The Power and the Money

The Trump administration is not joining OPEC and the deal will not last

The United States is not joining OPEC. The United States is not leading a cartel to raise oil prices. The United States is, to quote my 5-year-old daughter, “not doing nothing.” The President of the United States is posturing.

Right now, the Trump administration is doing absolutely nothing to jawbone U.S. producers into cutting. In fact, it’s made it clear that U.S. “cuts” will come from market forces. It is remotely possibly that the Texas Railroad Commission (RRC) will order production cuts in Texas, but right now only one of the three commissioners supports the move and hearings about the idea have been contentious, to say the least. Moreover, what would be the point? If a putative 9.7 million bpd cut didn’t move markets, why would anything Texas could do make a difference?

It seems to be true that Trump worked the phones to get the Saudis to accept an agreement. But OPEC has no enforcement power and all the low-cost producers have incentives to cheat. Moreover, the deal is almost a sham. Both Russia and Saudi cut from a baseline level of 11 million bpd (the link goes to the OPEC press release) … but Saudi has never hit that level. The supposed highs of 12 million bpd included sales of stored Saudi crude. Ultimately, Saudi production will be down only 1.2 million bpd.

So good luck with enforcing that deal. As with so much of the Trump administration, this is for show. He gets to show off much he’s in with the Saudis and the Russians, and he gets to tell his backers in the oil industry that he went to bat for them. Good for him, I suppose. But it isn’t much of a cartel and the U.S. government isn’t ordering any production cuts at all. With Covid-19 having destroyed oil demand, prices are not going to go up anytime soon, least because of this deal. 

“Frankly, I’d like to see the government get out of war altogether and leave the whole feud to private industry.”

Thus spoke Major Milo Minderbinder in 1943.

Was he right? Does contracting out combat support functions save money? I mean, that is not quite the whole feud, but it is some of it.

The best answer comes from study published by John McGrath, at Fort Leavenworth. Below are the figures from Table B-2 for various American wars. The figures apply only to the Army but rightfully include staging areas in Korea and both Gulf Wars: Japan and Kuwait, respectively.

So what do we got? At first glance, success! A higher tooth-to-tail ratio, awesome sauce!

We are back to the levels of World War 2! (AEF = American Expeditionary Force of WW1; ETO = European Theater of Operations in WW2.) Hooah!

Only, well, that does not include the contractors. We really should put them back into the mix, since they did jobs that soldiers did in Gulf 1 and before.

Ah. Well. Not so good.

Now, to be fair, these figures do not include the extensive host-country support the U.S. received in Korea, which would make that war look pretty bad. (Korea would fall to 28% combat troops on a BOTE calculation.)

They also do not include potential cost savings. After all, if private contractors are cheaper, then you would expect that the military would use more of them. Calculating that, however, is incredibly complex, because American operations have become far more capital and resource-intense over time. The simple calculations show ever-rising real deployment costs, but that could be a reflection of the fact that the American soldier in Gulf 2 was rather more lethal (and well protected) than the American soldier of Gulf 1, who was both more lethal and better protected (and better fed) than the American soldier in Vietnam, who was more lethal than the American soldiers who beat Hitler.

It is hard to figure.

But the headline figures should induce skepticism.

This, note, is just for outsourcing support functions; we have not gotten into questions of outsourcing actual genuine combat. You know, what Major Minderbinder really wanted to see. That is an even less-satisfying topic for another post.

Calling McDevite: Qatar versus the Arabian Gulf

By now, most of you have heard of the contretemps in the Arabian Gulf. Just a few notes.

