Power Plays: How Energy Fuels World Politics

• Remarks
• Questions and Answers

Remarks

EDWARD L. MORSE: I am pleased to be invited back to Merrill House again to discuss my observations about the world energy scene.

It's always a challenge to figure out how I'm going to launch into a subject that deals with domestic politics in the United States, in Mexico, in Algeria, in Russia, and Saudi Arabia—in fact, virtually all the countries of the world—and that crosscuts not simply international economics, but international security policy. It's even more of a challenge to do so, given where the United States is right now politically, also in terms of the world economy.

And today is the day that the judges who are hearing those alleged to have committed terrorism on Pan Am 103 on behalf of the state, delivered their verdicts. The verdicts, to me, were a little surprising. I thought that there was going to be an acquittal, with not enough evidence for all of the accused. Instead, the justices gave us a split decision and provided one victim, finding one of the accused guilty. That is an important occasion, one that will mark the beginning of an end to an episode where the international community used the oil weapon against a single state and where two governments, British and American, imposed unilateral sanctions against that state, using their own oil weapons. How the verdict unfolds will be interesting to watch in the oil world over the next six months—a subject that I will touch upon later.

The other event that is on the horizon, of course, is the election in Israel, which could very well trigger another oil supply disruption, depending on what the reaction is among Palestinians, between the Palestinians and the Israelis, and among Israelis to the almost inevitable election of Ariel Sharon as the next Israeli leader. This comes at a time when the world's most significant oil-producing states have reached a low point in their relations with the United States—the lowest point since at least the outbreak of the Iranian revolution in 1978. The United States is by no means the most popular country in any of the oil-exporting countries of the Middle East—from Egypt through the Arabian Peninsula, and in Iraq, obviously.

The world is a little different from what it was in the 1970s. It's a world in which the views of people in the domestic populations of these countries count a great deal. We are living at a time when the United States was seen as the guilty party when oil prices reached their lowest point historically, only three years ago, and when the incomes of these countries suffered as tremendously as they did. And then, this past summer and into the fall, the proclamations coming out of Washington—including the one in late August and early September indicating that the U.S. government was prepared to recognize Jerusalem as the capital of Israel and move its embassy to that city—further exacerbated anti-American feelings in these countries.

This is not a time when the U.S. government is going to be able to use its influence among oil-producing countries, even its most closely allied oil-producing countries, to put a lid on oil prices, and I'll talk more about that in a bit. First I want to make several observations to try to bring you up to speed on what's happened in the very fast changing oil environment.

New extremes in price volatility

Over the last three years, there has been more volatility in the oil market, in the gas market, and in the electricity market than at any point ever in the history of energy. If you look at the oil market in the last three years, oil prices, with the exception of the month after Iraq invaded Kuwait in 1990—with that one exception, oil prices reached their highest point and their lowest point in an eighteen-month period in two decades. They reached their peaks and they reached their lows. This volatility has created enormous burdens of adjustment, both internationally and domestically.

What's more, the volatility was, in part, caused by things that were outside of anyone's control. The volatility that we see in the energy market in California, in the gas market in the United States, in the oil market of the world, is the result of an unprecedented decade of economic growth globally, where surplus capacities in the energy sector—like surplus capacities in a lot of other sectors—have been eliminated and where the world has reached the limits of its capacity to consume. California is at the limit of its capacity to consume electricity—not much more electricity could be generated; and the result is not only higher prices but a pandemic of blackouts.

In the oil market, surplus production capacity, which had been huge in 1985—huge in terms of OPEC having 30 million barrels a day, roughly, of production capacity—by 1995, they were only able to produce 14.5 million barrels a day. Half of their capacity was unutilized. It has taken the world from 1985 until last year to reduce the amount of available capacity to produce oil to zero. That's why oil prices went up. They were volatile and they were spiking because there was not much more capacity to produce.

The same could be said about gasoline prices in the United States last spring, diesel prices in Europe late September, fuel oil prices in the world a month ago. When there is volatility, when there is movement between peaks and troughs, there are also enormous burdens of adjustment. So in 1998 governments that were oil producers saw their incomes decimated, literally decimated. In 1997, all of the OPEC countries—not excluding Mexico, Egypt, Norway, and Oman (not the non-OPEC oil exporters but the OPEC exporters)—saw a combined income of about $157 billion. That was their highest level of combined income since the early 1980s. 1981 was their peak, of $400 billion. It really fell in the 1980s, but it had gradually risen and had attained this new peak of close to $160 billion in 1997.

