NEHA KHANNA (*)
Geologic estimates of remaining global petroleum resources place about 50% in the Persian Gulf. Production costs are estimated at $5 per barrel there and $15 per barrel in the North Sea and Alaska. According to mathematical results derived from depletion theory, the present value of economic rent from oil is on the order of $20 trillion. This article uses game theory to explain the $15-$20 per barrel price band that existed from 1986 to 1999. New economic forces have displaced this previously stable pattern; a new price range of $23-$30 is emerging. International trade in petroleum and conventional weapons are analyzed with econometric methods; the occurrence of nuclear weapons capability in the Persian Gulf region is explored. (JEL C61, Q32, Q41, 043, 048)
In 1980, shortly after Saddam Hussein assumed the presidency of Iraq, that country attacked Iran in the southwest Khuzistan region. Iraq sought control over two major geographic goals: the Shatt-al-Arab channel, a shipping route for export of Iraqi oil, and the petroleum production facilities in Khuzistan, where more than 75% of Iran's oil resources were located (Yergin, 1991; International Petroleum Encyclopedia, 1983).
In 1990, Iraq occupied Kuwait and threatened Saudi Arabia. If Iraq had been successful in these military actions, it would have controlled 40% of identified global reserves and 75% of Persian Gulf reserves (see Table 1).
In 1991, U.S. president George H. Bush supported a U.S.-led United Nations (UN) military coalition that defeated Iraq, emphasizing that "[o]ur jobs, our way of life, our own freedom and the freedom of friendly countries around the world would all suffer if control of the world's great oil reserves fell into the hands of Saddam Hussein" (Yergin, 1991, 773). This military action eliminated Iraq's potential to raise crude oil prices and attain quasi-monopolistic profits. Yet five years earlier, then Vice President Bush had flown to the Persian Gulf, meeting with Saudi government ministers and the king. The purpose of this 1986 trip had been to raise crude oil prices, which at the time were below $10 per barrel.
The purpose of the following analysis is to illuminate part of the economic rationale for these superficially contradictory U.S. policies. It shall show the magnitude of the economic incentives for control of Persian Gulf oil and show the logic which led the United States and some other Organization for Economic Cooperation and Development (OECD) nations to work against crude oil prices below $15 per barrel and above $20 per barrel for a 13-year period from 1986 through 1999. The same incentives operate now to create a new, higher price range of potentially comparable stability.
The first section identifies the magnitude of economic rent (defined below), which partially motivates foreign policies of the Gulf countries and the United States. It uses game theory logic to explain the $15-$20 per barrel range within which crude oil prices usually moved. The next section analyzes the framework now evolving toward a new price range. The third part analyzes global military trade in the context of petroleum imports and exports. Next appears a brief summary of the growth in nuclear weapons capability in the region, followed by a summary of the pre-1980 history of Gulf production and international relations. A discussion of implications for the early part of this century, and the likelihood of a new near-term price range, concludes the study.
II. PETROLEUM PRICE, RENT, AND GAME THEORY, 1986-1999
In the petroleum economics literature, $5 per barrel is widely used as the likely equilibrium price in a theoretically competitive world oil market working without production quota agreements (Adelman, 1986, 1993; Economist, 1999; Yergin, 1991).
Table 2 illustrates the production cost in a low-cost area in the Persian Gulf and in the North Sea. …