1. The Saudi-Emirati coalition has not put up a blockade. They have closed their territories to all Qatari commerce, but there is ginormous difference between that and a blockade.
2. The Qataris are claiming to play nice by not expelling 250,000 Egyptians. They are not. They have no choice. The Egyptians are about 16% of the foreign population and fill a number of key roles. (Other statistics say there are only 72,000 Egyptians; 5% of the total workforce.) But even if the smaller number is correct, expelling them would be hugely costly. Egyptians are predominantly skilled and semi-skilled. In 1985-2002, 52% of Egyptian emigrants to Qatar were scientists, managers or technicians and 21% of them were university graduates. (Page 252.) The Qataris might decide eventually to retaliate by expelling the Egyptians, but it is not a move that they would take lightly. 
3. It seems obvious that this is related to the recent Trump visit. Sadly, because Trump, we do not know if he explicitly authorized it or merely gave the Saudis the assurance they needed that they could do anything without American pushback. (See our president’s recent tweet.) That said, I am curious as to the exact mechanism previous administrations used to keep Saudi policy aligned with ours. I can guess, but does anyone know?

Three and one-half more years.

Economic growth is not weakening the North Korean dictatorship

The New York Times recently published an interesting article with a weird headline: “As Markets Spring Up, Leader’s Grip on North Korea Slackens.”

Apparently somebody noticed that the substance of the article showed no such slackening of the leader’s grip on the DPRK, since the on-line headline has been changed to “As Economy Grows, North Korea’s Grip on Society Is Tested.” 

The article shows an increase in market activity and corruption, but shows zero sign of less state power. In fact, most of its evidence comes from one person who had to flee, which undercuts the message in the print headline. 

It is (probably) true that high Stalinist totalitarianism cannot survive economic growth and the introduction of private markets.

But Italian fascist totalitarianism did just fine in a wealthy market society ... and one made up of Italians, not exactly a culture wedded to obediance to authority. Saudi totalitarianism does just fine today. And if we step back from totalitarianism to simple authoritarianism, it becomes even clearer that dictatorial societies have no problem surviving market forces, even in the age of the internet. There is the People’s Republic of China, but also the Russian Federation, its little Belarussian brother, the regime in Gabon. I do not know whether the Islamic Republic of Iran should be considered authoritarian or totalitarian, but either way it does not seem to be losing its grip on power. 

Here is a picture of modern totalitarianism, Jeddah circa 2007:

Looks pretty nice, no? Jeddah circa 2007 had markets, a large middle class, and a great deal of immigration. It also had the Internet. At the time, wireless service was better than in the United States. But it was thoroughly totalitarian, as the badge around my neck might indicate. The grip of the Saudi state was not to be challenged.

A prosperous but dictatorial DPRK will not look like Saudi Arabia. It might not even be totalitarian; something more like China or Russia is likely. But there is no reason to think that economic growth or modern communications will by themselves make it any more free. In fact, the modern panopticon, manned by artificial intelligences in addition to human surveillors and wedded to an elite enriched by its control over old-fashioned real estate could create a dictatorship of a power unimagined in the 20th century. 

So, please, cut it out with the Whiggian optimism. Especially an American newspaper in the age of President Trump. 

The failure in Yemen and the President

By now, most of you have heard of the tragic fiasco in Yemen. An attempted U.S.-Emirati raid went badly wrong, resulting in unnecessary loss of military and civilian lives. 

On one hand, the fault lies with the U.S. military, which proposed the operation.

But the buck stops with the President. It is easy to imagine a Commander-in-Chief disapproving or postponing the raid. This particular Commander-in-Chief chose not to do so, and thus the failure lies with him, just as it lay with President James Carter in 1980. There is no way around that.

Tragic mistakes happen. Failing to own up to them is inexcusable. The President has the authority and the responsibility. Regardless of the other failures on the chain of command, he is the one who needs to learn from the mistake and force his underlings to do the same. 

Saudi Arabia will not win its war on fracking

 At Fivethirtyeight, Ben Casselman suggests that Saudi Arabia may finally be winning its war on fracking. In his words:

Recently, though, there have been signs that the Saudis’ strategy might be working after all. On Monday, Chesapeake Energy, once the highest flier of the U.S. oil boom, had to deny publicly that it was preparing to file for bankruptcy; some 60 oil companies have already done so, and the research firm IHS estimates that as many as 150 companies could follow suit. On Wednesday, The Wall Street Journal reported that private-equity giant KKR & Co. was backing away from risky bets on oil companies. Industry leaders are starting to sound desperate: The New York Times quoted the head of a Texas oil group as telling his members that “today our goal is to survive.”