And then, oil prices went down: West Texas intermediate crude was $27.00 a barrel in the winter of 1996-1997, and by the spring of 1999, it had fallen to $10.00 a barrel. So when it falls that much, income falls, and OPEC countries' collective revenue fell from $157 billion in 1997 to less than $100 billion the next year because of the lag effect of prices on national income.

To understand the burden of adjustment that the governments of Mexico, Algeria, and even Saudi Arabia underwent, think of the world of the 1970s. Think—and most of us can think that far back—of how we felt as consumers in the 1970s when we had gasoline lines, when the prices of heating oil went out of control. Remember that we had a sense of a burden of adjustment as the world economy tried to accept the hot potato of high oil prices, and when the benefit of the wealth transfer and income transfer went to a handful of countries. We suffered and they benefited.

What happened between 1997 and 1999 was that a handful of mostly impoverished, poor, developing countries took on the entire burden of adjustment to this radical change in oil prices—while the rest of the world, including U.S. citizens, benefited by having much lower energy prices, helping to fuel our economic growth.

So my first point is we live in a volatile world of prices. This volatility is here to stay, it is not going to disappear, and we can discuss the factors underlying that when I close.

Market share wars

There are a lot of politics in the world of low prices and a lot of politics in the world of high prices. There is no permanent coalition when it comes to managing the international energy sector; there are only shifting coalitions. Let me talk a little about some of the oil-producing countries in this regard, because it is true that in the first week of February 1999, The Economist had a cover story saying that we were in a world of $5.00 oil and this was a permanent world.

How did we get to that low set of prices? After all, in 1997 prices had reached a new post-1970s peak, with West Texas intermediate crude at $27.00 a barrel. Well, it happened through a bunch of factors.

One of the factors, of course, is that Americans think that energy security means permanent low-priced energy, and we have set up a world willy-nilly of market forces, which puts great pressure on oil producers that is almost always a downward pressure.

But the real cause of low prices in the latter part of the 1990s was not, in my mind, the recession in Asia leading to a downturn in purchasing from the Pacific, which most people focus their attention on; nor was it essentially three of the four warmest winters on record in the post-World War II world. Rather, to me, the cause of low prices was intentional—based on politics among critical oil-producing countries.

The politics really began in July of 1990, when there was an OPEC meeting during which the Iraqi Government, pointing guns at the heads of state of their neighbors in Saudi Arabia and Kuwait and the Emirates, said, "You're going to reduce oil production and we're going to have higher prices. Unless you do it, we're going to take military action against you." In fact, military action was taken.

At that time, the Venezuelan government decided that never again would it participate in an organization in which a decision on oil prices was made on the basis of international politics among Arab oil-exporting countries. So they decided to go it alone in their quest to increase market share and production capacity, and they did so by taking radical measures. If you think about Venezuela, you have to remember that in the 1950s Venezuela was the largest oil-exporting country in the world. It had the capacity to produce oil of about 5.5 million barrels a day. That's what the United States produces today. Venezuela produced more oil than Saudi Arabia, Iraq, or Iran. It was the second-largest oil-producing country—larger than the Soviet Union, and second only to the United States.

Venezuela then saw that capacity of 5.5 million barrels a day—larger than Iran's or Iraq's capacity today—slowly disintegrate, so that by 1990, they could barely produce 2.3 million barrels a day. And they wanted to reverse that. So they had an enormous capital program of their own, and they radically opened up their oil sector to foreign investment. They were the first major oil producer to do so—although Algeria had done so earlier and Russia in a sense did so at more or less the same time. Slowly the Venezuelans built up their production capacity, becoming the most flagrant violators of OPEC quota agreements throughout the 1990s.

