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The Third Wave:

Strategic Implications of the Surge in Oil Prices



By Shmuel Even During the month of October, the price of Brent light crude oil reached a peak of $90 per barrel. That surge follows continuous rises since 2003. In real terms, oil prices are now significantly higher than during the "first wave" of price rises after the 1973 Yom Kippur War and are close to the all-time high reached during the "second wave" that followed the Islamic Revolution in Iran.

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The basic reason for price rises is the growing world demand for oil, especially in developing countries. For example, from 2003 to 2006, Chinese consumption rose by about 30% while American consumption rose by only 3%. Additional reasons include regulation of production by OPEC members, tensions between Iran and the United States that give rise to expectations of supply disruptions in case of full-blown confrontation, and tension in northern Iraq. In contrast to price rises during previous waves, which were attributed to one dominant critical event, this rise has several causes and it is therefore unclear how high prices will go in this wave. As a result of price rises, the income of oil-producers has also risen dramatically. The most prominent example is Saudi Arabia, whose income in 2006 amounted to about $194 billion, 2.8 times higher than in 1996 and 5.9 times higher than in 1986 (in real terms). In 2006, Saudi Arabia posted a $95 billion surplus in its current balance of payments account, while Kuwait has a $50 billion surplus and Iran's surplus was $14 billion. Strategic Implications Assuming that oil prices remain at their current high levels, there are several possible ramifications: The enrichment of the oil-producing states and the growing dependence on Arab oil will strengthen those states politically, particularly in the eyes of oil importers, including those in Asia whose role in global affairs is growing. Moreover, some companies may prefer not to do business with Israel or invest in Israeli companies in order not to harm ties with Arab states and Iran. At the same time, political use of the oil weapons is not likely in the foreseeable future given the lack of solidarity in the Arab world and the state of relations between the oil-producing states and the West. Among Arab oil-producers, some of the phenomena that characterized previous waves of high prices are apparently recurring, including higher current consumption, accelerated construction of large infrastructure projects, and growing investments abroad. Assuming that lessons were learned from previous experience, it is likely that there will also be investment in local production, which will contribute to long-term growth. The dramatic rise in income of some Arab states will also encourage higher military spending, though that is also affected by the regional political-security climate. Still, rising incomes have already led arms producers to cultivate oil producers (some large deals are already underway), and that raises the risk of arms deals that could affect the qualitative military balance in the region. Iran's capacity to finance arms deals and provide economic support to Hizbullah and Islamist Palestinian organizations has grown. Iran can also be expected to increase civilian consumption and infrastructure investments, including in the field of energy. The surge in incomes of oil-producers is trickling down to non-oil states (Lebanon and Jordan) and to smaller producers (Syria and Egypt) in the form of remittances of workers in the Gulf states, inter-state trade and project financing. These revenues contribute to the economy and the domestic stability of the recipient states. For the non-oil states, some of the benefit is offset by rising energy expenditures. In any case, the gap between Arab oil producers and others is growing. Saudi Arabia and the Gulf sheikhdoms have about 75% of Arab oil reserves (and close to 40% of proven world reserves), whereas Egyptian reserves are running out. The growing importance of the Gulf as the main source of global energy supply will make it difficult for the United States to withdraw from Iraq without arrangements that promise regional stability. The situation in the oil market underscores the need to restrain Iran's ability to acquire a nuclear weapon that would allow it to control this key area. At the same time, as long as oil prices remain high, it will be increasingly difficult for the United States to impose more severe and sustainable economic sanctions on Iran. The need to develop alternative energy sources continues to grow for both economic and political reasons; most global reserves are in unstable (e.g., the Gulf) or problematic (e.g., Venezuela) places. Growing oil revenues create the potential for more extensive inter-Arab assistance. Unlike the "Baghdad aid" (1979-1988) that was intended to support Syria, Jordan and the Palestinians in their struggle with Israel, there is now an opportunity to provide assistance to peace and stability projects in the region. For example, if 5% of Saudi and UAE export revenues were set aside, it would be possible to create a $180 billion aid package for the next ten years. That money could be used to fund solutions like rehabilitation of refugee camps in Arab states and the West Bank and Gaza (something that could facilitate a solution of the refugee problem), construction of a tunnel or above-ground passage between Gaza and the West Bank, desalination projects and transfer of water from Gaza to the West Bank, and others. The chances that any of these ideas will be adopted may be low, but developments in the oil market and signs of Saudi involvement in the political process nevertheless at least make them more promising than in the past.


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Institute for National Securities Studies, INSS is an independent academic institute.

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