I have some doubts. But let’s say bankruptcies take hold across the sector and production does crash. What then?

Well, the rigs won’t be dismantled. The oil workers won’t lose their skills. The infrastructure won’t disappear. And drilling and completion of a known site takes only one month and costs about $6 million. (Page 13.) Even if you add in all pre-drilling activities you’ve got only about six months to complete a well.

In other words, once prices rise American production will shoot back up even faster than it falls. So what in the name of God does it mean to say that Saudi Arabia is “winning” its war on American production? You need one weird model of the oil market, in which removing American production sends prices up but bringing it back on does not cause prices to fall. (In that model, I should point out, Saudi Arabia would be doing the American industry a favor by forcing it to temporarily cut production.) Or one in which Saudi Arabia would be unable to sell as much oil as it wanted to in the face of full American production. Neither sounds particularly plausible.

Perhaps I am missing something, but the idea that the Saudis are warring on U.S. unconventional oil production does not make sense to me. It is a mighty expensive war and one that they cannot win. So why would they try?

Did Russia cause the decline in oil prices?

 No.

But some Russian observers believe that it did. (Hat tip: Randy McDonald.) Short version: the Russians did not offer to cut production enough back in October 2014. This sent the Saudis into a fit of pique and crashed oil prices.

Oh gosh. First, Russia is not a swing producer. It is hard for the Russians to cut production, especially in winter. Only the Saudis and Emiratis have the capability to shut down millions of barrels per day of production simply by turning a bunch of valves. 

Second, the Saudis really do not act out of pique. Not with billions of dollars at stake. We know exactly what they are trying to do, because they have told us. In June, Saudi Arabia increased production by 500,000 barrels per day. They did not do that because they were worried that the Russians might free ride on a production cut. They did that because they wanted oil prices to stay low for a while. 

Sure, in October the Russians might have tried to counteract the Saudi production hike. (Operative word: tried. Moscow is not lying when it says that such a cut would be technically impossible unless you were willing to risk permanent damage to the fields.) But why in the name of God would they have bothered? Just a few months before, the Saudis had jacked up production. The Saudis could have taken production down by 2½ million barrels per day (the 2010 level); five times what Russian critics think Moscow should have done. 

And the Saudi and Russian oil ministers talk to each other. The Russians would have known Saudi intentions. The Saudis would have known Russian technical capabilities. This is not the Vietnam War; the two sides do not have to communicate via the energy market equivalent of strategic bombing. 

Russia is a big important country. But the oil price decline, that one was caused by the dynamic duo of the United States (hooah!) and Saudi Arabia. The world’s weirdest superhero and sidekick. But there nonetheless.

Sorry, Russia. You are not that important. 

Yet even more evidence that the oil price slump will be prolonged

 The new EIA projections show that even with falling rig counts, production will stay high. They have a great chart attached:

It is hard to see, but the new wells have very high depletion rates. Consider the dark brown band: wells that will be drilled in the first quarter of this year. Their production is estimated to fall by 54% in their first year and then another 38% in their second, for a total two-year decline of 71%. Yet production is still expected to rise, because we are getting much better at drilling: initial production is going up. Consider the Bakken in North Dakota:

Or the Eagle Ford in South Texas:

Or my favorite, the Permian in West Texas:

Of course, rig counts could go lower. How low would they need to go? Well, once again the indispensable bureaucrats at the EIA have done the work:

In other words, we have a long way to go before American production starts to fall. You heard it here.

And let me say that if I know this, then the very good technical people at Saudi Aramco also know this! Saudi oil strategy is not about trying to kill American unconventional production, no matter how much they head fake. It is, as we said here, about trying to kill substitutes for oil, including conservation.

