GRM 2010 GRM 2011

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Political Detente and Economic Tension
Paper Proposal Text :
Øystein Noreng
Political Detente and Economic Tension
A nuclear deal permitting the reintegration of Iran into the world economy carries a risk of unleashing tensions in the Gulf, especially over oil. Iran’s demographic and economic weight makes a basis for political influence in the Gulf region, most likely to be bolstered by close ties with Iraq, with repercussions for the oil market. Historically, tension over oil market shares and prices has marked relations between Iran, Iraq, Kuwait, Saudi Arabia and the UAE. In relation to oil market strategy there is a structural divergence of interest, with populous Iran and Iraq wishing both high prices and high market shares for themselves, eventually at the expense of the less populous GCC states that generally have had an interest in lower oil prices, but also high market shares.
Conflict over oil prices and market shares was one of the factors driving Iraq in 1990 to occupy Iraq. The breakdown of the OPEC consensus in 2011, with Saudi Arabia unilaterally expanding volumes, indicates that such conflicts are still real. This was corroborated by disagreement over the succession of the OPEC Secretary General in 2012. Even if Iran and Iraq have different and competing interests, they also have salient common interests in relation to the oil market and thus to Saudi Arabia and the other Gulf states. With a nuclear deal, Iran is likely to open for foreign oil investors, most probably leading to considerably oil extraction capacity. Likewise, in Iraq, volume growth is essentially a matter of time. Consequently, the outlook is for a considerable volume growth from the two most populous countries around the Gulf.
The advance of unconventional crude extraction and the erosion of the predominant position of oil in the transportation sector exacerbate the dilemma, as new competition sets new limits to oil pricing. More than before, rising prices risks compromising oil demand, whereas lower prices may undercut competition and secure long-term volume and income growth, but at the expense of short-term earnings. Against this backdrop, the issue is to what extent total oil supplies from the Gulf will expand or to what extent Saudi Arabia and the other GCC members will renounce on market shares and earnings in order to sustain oil prices and accommodate Iran and Iraq.
Iran’s demographic weight can sustain military power as well as economic clout. Iran has become Iraq’s major trade partner in addition to developing close trade links with Turkey. Iraq apparently aims at once more to become an important military power in the region. Rising oil exports enhances economic importance. Fending off Kurdish attempts at controlling oil revenues would further strengthen the Baghdad government. Consequently, political weight in the Gulf region seems to shift from the GCC states to Iran and Iraq. This prospect has provoked different reactions on the southern shore of the Gulf. So far, Saudi Arabia seems bent on resisting the rise of Iran, by supporting opposition to the Syrian regime and by trying to corral the smaller Gulf States into a union, possibly a confederation with a common currency. This initiative has been resisted by the states concerned; they seem willing to accommodate to a more influential Iran.
Consequently, the stage seems set for an isolation of Saudi Arabia, at least temporarily. Insofar as Saudi Arabia should consider closer ties between Iran and Iraq as a security risk, it would have incentives to support the Sunni Iraqi opposition and eventually Kurdish independence. Insofar as the Iraqi government should consider Saudi and support for Iraqi Sunni forces as a security risk, it would have reasons to align itself more closely with Iran. Finally, if Iran were to see Saudi support for Sunni forces in Iraq as a security risk, it would have incentives to draw Iraq closer. Against this backdrop, there is a risk of escalating conflict, which could also include Iraq. Saudi Arabia has the ability to raise oil output in order to bring prices down and compromise Iran’s export earnings. Such a move would eventually raise tension in the Gulf, with the prospect of further isolating Saudi Arabia. The alternative would be to get to terms with Iran.
The integrity of Iraq is critical to the state system of the Middle East. Any implosion or disintegration of the Iraqi state risks provoking protracted disorder and strife involving all neighboring countries, also the Gulf, compromising oil supplies. For some time, it seemed as if Saudi Arabia and Turkey might have a common interest in unsettling the Assad regime in Syria and in promoting Kurdish independence. In relation to Iraq and the KRG, Turkey has contradictory interests, and has been attempting a difficult balancing act. Turkey has developed close economic links through trade and investment in Iraqi Kurdistan, but it also has salient economic interests in the rest of Iraq. In 2012, Iraq was Turkey’s third largest export market. Kurdish independence would bring Iraq closer to Iran. Anyway, Iran’s opposition to Kurdish independence strengthens ties to Baghdad.
Oil is a regional issue. To the extent that Saudi Arabia and other Gulf countries consider Iran a security threat, they have incentives to weaken Iran through lower oil prices by raising export volumes. And if Iran considers Saudi Arabia and other Gulf states an economic threat through their ability to lower oil prices, that gives it incentives to make an alliance with Iraq, perhaps to threaten the Gulf countries. Against this backdrop, prospects for the oil market and oil prices are conflicting, possibly indicating instability and discontinuities. There are good reasons to expect higher oil volumes from the Middle East to the market—not only from Iraq as its industry is being restored, but also (with political motives) from Saudi Arabia and other Gulf countries in order to hit Iranian oil revenues through lower prices. There are equally good reasons to expect Iranian counter-moves, perhaps together with Iraq, aimed at higher oil prices.
In an extreme case, a split-up of Iraq with an independent Kurdish state under Turkish protection might release large volumes of oil from present-day Iraqi Kurdistan, through Turkey and onwards to the Mediterranean market. At the same time, the revenue loss for the remaining part of Iraq might spur stronger policies for volume growth, despite the organizational and administrative problems. Consequently, a partition of Iraq might bring higher oil supplies and lower oil prices – unless it should lead to a regional crisis and perhaps war that would interrupt oil supplies.
As the historical hegemon, the United States remains the leading military power of the region. Even if US oil imports are declining, the United States retains strong economic interests in the Gulf. It is in the US interest that Saudi Arabia and the other Gulf States continue pricing oil in US dollars, although their major market is China. Likewise, the United States has an interest in Saudi Arabia and the other Gulf States to buy US military equipment and services, and that they continue investing their financial surpluses in US securities. The issue is what interest Saudi Arabia and the other Gulf States would have in continuing these policies.
China is the challenger and has become the major trade partner for the Gulf region. China is the major outlet for Saudi and other Gulf crude oil, the major investor in Iraq and Iran, and Iran’s largest trade partner. China’s interest is to conduct trade in yuan, not in US dollars, which is already the case for trade Iran. As the major buyer of Saudi oil, it may be matter of time before China requests the ability to pay for Saudi oil in yuan. The issue is what attraction that might have for Saudi Arabia. A final question is to what extent China’s economic clout in the Gulf might be employed to prevent conflict and promote regional stability, which is essential for the world’s major oil importer.