Then suddenly, in the winter of 1997-1998, Saudi Arabia discovered that it was no longer the number-one provider of oil to the United States. Being the number-one supplier of oil to the United States is extremely important to the Kingdom of Saudi Arabia, even today—even with the level of anti-Americanism on the streets in Riyadh and Dhahran. And the Saudis asked themselves why they had lost that market share in North America. And they were not only not number one, but they were not number two, and at times they were not even number three: they were the number-four supplier of oil to the United States—behind Venezuela, Mexico, and Canada, all Western Hemisphere countries.

The Saudis decided that this will not stay the way it is, so they began to subsidize even more than before their exports to the United States. My judgment of the export subsidy that the Saudis gave American consumers is about $1.00 a barrel—which amounts, on a 1.7-million-barrel-a-day export, to $1.7 million a day, $10 million a week, a lot of millions of dollars a year; and they were able to win back their market share slowly. In the process Venezuela and Saudi Arabia fought an oil market share war over the market of the Gulf Coast in the United States. No wonder a surplus was produced on a world level, and no wonder oil prices fell: it all came down to a lack of discipline and politics between Saudi Arabia and Venezuela.

The politics of low prices is not a new one when it comes to oil producers. Kuwait at the end of the Iran-Iraq War went on a rampage in terms of their exports. The government of Kuwait said, "Don't think of us any longer as a country; think of us as a company. What a company does is maximize market share." By maximizing market share, you produce more—and what the Kuwaitis wanted was low prices because of the neighborhood they lived in. They embarked on an intentional path to reduce the revenue flow to Baghdad and Tehran, so that a lot of the politics of 1990 goes back to the Iran-Iraq War—a year-and-a-half (not even two years) before Iraq took Kuwait.

OPEC countries thought, until the ramifications of the price crash of 1998, that low prices were desirable. By low prices they meant a price for West Texas intermediate crude of about $15 a barrel and a price of Brent, the other world market crude, of about $13 a barrel. Those levels were about right in terms of their revenue stream; and, more importantly, they were about right in terms of stopping others from intruding into and encroaching upon their market share. "Others" refers to the non-OPEC countries—which had by then developed an enormous capacity to produce oil in part because of the capital investment programs that ensued from the high prices of the 1970s, and in part because of the development of new oilfields in the North Slope of Alaska, in the Gulf of Mexico for Mexico, and in Western Siberia.

The other thing OPEC countries wanted to prevent was oil being developed in the Caspian, and they asked themselves, "Why should billions of dollars be spent in the Caspian Basin to encroach upon a market share belonging to countries that still have two thirds of the world's known oil resources? That money ought to be invested in us, in finding ways to develop our resources more cheaply."

So the politics of low prices won't disappear. There are too many forces—too many temptations—to engage in market share wars. Just because we're now in a world of high prices doesn't mean that they will last forever.

OPEC and non-OPEC countries were able to change the structure of the market as rapidly as they did in 1998, 1999, and into this year because all of them suffered from the burdens of adjustment that I spoke about a few minutes ago—the loss of revenue, the loss of income—and from the domestic political repercussions that ensued. I can tell you that the leadership, even of Kuwait and Saudi Arabia and the Emirates, looked at political changes in Algeria, Venezuela, Nigeria, and Indonesia, and attributed a significant amount of those changes to the domestic political consequences of low oil prices. They didn't want to have those same domestic political consequences forced upon them at home.

Pivotal role of Hugo Chávez

Another, related factor was the arrival of a new political leadership in Venezuela, which became critical to the new agreements made within OPEC. Venezualan president Hugo Chávez was able to forge an agreement among the three critical—in the political sense—oil-producing countries that fuel the Gulf of Mexico market in the United States. One of the two keys to the agreements struck by oil-producing countries in 1998 and 1999 were the relations between Saudi Arabia, Venezuela, and Mexico, the other being the change in heart of the Venezuelan leadership toward the sufferings that went on during the oil market share wars. Chávez felt the need to pull back from the initiatives taken by the Venezuelan government a few years before that.

Upon Chávez's arrival on the Venezuelan political scene, a truce was declared in the battle for market share in the U.S. market. I will note that, like all such things, they bear the seeds of their own destruction, because the real loser in all of that was Venezuela itself. Venezuela, at the time it had begun these discussions leading up to the first agreements, was embarked on a path of increased market share. I told you that they had the capacity to produce oil of 2.3 million barrels a day in 1990. By 1998, this at had increased to 3.5 million barrels a day—and they were hell-bent on reaching 5.5 million barrels a day in a couple years' time, and they surely would have achieved that goal.