And I am gratified to see that story make the front page of the Washington Post today!

What determines Saudi oil strategy?

 In comments, FS asks: “I’m all on board with the thesis that U.S shale will keep producing but from that thesis it doesn’t follow that oil prices will stay very low for the next year. Put differently, what do you think about the determinants of Saudi Arabia’s production decisions?”

I briefly alluded to Saudi Arabia in the last paragraph of this post, but allow me to expand as I puff on my cigar in a tent in the Arabian desert.

(Actually, that photo is from 2007. It was, however, taken in a tent in the Arabian desert with members of the Saudi royal family, whom you need to remember number in the tens of thousands. I had just gotten back from Afghanistan, at least one of this blog’s regular readers was in Iraq, and the whole thing felt even weirder than it would have normally. But I digress.)

I take the Saudis at their word when they say that they will keep pumping, come hell or high water. The Saudis clearly didn’t engineer the price crash, but they’ve decided to take advantage of it. The public evidence we have is that the reason they will not cut production is that they’ve decided to take on U.S. tight oil.

I doubt that tight oil is the full reason. American production isn’t that low cost. In the long run there is a relatively high price floor as long as the United States is the marginal producer. Moreover, the Saudis can’t kill the American industry dead just by keeping prices low for a year or two; once prices rise, the Americans will come roaring back. 

Rather, I think they’re deathly afraid of demand destruction. Their strategists are very knowledgeable. They’ve seen the figures on peak driving. They know about the new CAFE standards. They watch Elon Musk’s every move. They are seeing businesses and governments go after the use of petroleum products in trucking. They are more knowledgeable about biofuels than some of the industry’s biggest proponents. Heck, they are seeing New Englanders switch from oil to wood for heat! And those trends weren’t just in America. They were everywhere.

In the words of the great Saudi oil minister, Sheikh Zaki Yamani: “The Stone Age did not end for lack of stone, and the Oil Age will end long before the world runs out of oil.” By the middle of 2014, that prediction looked to be coming true. The Saudis could imagine a future where oil prices stayed high until sometime in the middle of the next decade and then began an inexorable plunge down towards zero.

Tight oil might be hard to cripple with a temporary period of low prices, but such a period really can do serious long-term damage to the creation of substitutes. Human capital will dry up, investors will run away, organizations will be liquidated, policies will be reversed (or not implemented) ... and millions of consumers will not change their consumption habits. When prices go back up, all of those changes will take years (or decades) to reverse.

Low prices do all that while striking a minor blow against American tight oil, a major blow against the Islamic Republic of Iran, and making the Americans happy! 

There is also some element of a replay of 1986 in the decision to let prices stay low: in November the Saudis tried to get the Russians to agree to cuts and were miffed when a hard-pressed Vladimir Putin said no. Punishing Russia serves a double purpose, then: your American protectors like it and it makes your threats more credible the next time you try to organize a production cutback. 

Sure, the Saudi budget goes into deficit when oil is less than $100. But with their foreign exchange reserves, that is less than a problem. $38.6 billion deficit? Nada. Saudi Arabia has foreign exchange reserves around $740 billion. Judging from the Saudi balance of payments (page 34), they earn a pathetic return on that $740 billion; maybe 1.5%. (No r>g here!) They could avoid dipping into their insanely high reserves just by a little more aggressive investing and some asset privatization. (Norway gets 6.7% on its money; r>g over there, and the Norwegians will own us all.) Hell, the Saudis could earn an additional $30 billion next year (at $40) just from letting their production rip: last year they kept a whopping 2.4 million bpd of capacity in reserve. 

In other words, I do not think that Riyadh is going to try to drive oil prices back up for some time. 

More evidence that the oil price slump will be prolonged

 At some point we should go through this blog and mark our beliefs to market: which predictions did we get wrong?

