An article published in the Infantry Journal (U.S.) many years ago contained the following  exotic question: “If you only had an hour in which turn  civilians into  soldiers, what would your instruction consist of?”

The thinking intrinsic in a question of that nature, as well as what might be called ‘the school solution’, struck me as being so original and provocative that I elaborated on it in my ‘required’ lecture at the Infantry Leadership School at Fort Ord (California). Remembering that wonderful occasion inevitably leaves me to believe that my enthusiasm was one of the reasons why I was the only trainee in my class to be expelled – which took place without explanation – from that splendid establishment. Of course, some months later I gave a similar lecture at Fort Lewis, and it was so well received that I was allowed to exercise my vocal chords in front of troops until I took the liberty of arranging a very long and well deserved vacation in Germany.

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In  alluding to the relevance of that long-ago adventure, I can turn to this matter of OPEC and its strategy, which I have touched on in many presentations, and which in a classroom or examination situation would lead to the following query: If you only had an hour to discuss OPEC’s objectives with an indifferent or unfriendly scholar, how would you begin and end this exercise?

The school solution in this case commences with the following: OPEC intends to export (and perhaps produce) as little oil as possible. It ends with: OPEC intends to export (and perhaps produce) as little oil as possible, regardless of what they say or do! It might also be wise to repeat this mantra a number of times during your exposition.

The logic in play here is an extension of the work of three brilliant economists. Professor Gunnar Myrdal, who was one of my teachers at the University of Stockholm; Professor Howard Chenery, who organized a small conference I attended in Paris in the l980s, and whose book (together with Paul Clark) I used when I taught at a U.N. Institute in Dakar (Senegal); and of course the superb article by Professor A.A. Kubursi ‘Industrialisation in the Arab States of the Gulf: A Ruhr without water‘ (1984).

A short comment about these gentlemen is highly relevant. Gunnar Myrdal, Nobel Laureate in economics, and  known and famous throughout the world, was unbeatable in a seminar room or conference, or for that matter at the Nobel Banquet in the Stockholm City Hall in 1974. His belief was that the study of development economics should be based on a study of the economics and sociology of successful economies. The two countries he recommended for study were the United States and Sweden.

Howard Chenery, a Professor at Harvard, went almost unnoticed by the Nobel Academy, which was another of their characteristic misunderstandings, although he was a leading mathematical economist in the study of economic development (and on the ‘applied’  level as good as the first winners of the economics ‘Nobel’: Ragnar Frisch and Jan Tinbergen). More remarkable however is the neglect by economists of Professor Kubursi (of McMaster University, in Canada), although the big mistake here might be the failure of Professor Kubursi to adequately market his theories of economic development to the ‘academy’. The only place that I have seen or heard his name called is in my books, articles and lectures, although it is not impossible that he discussed his work in OPEC councils, because somebody (or persons) in those councils listened to or read what he had to say,  and we have started to see the result. By that I mean much more attention being paid to  refineries and petrochemicals in some OPEC countries.

The explicit observation by Professor Kubursi – and implicit in the work of  Gunnar Myrdal and Howard Chenery – was that instead of exporting oil in its crude form, if the development process is taken to an optimal conclusion, that oil should be used in OPEC owned refineries, and a large amount of the refinery output used in the production of petrochemicals.  More important, simple mathematics leads us to conclude that investing in  facilities to produce refinery products and petrochemicals in e.g. the Middle East without having enough crude to utilize these facilities for ‘X’ years is a serious  mistake!

Rather than elaborate on mistakes of the kind noted above,  I would like to present the opinion of a distinguished oil economist who definitely was NOT a friend of OPEC, by whom I mean the late  Professor Morris Adelman of MIT, and his colleague Martin Zimmerman (1974).

“In the production of petrochemicals, most LDCs (less developed countries) are at a severe and permanent disadvantage for lack of know-how, and the high opportunity cost of capital and feedstocks. Other countries, particularly OPEC members, who do not face these obstacles are expanding their petrochemical capacities. This too will drive prices down, lower the profitability of all plants built today, and force losses on many investors. Few can compete with those that get their feed-stocks at a fraction of world prices, and are willing to earn low or negative rates of return.”

Earning “low or negative rates of return” is not (and probably never was) the goal of new OPEC refiners and petrochemical producers, since with the huge amounts of feed stocks  at the disposal of  these firms, acceptable margins should be available for a very long time for these firms, as well as impressive national incomes for countries in which these firms are located. Moreover, even if desired outcomes are not immediately achieved, major oil producing countries can look forward to returns that result from transforming inexpensive refinery products into high-priced petrochemicals. This was pointed out by the Nobel Prize (in chemistry) winner Sir Harry Kroto many years ago.

It cannot be overemphasized that since energy costs are the key burden for chemical industries, the combination of inexpensive energy and state-of-the-art technology could result in the center of gravity of the global petrochemical industry moving toward the ‘least-cost’ Middle East. According to the time honored theory of comparative advantage, that is where it might belong.

“Center of gravity” though does not mean complete domination. At any time this industry is a mixture of small and large, low and not-so-low cost, new and old, etc, and so theoretically the OPEC commitment will be adjusted so that the price will be high enough to keep some of the less favourably endowed plants in operation in order to supply total demand. Even so, many firms in this line of work have become unpleasantly aware of the realities brought about by the cheaper methods of production at the disposal of countries that  no longer want to be a hostage to unfavourable oil or gas prices. Exactly how traditional firms will react to this challenge is uncertain, particularly in the short run, although in the long run  many of them have no choice but to cut-and-run, to use one of President George W. Bush’s favourite expressions.

After reading my above thoughts on this subject, and once again reviewing the paper of Professor Kubursi, I would like to say that while you may not find the observations at the beginning of this (shorter than one hour) essay relative or attractive, it is impossible to deny the bottom line. Sooner or later OPEC strategy is going to turn on producing and exporting as little crude oil as possible, regardless of strategic deviations that may have to take place when faced with surprises from other parts of the world. Surprises resulting from the appearance of shale oil and natural gas for example.

References

Adelman, Morris A. and Martin B. Zimmerman (1974). ‘Prices and profits in Petrochemicals: an appraisal of investment by less developed countries’.

Journal of Industrial Economics (1974).

Banks, Ferdinand E. Banks, (2015). ‘Energy and Economic Theory’ Singapore , London and New York: World Scientific’ 

(2008)’ The sum of many hopes and fears about the energy  resources of  the Middle East’. Lecture at the Ecole Normale Superieure (Paris), May 20, 2008, Chenery, Hollis and Paul Clarke (1962).  Interindustry Economics. New York: Wiley.Chevalier, Jean-Marie (2009). The New Energy Crisis: Climate, Economics and and Geopolitics. London:Palgrave McMillen (with CGEMP, Paris-Dauphine).

Eltony, Mohamed Nagy (2009). Oil dependence and economic development: the tale of Kuwait. Geopolitics of Energy (May).

Kubursi, A.A. (1984) ‘Industrialisation in the Arab states of the Gulf: A Ruhr without water’. In Prospects for the World Oil Industry, edited by Tim Niblock and Richard Lawless.  London and  Sydney: Croom Helm.