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, of what would your instruction consist ?”

I’m not sure that I answered that question correctly, because somewhat later – though I was first in my class – I was expelled from the infantry leadership school at Fort Ord (California) and put to work on a garbage truck. (In case you are sorry for my dilemma, let me note that  the place where that garbage truck was parked was about 25 minutes from wonderful Carmel (California), and had it not been for thoughts about visiting wonderful Paris in the near or distant future, I would have been quite content to be a crew member on that truck for the remainder of my time in the U.S. Army.)

These days I am interested in an equally important query, which has to do with OPEC’s intentions where the production and export of oil are concerned, and this matter has suddenly become extremely important because of a change in strategy of Saudi Arabia. I dealt with oil economics several years ago in lectures in Paris, and publications on 4 or 5 sites both then and now, and on that occasion was  certain that I had all the  correct answers. What happened shortly after proved that I was correct, especially when the price of oil went into orbit.

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When I presented my conclusions to students and teachers at the Ecole Normale Superieure and the University of Paris (Dauphine) 6 or 7 years ago, I began my sermon in the following manner: OPEC intends to export (and perhaps produce) as little oil as possible. It ended on both occasions with: OPEC intends to export (and perhaps produce) as little oil as possible, regardless of what they say or do! I also employed my favourite pedagogical strategy and repeated this mantra a number of times to friends and neighbours, although many of them  had a difficult time getting the message.

In dealing with OPEC’s strategy today I am mainly interested in the intentions of Saudi Arabia, because when so-called experts talk about what is going on in the Gulf, it is obvious that they are primarily interested in oil rich or super-rich Saudi Arabia. But 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 to which I contributed  in Paris in the l980s, and whose book (together with Paul Clark) I occasionally 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).

Equally important are economists, journalists, managers and commentators in the Gulf whose names I mistakenly failed to write down, but who were thinking along the same lines as the Gentlemen mentioned above. In case you want the denouement of this contribution, if they had been asked for advice and chose to answer, they would have told the Gulf countries to minimize their exports, and to go over to the production and export of oil products and petrochemicals.

A short comment about these gentlemen is probably relevant before continuing. Gunnar Myrdal, Nobel Laureate in economics, and  known and famous throughout the world, was unbeatable in a seminar room or conference or formal or informal debate.  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 equal to 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’, as well as the continued lack of interest in what might be called ‘scientific energy economics’ as compared to the kind disseminated by CNN or the popular press. 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 see the results today. By that I mean an emphasis placed on an 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! ONCE MORE: without having enough crude to utilize these facilities 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, Professor Morris Adelman of MIT, and his colleague Martin Zimmerman (1974). They wrote: “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 feedstocks  at the disposal of  these firms, acceptable margins should be available for a very long time. But a very long time means something very different for those countries than it means for the present American government, with its ignorant ‘Trans-Pacific Partnership’, and its growing belief in the export of resources that the U.S. still imports in large amounts.

Moreover, even if desired outcomes are not immediately achieved, major oil producing countries can look forward to profits 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. Let’s put this another way: the combination of inexpensive energy and state-of-the-art technology will ensure that the center of gravity of the global petrochemical industry will move toward the ‘least-cost’ Middle East. According to the time-honoured theory of comparative advantage, that is where it belongs.

“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. One way or another OPEC strategy is going to turn on producing and exporting as little crude oil as possible, saving a large amount of their product to use in their refineries and petrochemical facilities, and their business and political acquaintances abroad will simply have to get used to and adjust to this arrangement.

John Maddox, a theoretical physicist who was once an editor of Nature (which along with Science was the foremost scientific journal in the world) pointed out at a lecture in London about l975 that the first oil price shock was a part of the “general realignment” of the relationship between the industrialized countries and OPEC. That is still  true, although Bob Moriarty  – publisher of the invaluable site 321 Energy –  has implied a realignment between oil producers in OPEC and elsewhere (especially North America) that has some of the characteristics of a war.

I’ll close by saying that there might appear to be a few logical glitches in this contribution, but in reality other authors have patched these up, although all of them may not know it. The important thing for me is that I know it, and can use it in my own research.

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, 22(4):245-254.

Banks, Ferdinand E. (2007). Energy  and Economic Theory. World Scientific: Singapore,  London and New York.

The  Political Economy of World Energy. World Scientific: Singapore,  London and New York. (2004).

‘Beautiful and not so beautiful minds: an introductory essay on economics and the supply of oil’. OPEC Review (March).  (1980).

The  Political Economy of Oil. Lexington Books: Lexington Massachusetts.

Bushaw, Donald and Robert Clower (1957). Mathematical Economics. Irwin Publishing: New York Kubursi, A.A. (1985). ‘Industrialisation in the Arab States of the Gulf’. (in) Tim Niblock.

Prospects for the World Oil Economy. Croom Helm:London Salameh, Mamdouh G. (2004). Over  a barrel. Salameh: Surrey England.