But before we do that, here is some supporting evidence for our prediction that oil prices will stay low for a while. The reason is that tight (aka “shale”) oil production in the United States will not fall as quickly as many hoped. Here is a concrete example. Continental Resources plans to reduce the number of operating rigs by 40% and cut its drilling budget from $5.2 billion to $2.7 billion. At the same time, however, it expects the cost of a well to fall 15-20% and average production to rise 16-20%.

And Continental, bear in mind, is unhedged! Most American drillers are hedged, meaning that the price drop won’t affect them until 2016. Total rig counts are down only 1% in the past week and up by 6% on this time last year.

Add that to Saudi Arabia’s refusal to cut production and you’ve got a situation for a prolonged bust. We do, however, predict that oil prices will be back up near or over $100 within a few years ... but a few years is a few years. 

As for why Saudi Arabia wants a period of low prices, well, it isn’t that hard to understand. They have a big enough war chest to withstand the pain. Meanwhile, they get to (a) discipline OPEC; (b) slow down the growth of high-cost competitors; (c) prevent demand destruction; and (d) help out their patron, the United States, in a rough geopolitical time. What’s not to like?

Bahrain against America? Not yet, but it is getting personal

 My friend and occasional co-blogger, Suresh Naidu, is a professor at Columbia. He is also an activist for human rights, as is his wife, Radhika Sainath, along with her colleague Huwaida Arraf. Radhika and Huwaida travelled to Bahrain in order to place American observers inside the demonstrations scheduled for the February 14th anniversary of the Pearl Roundabout demonstrations. The Bahraini government detained both of them and then had them forcibly deported. In a gratuitous move, the government kept their hands tied behind their backs for the entire flight to London.

On the exact same date that the Bahraini government detained Radhika and Huwaida, I was told that the Bahraini government was disinviting me from giving a talk next month due to this piece on an HBS blog.

Demonstrations in the Shia townships and villages are regularly met with violence from the government, as have spontaneous protests. (The embassy publishes demonstration notices, which are useful for those who like the smell of tear gas.) There are continual rumors of violence aimed at foreigners, but the horrifying incident in which a Briton lost two fingers to a “sword” attack turned out to be a mugging gone wrong. The fellow had fallen asleep in his car when a group of kids tried to rob him. When he resisted, they slashed his hands. It is not clear that the blade was a sword, or that they cut off his fingers as opposed to slashing them badly. Given my background, my standards are probably low, but the story could have happened in the United States.

What is going on in Bahrain? Justin Gengler has a useful roundup. The basic split, as discussed here earlier, is between the Sunni monarchy and poorer Shia citizens. There were demonstrations in February, and the government resorted to repression, with help from Saudi troops. The Bahrain Independent Commission of Inquiry reported in June of last year that the government had tortured detainees, but it did not name any names. On September 24th, the government held new elections to replace the Shia parliamentarians who resigned in the wake of the crackdown. Violence surrounded the elections. Turnout, unsurprisingly, was low.

According to Gengler, five important trends have emerged over the year since the crackdown:

1. The Sunnis are unhappy. Some of it is anger at corruption, which is probably good. But some of it is that they think the government has been too soft of Shia, which is probably not;
2. The Bahraini government has thrown a lot of money at the population to head of dissatisfaction (much of which has come from the rest of the Gulf Cooperation Council (GCC) ... and it has not helped. People are still angry;
3. Sectarianism is dangerous. That makes sense, but I am unclear as to why this is something that we didn’t know in February 2011;
4. The GCC is split. All the GCC governments united around support for the Bahraini monarchy, putatively out of fear of Iranian influence, but since then it has become clear that some are more worried than others. The Qatari government hosted Muqtada Al-Sadr, which did not the Bahraini happy. The Omani government went further and “denied Tehran’s interference in Bahrain’s internal affairs.”  These splits could widen;
5. This is gonna take a hella long time to sort out.