Now what has happened as a result of lower income and a new regime is that capital has dried up and Venezuela's production capacity has already slipped from 3.5 million barrels a day to once again under 3 million barrels a day. They—not permanently, but for a long time—lost that battle with Saudi Arabia.

Chávez is important in another way—and this is a diversion for a minute. When you look at oil politics, you need to remember that in the oil world there are three governments that have a declared interest in reducing the influence of the United States in both the Middle East and the world's oil market—one or the other—and they are three chunky, significant oil-producing countries: Venezuela, Russia, and Iraq. I think it's no accident that among all the oil-producing countries, these three are gravitating towards each other given their shared interest in fighting the dominance of the United States in the international political scene.

Impact of shifting Saudi-Iran relations

I said there were two important political changes that took place in that world of the late 1980s that reversed the low-priced world and made it a high-priced world. One was Chávez's arrival on the scene. The other is a radical shift in Saudi-Iranian relations, which came about through

• the struggle of Iran, after the election of Khatami to the presidency in 1997, to regain legitimacy on the international scene.

• the Saudis' realization that the American protector would not necessarily be there forever. The American protector had led the kingdom to be vulnerable in terms of domestic politics in a world of high prices—a world in which only Saudi Arabia had an ability to radically increase its oil production capacity rapidly.

In fact, today's oil price agreements are the result of a bilateral agreement between Saudi Arabia and Iran that effectively allows Iran to lie about how much oil they produce. When the countries together reduce their production capacity, Iran is seen as reducing from a level they never actually reached—a level assumed for the group as a whole by Saudi Arabia. That was a very important political step taken by the Saudi Kingdom, one that led to where we now are with a new security treaty between the two countries and the Saudis looking to what they hope will be their strongest neighbor to protect them in what is a very nasty neighborhood.

I want to skip over some other observations and open this up for discussion, but before doing so, I want to make a couple of tangential observations on oil politics, starting with Libya and the Lockerbie trial because surely, in a way, the end of the Lockerbie trial is the first in a series of steps toward closure to unilateral and universal sanctions imposed on Libya.

Kicking the oil sanctions habit

I raise this because it is part of a sea change in the way oil has been used as a political weapon. In the 1970s oil was used as a political weapon by individual countries, Libya being the first, and by a collectivity of countries called the Organization of Arab Petroleum Exporting Countries, or OPEC. OPEC used the oil weapon as a sanction against U.S. support of Israel in the Yom Kippur War of 1973, which led to the building of the International Energy Agency (IEA) as a mutual protection society for most of the OECD countries of that time, as well as to a tightening in the United States (and in other OECD countries) of anti-boycott legislation.

And yet, in the world of low prices, we found the U.S. government loving the oil weapon, using it for non-energy foreign policy purposes such as fighting

• terrorism

• violations of human rights

• the dissemination of conventional weapons

• the dissemination of nonconventional weapons of mass destruction

• alleged acts of terrorism.

Thus some of the anger in the oil-producing world against the United States clearly comes from the unilateral use of sanctions by the U.S. government—against not simply Iran and Libya, but also friendlier countries, including Nigeria, and poorer countries, including Burma.

There is a change in attitude on sanctions in the United States in part because of the tightness of supply in the world market and the realization that without any sanctions, world oil supply would be significantly greater than it is today. I can't predict the pace at which unilateral sanctions will be removed, but I think there are some milestones that we can see, and one of them is the end of the Lockerbie trial, which will bring about discussions in the UN between the Security Council—the U.K., the U.S., and Libya, in particular—on the next steps that Libya might be expected to take so that the suspension of sanctions can be resolved. We have to figure out what happens next.

What happens next in the UN is less clear than what happens next in the United States. Those of us who got up early enough to watch television this morning know that the families of the victims of the Lockerbie tragedy are split in their emotions, some saying "This is enough," others saying, "Okay, now let's really get them." The latter group wants to see what further steps another U.S. government—not the government of George W. Bush—will be willing to take on their behalf, namely, steps that would lead to

• appropriate compensation for victims' families.

