By Costis Stambolis
On a recent visit to London, I had the opportunity to meet Dr Leonidas Drollas, the right-hand man to Sheikh Zaki Yamani, the former oil minister of Saudi Arabia and a prime mover behind OPEC, at the Centre for Global Energy Studies (CGES). Drollas is a graduate of the London School of Economics and the first econometrician to be hired by BP at its London headquarters. He became scientific director of the newly established CGES in 1989. He is nowadays considered one of the great oil market analysts and his answers are quite illuminating and shed light on many questions that concern the public.
1. The war in Iraq is now in full swing, yet the oil price has weakened. What is going on?
Although the oil price has rebounded somewhat with the recent news of oil production shutdowns in Nigeria and stiffer resistance being met by the coalition forces in Iraq, its general direction has been steeply downwards since the 10th of March. Dated Brent fell by almost $8/bbl, or 23%, in the ten days after the 10th. This was quite unexpected, for although the price of oil had fallen heavily after the commencement of the air war in mid-January 1991, during the first Gulf War, few were anticipating this time around a price fall before hostilities had even started. That this was the case is due almost entirely to the oil market's so-called fundamentals.
Because of the loss of Venezuelan oil due to the general strike that began there in December 2002, the OPEC-Nine (i.e., excluding Venezuela and Iraq) boosted their output to compensate for the absence of Venezuelan oil during what threatened to be a parlous period in the Middle East Gulf. By February 2003, the OPEC-Nine had increased their production by 2.2 mbpd over the November 2002 level, whereas Venezuela's loss against November was only 1.5 mbpd. In March 2003 the OPEC-Nine's output boost is expected to reach 2.4 mbpd against a Venezuelan loss of 1.2 mbpd. Replacing short-haul Venezuelan oil (five days steaming to the US Gulf) with long-haul Middle Eastern crude takes a while (42 days), but this oil arrives eventually. It is beginning to show up now, boosting US inventories of crude oil and alleviating the upward pressure on prices.
The second factor that is contributing to the recent weakness in the oil price is warmer weather. March and April in the Northern Hemisphere are obviously warmer than the preceding four months, but during this past winter the period November to February was colder than average. This makes the usual warmer weather in spring even more pronounced and the seasonal drop in oil consumption more conspicuous than normal. Higher oil supplies and seasonally lower oil demand implies a global build-up in the cover provided by oil inventories and, eventually, lower oil prices. As the graph below shows, the CGES' estimate of the turnaround in oil stockcover in March is dramatic indeed.
2. Is OPEC going to maintain its unity during this difficult period? Do you foresee the return of Iraq to the OPEC fold after the end of hostilities in the Gulf?
OPEC recently suspended its quota ceiling, declaring that it wishes to keep the market well supplied with oil during the period of conflict in the Gulf. The cartel's output restraint is therefore in abeyance for the time being. However, if the price continues to weaken in the months ahead, as Figure 1 suggests, then OPEC will have to re-impose quota discipline from July onwards so as to prevent the price falling below $25/bbl some time in the summer. This re-imposition of discipline is likely to happen, but without Iraq.
Assuming that Iraq has a new government by the summer, it is difficult to see this government submitting to OPEC's operational strictures so soon. OPEC means quotas and constraints on oil production, whereas Iraq will require as much production freedom as possible. It needs to rehabilitate its oil infrastructure as well as revamp the laws and procedures governing its oil industry, but most of all it needs money – and lots of it – and oil is Iraq's only means of getting the financial resources it desperately requires. Furthermore, Iraq will claim that the rest of OPEC has had the market to itself during the years since the invasion of Kuwait in August 1990 and that it is therefore about time that it made way for Iraqi production. It is my view that Iraq will remain within OPEC, but that it will not adhere to OPEC's quota system for a while yet.