Here is an interview with Radhika and Huwaida. I am much more sympathetic to the American consular officials who helped them while in detention. They might not have gotten back their equipment, but the American embassy in Manama is not a viceregal office. (We have an empire, and Bahrain is part of it, but it is a particularly incoherent and weak empire.) More broadly, I am sympathetic to the American dilemma. We need the Fifth Fleet to keep the sea lines open and constrain Iran. Perhaps Qatar would offer a more peaceable home (and I should note that Dubai already allows our vessels to use its facilities) but in practical terms that would change nothing in Bahrain. Much as I would like to get worked up about the way we coddle the Bahraini government, I just can’t, not until somebody convinces me that we could accomplish something by yanking our support.

So, please, convince me! Why is the Obama administration wrong?

Not worried about the Straits of Hormuz

 A number of people have been asking about the risk that Iran will shut down the Strait of Hormuz. The short answer is: we’re not worried about it. But it’s worth running down why.

The ostensible reason why the Iranian government might want to shut down the strait is retaliation against a Western oil embargo. Sanctions are already causing Iran pain;  there is little doubt that such an embargo could be devastating. The European Union purchases 18% of Iranian production; Japan and South Korea take another 27%. China absorbs 22%, and could take more, but probably won’t for two reasons. First, after China’s recent self-imposed foreign policy disasters, the People’s Republic seems to have little appetite for antagonizing the West. Second, China and Iran are right now embroiled in a pricing dispute that could cut Iran’s exports by 40%. The truth is that God only knows if the European Union will get its act together, but let’s say that they do. 

Would Iran respond militarily? Military actions against commerce will, of course, provoke a response by the United States Navy. The ensuing naval war has two outcomes:

(1)  Iran loses. That would be a bad result. The best-case loss for Iran is something like the 1988 battle. (This was called Operation Praying Mantis back in the day when the Defense Department chose names for reasons other than propaganda.) The worst case loss is a wrecked export infrastructure, no naval capacity, and airstrikes against the nuclear facilities. All that, and you get blamed as the aggressor in the court of world opinion.

(2)  Iran wins. Is that possible? Probably not. But … back in 2002 the United States held a wargame called Millennium Challenge 2002. The results were rather interesting.  

Red, commanded by retired Marine Corps Lt. General Paul K. Van Riper, used old methods to evade Blue’s sophisticated electronic surveillance network. Van Riper used motorcycle messengers to transmit orders to front-line troops and World War II lighting signals to get airplanes off the runways without using radio communication.

Red received an ultimatum from Blue that was essentially a surrender document that Red must respond to within 24 hours. Given that Red knew that Blue was coming, by the second day of the exercise Red used a fleet of small boats to determine the position of Blue’s fleet. In a preemptive strike, Red launched a massive salvo of cruise missiles, overwhelming the Blue forces’ electronic sensors, destroying sixteen warships. This includes one aircraft carrier, ten cruisers and five out of the six amphibious ships. The equivalent of this success in a real conflict would have resulted in the death of over 20,000 service personnel. Soon after the cruise missile offensive, another significant portion of Blue’s navy was “sunk” by an armada of small Red boats carrying out both conventional and suicide attacks, able to engage Blue forces due to Blue’s inability to detect them as well as expected.

At this point, the exercise was suspended and Blue’s ships were “re-floated” and changes were made to the rules of engagement; later this was justified by General Peter Pace as: “You kill me in the first day and I sit there for the next 13 days doing nothing, or you put me back to life and you get 13 more days’ worth of experiment out of me. Which is a better way to do it?” … Due to his concerns about the scripted nature of the new exercise, Van Riper resigned his position in the midst of the war game. Van Riper later expressed concern that the wargame’s purpose had shifted to reinforce existing doctrine and notions of infallibility within the U.S. military rather than serve as a learning experience.