• Libya's public acknowledgement of responsibility for the Lockerbie tragedy.

• Libya's public repudiation of terrorism as an act of state.

My guess is that these steps can be taken in stages and the sanctions can be lifted in stages. One of the things that can change in the world we live in is that U.S. companies will be allowed to buy Libyan oil again, even before U.S. companies are allowed to invest. And, believe it or not, that would be a good act because of what it would do in terms of the world's oil market: it would not increase Libya's revenue, but it would decrease the dislocations of the market that occur because Libyan oil can't go where it's wanted at times—namely, to the Gulf Coast of the United States.

The second major oil-exporting country on which there are unilateral sanctions is, of course, Iran. As in the case of Libya, sanctions on Iran are partly embodied in the Iran-Libya sanctions act, which expires in August and is not likely to be renewed. The U.S. government, I think, is likely in the next few weeks to take steps to reduce some of the oil sanctions. The easiest step is to license U.S. companies that have oil and gas investments in the eastern part of the Caspian Basin to swap those resources through Iran and to get oil (or its equivalent) from Iran rather than from Kazakhstan. I predict we'll see that as the next step—that said, I don't think anything will happen until the aftermath of the Iranian elections in June.

Rising oil demand in Asia Pacific

In the world of the 1970s, all governments intruded into the oil and gas sectors. One of the major changes from 1981 to the present is the withdrawal of the state from the management of the oil sector in favor of allowing markets to operate. Governments are now deprived of the ability to set prices of oil either at home or internationally. Market forces are a very efficient mechanism for burden allocation and adjustment allocation. Market forces enable investments to be channeled where they want to be channeled and commodities to flow where they want to flow. So they smooth out the adjustment more rapidly and marshal capital more efficiently, letting oil flow where it wants to flow.

One of the things that happens as a result of that, going back to my remarks about the oil market share war between Venezuela and Saudi Arabia, is that the Atlantic Basin really is a self-sufficient enterprise: the U.S. and Brazil don't actually need to import oil from the Middle East. Middle East oil in the world we live in wants to go not to the Western Hemisphere but to Europe and Asia; these are the big growth markets. Virtually all of the 17.5-million-barrel-a-day increment—from 1985, when global oil demand was at 60 million barrels a day, to 2000, when oil demand was at 77.5 million barrels a day—can be attributed to the Asia/Pacific Basin, and in the world ahead I predict that 80 percent of the increment in demand will continue to be attributed to the Asia/Pacific Basin. When there are projections that oil demand will go from 78 million barrels a day in 2001 to 100 million barrels a day in 2010 (and to 120 million barrels a day in 2020), almost all of that baseload is China and India and other Asia Pacific countries. When that happens, the American interest in securing the free flow of oil from the Persian Gulf will be reduced and the interest of the Asia/Pacific countries will be increased.

And there is no multilateral mechanism for channeling the politics that go along with that. We are looking at not only the end of an American protectorate—not tomorrow, but in sight—but also a very different kind of political world. Bear this in mind.

Another difference between now and the 1970s is that in 1978 there were no strategic stockpiles of oil in the world, whereas today there are 1.4 billion barrels of oil in strategic stockpiles in North America, Western Europe, and the industrialized countries of Asia/Pacific (i.e., Korea, Japan, and Taiwan). That makes a big difference to a world that must constantly adjust—domestically, politically, and economically—to price volatility.

We've already seen the U.S. government make use of its strategic resources—not in 1990 or 1991, when the liberation of Kuwait began, but in 1996, 1997, 1998, and very visibly in 2000, for essentially domestic economic reasons. I suspect, political rhetoric notwithstanding, that oil will become a permanent element of domestic politics—not only in the United States but in other countries.

Questions and Answers

QUESTION: I want to pick up where you left off, looking into the future—say, twenty years from now—at changes in oil politics. George W. Bush has already begun talking about energy security in North America. He's talking about what seems like a continental agreement, speaking about it, I assume, this month in Mexico with President Fox. What's the likelihood of having some kind of continental energy agreement? Does it make sense, and what would be the architecture?

MORSE: Fortunately or unfortunately, the architecture of such a plan is defined to a significant degree by domestic politics in the three countries of North America. In this case, it's Mexico that counts a lot. There are some positives that would result from a hemispheric approach. Let me talk about where it makes the most sense first.

