallel, often fueling fears that shortages will occur. (3) Oil prices then rise, generally in combination with irrational exuberance and market bubbles. (4) High oil prices eventually stimulates more investment in oil exploration and drilling, encouraging technological innovation under the pressures of a renewed belief that high prices mean oil is permanently running out. But gravity eventually takes its course. Exceptionally high prices that follow the boom cycle then hinder continued economic acceleration. Commodity and asset market bubbles burst and recession ensues, limiting new demand for oil and thereby bringing oil prices to a collapse. This lasts until cheap energy and government financial market interventions yet again restore economic equilibrium and growth. Producers, concerned about losses in their market shares, initiate price wars, which leave markets even more oversupplied, until low prices stimulate economic growth and oil demand once more.

The oil cycle has brought with it a similarly volatile economic cycle for the petrostates of the Middle East, whose governments have rapidly fluctuated between gigantic cash surpluses of so-called "petrodollars" and socially devastating budget deficits. Dubbed the resource curse, the massive influx of oil revenues during the commodities price up cycle discourages productive, non-commodities-1 inked investment, which is needed for long term-growth. The influx of petrodollars also fosters corruption and patronage, drives real estate and stock market bubbles, as well as provides irresistible incentives for wasteful government spending on white elephant projects and military expansion.

The geopolitical component of this oil megacycle can be particularly insidious. As oil capitals like Moscow, Riyadh, Abu Dhabi, Doha and Tehran reap massive profits with a sudden influx of petrodollars not easily recycled into domestic economies, significant financial reserves become available for arms purchases and military adventurism. Such initiatives are designed to protect the ruling class from both external threats (real and imagined) and internal challenges through robust internal security spending. Today, military employment in the Middle East is particularly high at three percent while military expenditures as a percentage of gross domestic product (GDP) is also strikingly high. (5) For instance, it is above ten percent in Saudi Arabia. (6) The regional arms race that accompanies high oil prices boosts not only arsenals of key countries...