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Challenges in a World of Oil Scarcity

The Coming Saudi Oil Crisis

by MATTHEW R. SIMMONS

As oil becomes a scarce resource, its use will have to be rationed in one way or another. There are ways to allocate oil use and direct it to its most valuable applications. But achieving such a rational plan will require a carefully orchestrated, global, country-by-country effort. Left unattended, this process could quickly evolve into genuine chaos. The global economy can function after oil supplies peak, but not in the same manner in which we live today.

Once oil supply peaks, the world will be forced to create ways to substantially conserve our oil and other energy sources. This shift should force a rapid rethinking of the notion that transporting people and products anywhere in the world is an almost incidental cost of doing business. "Transportation" turns out to be the biggest single user of oil, and we need to begin finding ways to minimize everyone’s transportation needs and make the use of transportation fuel as efficient as possible. Today, the most wasteful use of transportation fuel is probably traffic congestion. A world beyond Peak Oil will be forced to solve this problem, too. Whether its solution is living closer to one’s work or using more mass transportation, both become viable ways to address traffic congestion and use oil more efficiently as prices rise. Simply building additional miles of wider and wider roads no longer works. Even a new fleet of more fuel-efficient vehicles will take too long to implement and may still use too much oil. If we do not alter our transportation systems as a matter of policy and public planning, the inexorable operation of pricing mechanisms will do it for us. At some price for gasoline, traffic congestion will diminish.

There is no question that a world of increasingly scarce oil will foster a growing competition among energy-consuming countries. As the reality of declining oil supply becomes better understood, this country-by-country competition could evolve either into a manageable process (like the economic competition that has existed for decades among the various OECD countries) or an aggressive free-for-all that triggers new wars. If the problem is misunderstood or left unaddressed, war could easily prevail over peaceful competition. Securing adequate oil supplies was, after all, an important element in all the major wars of the twentieth century and in the United States’ two most recent interventions in the Middle East. If the magnitude of the problem is fully understood and the risks of a laissez-faire approach are appreciated, all nations should be able to recognize the necessity of working out comprehensive ways to allocate an increasingly scarce supply of oil among the world’s many deserving countries.

The competition for oil supplies is not waiting for the day when oil production peaks and begins to decline. Scarcity is not simply a function only of production and supply; it also results from increasing demand. And that is the situation we are facing today. More people in more places want a share of the world’s petroleum resources. Rising demand over the past several years has altered the previous market balance and quickly turned oil from a relatively abundant to a far scarcer commodity. The most aggressive new entrants into the international petroleum markets are China and India, the world’s two most populous nations with two of the fastest growing economies. They will, within the lifetime of a majority of Americans and Europeans alive today, become the two largest national economies in the world by most measures, although they will not be the wealthiest.

The developing oil needs of China and India are huge, and their leaders seem now to be truly understanding the issue, perhaps far better than the leadership in many already prosperous countries. They are now using every means traditionally employed by Western nations and their oil companies, short of military force, to secure sources of supply. These means include diplomatic relations and foreign aid, direct investment, bilateral agreements, technology assistance and transfer, and the exploitation of frictions in the traditional relationships between Western nations and non-Western oil producers. China has forged agreements with three of the largest Petroleum exporters — Saudi Arabia, Iran, and Venezuela — and with several others. Not surprisingly, several of these exporting countries are currently in disputes with the United States. These countries may not be above using their increased market leverage in ways that will damage U.S. interests.

The growth in China’s and India’s need for oil has now become very visible. Less visible is the meager oil use by many other countries that now also aspire to be like "us." In a world where oil is limited, it is vital that a truly global International Energy Agency (IEA) begin to embrace the needs of all the world’s energy users and not simply view its role as that of the energy watchdog for the prosperous energy consumers.

I happen to think the world can make the transition into what we might call the post-Saudi oil era in some very rational ways that will limit economic disruption. As a perpetual optimist, I believe the world still works beyond Peak Oil. While oil prices in this new world will obviously rise, this rise can be a blessing, not a curse. Far higher oil prices make all other forms of energy more competitive and spur on energy research programs that might discover some real long-term fixes.

Higher oil prices will also trigger a massive influx of money to all oil-exporting nations, even as their reserves and daily outputs shrink. With proper guidance, and based on the grim reality that this great flow of fluids for these oil countries is essentially a "last call" instead of just another boom that will be followed by another bust, oil-producing countries can make the most of the revenues that higher oil prices create.

It is imperative for countries like Saudi Arabia and the Middle East producers in general to wisely invest their pending windfall profits toward creating modern societies that work beyond oil. If such plans are enacted, their unforeseen benefits could turn into a surprising global miracle. The time for using high oil prices for guns, palaces, and Swiss bank accounts is over. This money now needs to be used to create the basis for more abundant life in these countries after Peak Oil.

Do the math to understand how powerful this spending boom could be. OPEC, as a group of countries, now has about 600 million people. By 2025 or 2030, the OPEC population could easily exceed one billion people. If future oil prices were to remain as low for the next 20 years as they have been over the last 10 years, it would almost ensure an ever-increasing gap between vast wealth for the ruling elites in these important countries and increasing poverty for the masses. Such a model is unsustainable. Social chaos, increasingly violent terrorism, and political or military revolutions would ultimately become "normal events" throughout all OPEC countries.

If the process is managed in a rational manner, an era of high oil prices can create the necessary revenue to begin building a genuine middle class in most OPEC nations. This process would, in turn, unleash a buying spree for OECD goods and services. The growth in demand for such goods that this new middle-class OPEC society would want might make even the economic miracle unleashed when the Marshall Plan rebuilt Europe appear modest in comparison. It would certainly overwhelm the economic miracle of the 1980s and 1990s when the Asian tigers finally rose to prominence.

A world that learns to live with a dwindling oil supply will also be forced to control the emissions that energy use creates in an entirely different way than anyone envisioned when worries of global warming first began to surface. A continuation of urban sprawl would become an intolerable trend as the transportation that supports it becomes too costly. Fortunately, the world has already created the necessary tools to allow many highly productive people to stay and work at or closer to home. How odd it would be if the Internet became best known as a great tool to help pave the way for a world that uses less oil.

The biggest danger the world faces, if my thesis about Saudi Arabia’s oil is correct, is that no one will begin preparing Plan B. As far as I know, there is not a single contingency plan in place or currently being written by any of the think tanks of the world that sets out a model illustrating how the world can continue to function smoothly once it is clear that Saudi Arabian oil has peaked. In a nutshell, it is this total lack of any "alternative scenario thinking" that makes this unavoidable event so alarming.

MATTHEW R. SIMMONS is Chairman and Chief Executive Officer of Simmons & Company International, a Houston-based investment bank that specializes in the energy industry. Mr. Simmons serves on the boards of Brown-Forman Corporation and The Atlantic Council of the United States. He is also a member of the National Petroleum Council on Foreign Relations. He has an MBA from Harvard University. He is the author of Twilight in the Desert: the Coming Saudi Oil Shock and the World Economy, from which this essay has been excerpted.

Copyright © 2005 MATTHEW R. SIMMONS