Posted by: bmeverett | February 13, 2011

Tom Clancy: Great writing, bad economics

I just finished Tom Clancy’s new book “Dead or Alive” – another exciting thriller that won’t disappoint you. I love Clancy’s open patriotism, his respect for those who defend our country both in and out of uniform and his common sense approach to dealing with our enemies. His economics, however, are off base, and “Dead or Alive” illustrates some common myths about US oil imports and our national security.

WARNING: I am about to reveal some elements of Clancy’s story, although not the main plot line. “Dead or Alive” tells the story of a jihadist group called the URC (read “Al-Qaeda”) headed by a vicious terrorist nicknamed The Emir (read “Osama bin-Laden). The URC plans a series of separate terrorist attacks designed to hit the US hard. One of these attacks is the destruction of a large new oil refinery in Brazil. As US agents get word of this plot, they ask “Why Brazil?” Jack Ryan, jr. (son of Clancy’s long-time hero Jack Ryan, sr.) replies, “I don’t think it’s got anything to do with Brazil. That’s meant for us. [US President] Kealty just signed a deal with Petrobras. Sub-OPEC-priced oil from Brazil. They’ve got it coming out of their ears – the Lara and Tupi bloc fields alone could put Brazil’s reserves at around twenty-five billion barrels.”

There are several common fallacies here. First, the US government does not acquire oil for the US market. There is no Federal Oil Purchasing Department. US consumers buy petroleum products, such as gasoline, diesel, jet fuel, heating oil, etc. from refineries which are owned by private companies. Each company acquires the crude oil it needs for its refineries based on quality, logistics and price. During the 1970s, the US government toyed with the idea of government-to-government contracts, but such arrangements would in fact carry no advantage for consumers and would be just another source of political game-playing at taxpayer expense.

Second, US oil consumers are not tied to specific supply sources. For example, in 2009, the US bought about 9% of its oil from Saudi Arabia. That figure is the outcome of a large number of commercial transactions by US companies, not the result of a political arrangement between the US and Saudi Arabia or a contract between the US Government and the Saudis. Before 1987, the US imported oil from Iran. As part of his sanctions, President Reagan banned all imports from Iran. Did the US suffer an oil shortage or a price shock? No, the market simply reshuffled available oil supplies with Iranian oil going to non-US consumers, displacing oil which then came to the US market.

The third fallacy is the idea of “sub-OPEC-priced” oil. The global oil market is highly integrated and there is a single unified price structure. There are hundreds of oil refineries in the world, many at coastal locations. Oil currently sells for $85-90 per barrel, but it can be moved from any coastal location in the world to any other coastal location for $2 per barrel or less. Quality differences are well understood by the industry and fully reflected in the price structure. Brazil’s newly found oil fields do moderate price pressures in the market – at least a little. Remember, however, that Brazil’s 25 billion barrels of proved reserves are a small part of the world’s 1,400 billion barrels and pale beside Saudi Arabia (250 billion barrels), Iran (135 billion barrels) or Kuwait (100 billion barrels). In any case, every oil exporter sells crude at the market price. Why would they do otherwise? If you put your house on the market, that may slightly lower housing prices in your neighborhood, but you are still going to sell your house for whatever you can get. The idea that the US could negotiate a below-market price is silly.

OPEC does have an impact on oil prices, but it’s rather small. Cartels operate by restricting production to force up the price. Since the 1970s, OPEC has been trying to perform as a cartel by assigning quotas to each member and agreeing that no member would produce more than allowed. This system broke down quickly, as cartels almost always do. Saudi Arabia, the largest OPEC producer, reduced its output from 10 million barrels per day (MBD) to 4 MBD, but most other countries did not stick to their quotas. They were happy to allow the Saudis to take the pain of reduced output, while they enjoyed both full output and high prices. By 1986, the Saudis had had enough and increased their oil production back to the 8-10 MBD level, where it has remained since. OPEC production has fallen in the last couple of years as oil demand declined during the recession, but OPEC lacks the discipline to behave as a true cartel. Would the price of oil fall much if OPEC disbanded? Probably not. Breaking OPEC’s hold on the world oil market is not really a national security issue for the US, since OPEC doesn’t really control the market. They might at some time in the future, but their current behavior suggests otherwise.

This is not to say that oil resources are not heavily concentrated in the Middle East. Five countries (Saudi Arabia, Iran, Kuwait, Iraq and the United Arab Emirates) own about 55% of the world’s proven oil reserves. These countries lack either the incentive (Saudi Arabia, Kuwait and the UAE) or the capability (Iran and Iraq) to increase production much above current levels. That’s a problem, but it’s not a cartel.

Later on the same page of “Dead or Alive”, the agents conclude that destruction of this Brazilian refinery will keep the US from acquiring Brazilian oil. “So Brazil’s got the oil but no way to process it. Which means that our deal is down the tubes.” Actually, no. The US imports most of our oil in the form of crude oil shipped to US refineries. In 2009, nearly 80% of our 11.7 MBD of oil imports were crude. Only 0.3 MBD or about 3% were from Brazil. About 95% of our Brazilian imports were crude oil. If Brazil loses refining capacity, Brazilian consumers may have a problem, but US consumers wouldn’t care very much. The logistical system is very flexible, and bringing Brazilian crude into the US market would be easy.

Tom Clancy is showing some basic misunderstandings about US national security. We can’t define a sensible energy policy until we get this right. The US economy is heavily integrated into the global economy. We can’t change that situation without giving up our standard of living. Oil is critical to the functioning of the global economy, and the Middle East is the main supplier of crude oil. The US is vulnerable to oil supply disruptions regardless of where we buy our oil. If Saudi Arabia collapses and oil prices skyrocket to $200 per barrel, the Canadians will charge us $200 per barrel. Neither can the US reduce its vulnerability by replacing oil with substitutes that cost the equivalent of $200 per barrel. If we did, our economy would hit the skids while the rest of the world remained dependent on oil. All we can do is use our diplomatic, economic and military resources to keep the world trade system in general, and the global oil market in particular, functioning smoothly. There is no other choice.


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