Iran has invested heavily in mine technology, which suggests they are at least committed to making a plausible threat. Their mines would be a lot better — more destructive, smarter/more selective, and harder to detect — than they were in 1988. They’re believed to have several thousand, and could plausibly get hundreds of them in the water on short (less than 48 hours) notice. Iran has also invested in cheap, dumb anti-ship missiles: in increasing order of size and scariness, the Kosar, Noor, and Raad. That last is a 3-ton subsonic shore-to-ship cruise missile with a payload that could probably disable a warship with a clean hit. The Kosar and Noor are smaller and shorter-range but can be mounted on small boats — these are the missiles modeled in Millennium Challenge. The U.S. counter-campaign would not be as simple as just sailing in and claiming naval control of the Straits; a sensible admiral will want to see missile launch, radar and airbase sites suppressed first.

Since a spike in energy prices will hurt almost everyone, world opinion would set firmly against Iran pretty quickly. Notable exceptions would likely include Venezuela and Russia, with the latter being important for its Security Council veto. So, military counteraction won’t have the benefit of a U.N. resolution. Another interesting legal aspect is flagging. Under international law an attack on a flagged ship can be treated as an attack on the flag nation, so if a Panamanian-flagged tanker hits an Iranian mine, Panama has a formal casus belli. Mines have gotten a lot smarter, but not yet so smart they can detect a flag. Moreover, the GCC will firmly line up against Tehran. The U.K. will almost certainly back military action, and France is even more likely to act. (France has a small military base in Abu Dhabi.) In other words, the lack of a UNSC resolution will probably do little to slow Western action.

Let’s say, then, that Iran could win the opening battles of a naval war in the Persian Gulf. Then what? The U.S. and E.U. won’t lift sanctions. The world’s largest navy will regroup and counterattack. There will be a period of prolonged high oil prices, but that won’t make the West (or the GCC) more willing to back down.

The nature of a counterattack would be open to considerable debate. Attacking the oil export facilities, for instance, could cripple Iran’s economy — but would also ensure that oil prices would stay high, as Iranian production would be offline for a long period of time. Nonetheless, even limited American action will destoy a great deal of Iran’s export capability along the way. Attacking the nuclear facilities would mean a dramatic expansion of war aims. It would probably be expensive, too — those facilities are far inland, dispersed, and well protected. Still, Iran will run a high risk that the U.S. will take the opportunity to attack the nuclear program: after all, Iran will have already used the biggest arrow in its quiver, and a counter-campaign will have to involve prolonged airstrikes on Iranian coastal defenses. 

In theory, of course, Iran could escalate further. Iran could launch missile attacks against GCC targets, but the U.S. and its Arab allies would respond with strategic attacks of their own — e.g., the destruction of Iran’s export capability. Iran could intervene in Iraq, but the U.S. no longer has combat troops in that country. A year ago, Iran could possibly call on Syrian support, but nowadays Syria has other problems. Finally, Iran could attempt to mobilize Hezbollah, but launching a Third Lebanon War isn’t in Hezbollah’s interests at the present time. Moreover, Hezbollah can do nothing to dissuade the United States.

In other words, if Iran loses the naval war, then it loses. If Iran wins the naval war, then it loses, possibly worse. There is no obvious endgame that ends with Iran ahead.

If a war starts by Iranian action, it won’t be because there is an international payoff. The reasons would be domestic. Some elements in Iran might consider a conflict with the U.S. worthwhile, even if Iran clearly comes off the worse, as long as critical regime assets are not endangered. There’s nothing like a foreign war for rallying popular support, after all. The most likely scenario would involve an actor or actors rather than the central government as such — the Revolutionary Guards, or some other group, taking an action that pulls Iran out on a limb. Nonetheless, that seems unlikely. 

Therefore, we will be greatly surprised if Iran mines Hormuz or otherwise attacks shipping, except in retaliation for an American (or Israeli) air raid. It simply has nothing to gain.

A one-sentence counterargument below the fold.