The North American market is one market for a lot of trade purposes. It's also one market when it comes to natural gas and petroleum products. The natural gas grids of North America are, in part, the result of politics at a time when the Canadian government, the U.S. government, and the Mexican government looked at border controls and tried to control prices of natural resources flowing across their borders.

A continental agreement could lead to three efficiencies:

1. Greater integration of energy initiatives into environmental activities. The wisest thing President Bush has done thus far in setting up the Energy Task Force in the government was to put not the Energy Secretary but the Vice President in charge—and to enable the Vice President to bring in one room the Environmental Protection Agency, the Department of Energy, the Department of Interior, the Department of Transportation, the Department of Treasury, and the Department of State. That needs to be done on a North American basis, so that the two activities, environment and energy, can be coordinated. It would be wholesome to do that on an international level as well, but I'm not sure it's doable. If you think about it logistically, what normally happens in the United States also tends to happen internationally, namely, that those who are responsible for the environment and the protection of the environment and those who are responsible for the mobilization of capital for developing natural resources work on separate tracks...

2. Opening up of Mexico's energy sector. At least according to Bush's campaign rhetoric, he hopes to induce the Mexican government to open up its energy sector.

3. Better alignment of product specifications. Another issue that's specific to North America is a technical one having to do with aligning the specifications of products, not only within our own markets—the Canadian market, the U.S. market, and the Mexican market—but across them. Product specifications, if they are aligned, will also increase supply. This is because when you're making fifty different kinds of gasoline, you use up a lot more resources than if you're making two kinds of gasoline. Refineries operate less efficiently; the supply system operates less efficiently.

Yet another issue for North America is freeing up supply. During the campaign, the Bush team said, "We're going to give every incentive to the Mexicans to enable foreign companies, American companies, to invest in Mexican resources." I think that's just a non-starter. We live in a world where, beginning in the 1920s, resource nationalism became a major element of international politics. The first major nationalization took place in Argentina in the revolution in the 'teens. Then there was another major nationalization in Russia after the Bolshevik Revolution, in 1921. The next big one was in Mexico in the 1930s. The one after that was China. Then we saw the same phenomenon in the Middle East and elsewhere in Latin America in the 1970s.

In today's world—now that Russia has become a market economy, now that Iraq and Iran have reopened their oil sectors to foreign investment, now that Venezuela has done so (despite the setback that occurred in the last two years)—the only two major countries that don't allow foreign investment in the petroleum sector are Saudi Arabia and Mexico. There are all kinds of reasons why neither of them has opened up. The Saudi government may open up. It will do so much earlier than the Mexican government, and I believe the repercussions of pushing the Mexicans too hard on that issue might make us suffer more than they do. So I just don't think it will happen.

QUESTION: Could I ask you to elaborate on two events? One is the development of the Caspian Sea Basin, in which the international energy companies have placed a lot of stock. The other factor is Mr. Putin's recent visit to Azerbaijan and how it came off.

MORSE: No doubt Putin has struck out on a different path from his predecessor as regards Russia's relations with neighboring countries. From an oil perspective, among the most critical of these relationships is not necessarily the one with Azerbaijan but that with Georgia, which holds the key to alternate pipeline arrangements—i.e., to providing the transportation for evacuating oil from the Caspian Sea Basin other than through Russia and Iran.

It's clear that landlocked countries suffer whenever the subject of evacuation of oil takes place, because landlocked countries need to transport or evacuate their resources through third parties. It is a plight of the Caspian Basin and Central Asian countries that they are all landlocked, much the way Iraq is landlocked. The reason the international sanctions regime against Iraq works as well as it does is because Iraq is essentially a landlocked country. Likewise, it's very easy to control the chokepoints from the Basin.

Whether a pipeline goes west or south or through the north is in a way a chicken-and-egg problem, thus cannot be easily resolved. The failure of the U.S. government to do more than "jawbone" the issue by subsidizing evacuation routes meant that time was on the side of the Russians, pure and simple.