3. Do you believe that the United States has a plan to undermine OPEC and see it dissolved?
I do not believe that there is such a plan. However, there has been a marked shift in the US' foreign policy priorities, which entails a different attitude towards OPEC. Before September the 11th, the three pillars of US policy regarding the Middle East were
(a) ensuring the security of oil supplies,
(b) upholding the integrity of the state of Israel,
(c) and providing support for the House of Saud and other regimes favourably disposed towards the US (e.g., the Hashemite monarchy in Jordan and Mubarak's government in Egypt).
Maintaining pillars (a) and (c) often meant turning a blind eye towards what has been euphemistically termed 'democratic deficits' in a number of these countries and also accepting the Arabian Gulf's desire to engineer higher oil prices via OPEC. Moreover, OPEC's pursuit of high prices was thought to be good for oil producers in the US itself, which explains George Bush Senior's visit to Saudi Arabia in April 1986, when he was Vice President, to persuade King Fahd to push oil prices back up again.
Since the tragedy of September 11th 2001, the US' priorities have changed. The fight against terrorism has shot up to the top of the list, while dealing with so-called rogue states now comes second. This means that unconditional US political support for certain regimes in the Middle East can no longer be taken for granted. As a consequence of this, the US seems less inclined than before to accept higher oil prices as a price that has to be paid to keep autocratic regimes in power in the region.
The old paradigm for the Middle East of oil nationalism, state repression, high levels of military expenditure and a lack of respect for human rights is discredited in the eyes of influential US policy makers. Given this overall shift in perception, OPEC is increasingly seen as an anachronism, a relic of the post-colonial drive in the Middle East to assert full control over its oil resources. A pre-occupation with high oil prices does not appear to have brought these countries lasting prosperity, nor has it helped its people become freer. OPEC, along with the old model of economic and political development, has perhaps outgrown its usefulness.
4. On the 14th of March 2003, HE Sheikh Ahmed Zaki Yamani convened a high level one-day conference in London to discuss the state of the world oil markets in view of the situation in Iraq. What was the overall spirit that prevailed at the conference? Did the participants reach any conclusions?
The overall mood was one of apprehension at the impending conflict in Iraq that everyone seemed to expect. Iraqis at the conference believed that the fight for Iraq would not be easy and that the involvement of Turkey in the north of Iraq would present the allies with serious complications. Sheikh Yamani himself was fearful of chemical attacks directed at allied troops and neighbouring states by a desperate regime and warned of high oil prices should this happen. Many speakers thought that winning the peace was equally important and that Iraq should not be compelled to pay reparations. There was much debate about a post-Saddam Iraqi oil industry, some favouring continuation of the state oil company and others calling for partial or wholesale privatisation of the oil assets. The conclusion was that reconstructing Iraq would take longer and cost more than people think.
5. Could you please describe the work taking place at the Centre and how relevant this is to international developments in the energy field.
The Centre is first and foremost an independent think-tank and as such is able to analyse and comment on vital energy issues without being obliged to please particular constituencies. It has also gained a reputation for thorough, and often highly original, work on the oil market, especially with respect to the prediction of oil prices. The Centre pioneered thirteen years ago the idea that oil prices are largely determined by stockcover considerations and has developed a number of short-term models to quantify the relationship between inventory cover and prices. The CGES has also done a lot of econometric work on oil demand and has developed models to analyse world trade in natural gas, oil tanker freight rates, oil product prices and strategic hedging in the oil business, among other subjects. One of the CGES' beliefs is that the suggested connection between global warming and the burning of hydrocarbons is still not proven and that full implementation of the Kyoto Protocol would harm most economies unnecessarily.
The Centre's work is widely disseminated by means of regular publications and special studies and it holds four international events each year at which the key energy issues of the day are vigorously debated.
6. What are your functions at the Centre and how can you describe your co-operation with HE Sheikh Yamani?
I am the Centre's Deputy Director and its Chief Economist. I oversee the Centre's daily operations and I am responsible for its regular publications. I contribute articles and studies and also represent the Centre at many conferences and events. I have appeared on numerous occasions on national and international television and have given many radio and press interviews on oil matters. I have a close relationship with our Chairman, Sheikh Yamani, and Dr. Fadhil Chalabi, the Director of the Centre.