The Consequences of Failure

Most Americans aware of the meeting in Washington between Israeli Prime Minister Benjamin Netanyahu, Palestinian President Yasser Arafat and Jordanian King Hussein probably believe that the outcome will not affect them in any way.

They could be wrong. The economic health of the United States as well as that of most other industrialized nations could depend on how the Israeli-Palestinian issue is resolved, because the world’s major oil-exporting nations may respond to a failure by cutting output. In the current circumstances, such a cut would cause a dramatic increase in prices, one that would make last spring’s price rise look trivial.

Further, the summit occured at a propitious time for oil exporting nations--only a few weeks before elections in the U.S. and Japan. Thus the Middle Eastern oil exporting countries have an unparalleled opportunity to command attention, respect and even action from the major industrialized nations. This time, the assumption that Israel can ignore the demands of other nations may be incorrect.

Oil exporting countries in the Middle East have gained such power over the world’s economies for four reasons: inventories of petroleum are very low; the only unused capacity is located in the Middle East; world consumption of petroleum has been much stronger than expected, and finally, the world’s oil industry has been counting on substantial increased output from new projects in Europe, South America and the United States, an increase that has now been delayed.

These four factors have created a situation in which the demands of consumers are being met on a “just in time” basis. Crude oil arrives from foreign suppliers, goes straight to refineries and then is delivered quickly to consumers. Supplies have been so tight that prices have been pushed up dramatically. The price of heating oil has increased by almost 20% in Europe in just the past month as a consequence of low inventories.

Part of the explanation for tight markets can be found in industry expectations. For the past several months, refiners throughout the world have been operating under expectations that the world’s supply of crude oil would increase dramatically in the fourth quarter. These increases were projected to come from a resumption of oil sales by Iraq, a sharp rise in output from the North Sea and higher production in the Gulf of Mexico. The prospect of increased output caused many companies to minimize current inventories.

But these expectations have been dashed. Expected production from Iraq has been delayed by the West’s response to Saddam Hussein’s actions against the Kurds. Projections of increased production from the North Sea have been cut because of problems encountered in the construction of new offshore production facilities. Output from Mexico has been cut after a major facility exploded.

At the same time the world’s appetite for oil has increased at an unexpectedly rapid rate. A year ago, the International Energy Agency in Paris projected that the world would consume 71.2 million barrels a day in 1996. This projection has now been raised to almost 72 million barrels a day and many experts believe the true number will be closer to 72.5 million barrels a day. The principal source of growth has come from developing nations, where higher incomes have spurred a rapid rise in use. The unexpected rise in consumption must be met by producers in the Middle East who are the silent observers at the Washington talks.

The rapid increase in use combined with delays on new projects and the postponement of Iraq’s sale of oil has left inventories very tight. Any further disruptions in supply are likely to cause prices to shoot explosively upward. Indeed, in current circumstances, announcement of a cut in production of 2 million barrels a day (3% of world consumption) could easily add $10 to $20 per barrel to the price of crude and 25 cents to 50 cents to the price of gasoline in a few days. Such an increase in prices could also trigger massive selling on the world’s stock markets, bringing the current boom to a very quick and unhappy end.

This scenario has ominous implications for the reelection prospects of both President Clinton and Prime Minister Ryutaro Hashimoto in Japan. A rapid increase in gasoline prices, prospects of shortages of heating oil during the winter and a plunging stock market could quickly erode the confident aura that surrounds Clinton’s campaign. The rising price of oil and a falling market would also undermine Hashimoto.

A surge in oil prices would also isolate the United States and Israel from allies in Europe and Asia. Indeed, such an increase would be seen by many as justifying their claim that U.S. foreign policy is bankrupt.

Circumstances have created an opportunity for the Middle East oil exporting nations--the silent partners at this Washington summit--to affect the direction of world history. It is an opportunity potentially even greater than the situation confronting them in 1973, when they imposed an embargo that ultimately changed the course of events for the next quarter of the century.

It is an opportunity they are unlikely to seize if the negotiations reach a satisfactory conclusion. Oil exporting countries today have a much greater stake in the stability of the world economy, as well as a continuing need for the involvement of the United States in the Middle East. However, these countries do not have unlimited reserves of patience. Their leaders face restless populations and they may not be able to stand their ground if Netanyahu continues to pursue an obstructionist policy. If these leaders are forced to respond, then everyone in the United States will understand why the negotiations in Washington were so critical.