We see Kazakhstan and Azerbaijan at the brink of a breakthrough in terms of resource exploitation. If you look at their combined oil production in 1997, it was 500,000-600,000 barrels a day; if you look at their combined production in 2000, it was just under a million barrels a day; and if you look at their likely combined production in 2001, it will be 1.2 million barrels a day. In short, this is an area of the world that's among the fastest growing in percentage terms as far as developing its own resources and contributing increments to the international oil supply. Those countries now need a fast increment in transportation, and it's going to come through Russia faster than through any other place, whether or not Baku-Ceyhan is built.

QUESTION: I would like to ask you to comment on the United Nations' proposals about governing the world's energy supply. Do you think these ideas are realistic?

MORSE: There is no doubt that managing the world's oil reserves is a global issue, furthermore that it lacks global mechanisms to manage it. All of the existing mechanisms, dating from the 1970s, are inadequate. I also believe that the two steps being proposed—one by the UN and the other coming out of the official oil producer/consumer dialogue (to establish an information center in Riyadh)—are bad and ought not to be taken—and that if it's not in the interest of the United States to do them, it won't happen.

On the other hand, if I were czar of the world and able to do what I think is required, I would draft an energy agreement that would potentially be open to all of the countries of the world. It would be modeled on the European Energy Charter, which was basically a trade, investment, and third-party transportation agreement requiring countries to adhere to a free flow of trade, free flow of investment, and free flow of material. For all kinds of reasons, I think it's workable.

I imagine it would result not in a global agreement, but an agreement among the United States, Canada, Japan, all of Europe (including Russia), and virtually all of the North African producers. Mexico and Saudi Arabia couldn't be part, because they will not be able to join such a global agreement unless they play by the global rules that would be embodied in it: namely, trade, investment, and third-party access.

That's my answer, and it's a subject that I have thought through in great detail, have written about, will continue to write about, and I'm happy to discuss at any point.

QUESTION: Could you talk a little bit about what you see the implications of Ariel Sharon being elected as Israeli prime minister?

MORSE: We don't know what the implications are, and it's very hard to speculate about them. But given the very visible role he played last September—as the lightning rod that triggered an emotional outbreak—we should monitor the situation carefully. If that emotional outbreak is continued in a massive way and there are further uprisings—like the Al-Aqsa Intifada uprisings—which are then put down with the use of force resulting in a lot of people being killed, this will surely intrude on the politics of oil.

Under those conditions, no Muslim oil-exporting country could, in terms of its domestic politics, allow itself to be courted by the governments of the major economies of the world to release more oil, even if it was for macroeconomic purposes. And the market we move into next winter is surely going to require more oil. The result would be a short-term oil price spike—which would go down because the current market won't support tightness. But if the Middle East situation doesn't trigger the release of more oil resources in August, September, October, and November, we can expect to see very high oil prices next fall.

QUESTION: Can you comment further on what the second Bush administration might do to change what appears to have been the result of the Gulf War, particularly sanctions against Iraq? Bush, Cheney, and Powell seem to be quite concerned about this issue. Secondly, you talked about expansion in the demand for oil in Asia, India, and China. Can India and China ever be self-sufficient, and if not, will they, too, become involved in the politics of oil?

MORSE: The latter question is easy. They will never be self-sufficient. If you extrapolate current growth rates of China, by 2020 China will overtake the United States as the world's largest oil consumer. The only places this oil can come from are Iraq, Iran, Saudi Arabia, Kuwait, and the Emirates. There is no alternative.

I'd find it very hard to speculate on the Bush administration's likely policy toward Iraq. We know what they said before the election. We know what they've done since the election, which at least to me, has made eminent sense. Before the election, Condoleeza Rice, Colin Powell, and Dick Cheney made statements on a whole bunch of these issues and were much more vocal than President Bush himself. Condie Rice even said publicly that one of the first acts of the new administration would be to recognize Jerusalem as the capital of Israel and move the Embassy there. I don't think they're going to do that.

They have also been talking about strengthening the sanctions regime against Iraq. I don't know how they can do that without the cooperation of the other members of the UN Security Council, and I don't see the other members of the Security Council rallying around the United States in terms of tightening that regime.

So I find it very hard to speculate. When you're not in power, you have lots of freedom, and when you're in power, the realities hit you. Thus far, the judgment, I think, is to give them pretty good grades on what they've done on the energy side, although it's all been domestic.