Miscellaneous Saturday links

 Comin’ atcha from the Westside ... Medical Center in the very-creepily-named Plantation, Florida:

Department of Denominators: Really, the graph needs one, like, say, real tax revenue. I expect better.

Department of Thanks: “I want to express my sincere gratitude for your thoughtful discussion of the issues,” wrote Colonel Qaddafi in a letter to Congress. “We are confident that history will see the wisdom of your country in debating these issues. We are counting on the United States Congress to its continued investigation of military activities of NATO and its allies to confirm what we believe is a clear violation of U.N. Security Council Resolution 1973.”

Department of Trouble: Doug Muir made the good point that there must be reasons for the Anglo-French defense posture, since both countries spend significant amounts on their militaries. I would like to see this discussed seriously, for the simple reason that I do not discount the possibility that there is no plan, and NATO defense budgets are set simply out of a combination of momentum and interest group politics. Moreover, what’s the counterfactual? What would an alternate European defense posture look like?

Department of Panaceas: We’ll see if ending gerrymandering has an effect on California’s political woes. I doubt that it will, but I would also like to be wrong.

Department of Crime: There is less of it, and nobody really knows why.

Department of Bahrain: Things are very bad.

Informed blogging about Bahrain

 Justin Gengler is a graduate student at the University of Michigan. In 2009, he conducted a political survey of Bahrain, which gives him great insights (backed by actual data!) about the current state of play in that country. His blog about Bahrain is packed full of useful information, analyzed in a systematic manner and presented with no small element of style. Highly recommended!

Above is a brave Bahraini mother navigating Manama traffic with a stroller while her other child runs on ahead. Read “Religion and Politics in Bahrain.”

Around the Arab revolutions

 Usually an “around the Revolution” entry on this blog refers to left-wing Bolivarian governments on this continent. Here, though, it refers to Libya, Bahrain, Egypt, and Yemen. It will be brief: these are just observations; I have a bad head cold and a boatload of work. (See Laffer blogging.)

In Libya, it is surprising how quickly government forces withdrew from the east in the face of Allied airstrikes. The rebels still seem like a mob, by all accounts. The rapid withdrawal seems like a sign that discipline inside government forces is cracking, but that does not necessarily mean that the regime is about to fall. Gaddafi has a lot of support in Sirte; if his army holds together enough to crack Misurata (which will not be easy with Allied planes overhead) and hold Sirte, then he will probably hold on for a while. On the other hand, my prediction that oil would soon start flowing again seems to have been correct. The rebels now control export facilities with a capacity of 827,000 bpd, and it appears as though Qatar is willing to help with marketing. Oil markets reacted as you would expect. Ironically, it looks as though Chinese and Indian oil companies may in fact help, by being willing to purchase rebel oil without fear of what might happen to their interests in Gaddafi-held territory. That is the exact opposite of what observers expected when the violence first erupted.

I would very much like to go to Benghazi to see how Agoco is faring.

In Bahrain, 11 members of Wifaq have resigned from parliament, which is not a good sign. The party seemed to be willing to compromise in its conditions for talks with the government: all they want now is the release of 250 detainees. the idea of Kuwaiti-brokered talks now seems off the table. Reports are vague about the presence of GCC troops. There are reports that the Saudis are running checkpoints, but those should be taken with a grain of salt. Saudi troops wear the old U.S. three-color DCU pattern (on the right below), whereas Bahraini defense forces wear British-style camoflague patterns (on the left). Unless you are familiar with the uniforms, it is not easy to tell them apart.

The unrest is not good for the economy. The Grand Prix has been cancelled, as have other events. The 2008 race contributed $600 million to the economy, or 2.9% of GDP. Combine that with the proliferation of cancelled events and collapse of tourism, and Bahrain has a problem. The central bank has leaned on local banks to go easy on businesses affected by the slowdown. (It also insists that the financial industry is stable, but it would.) More importantly, on March 10 the Gulf Cooperation Council (GCC) announced a $10 billion fund for housing and infrastructure. Bahrain intends to use the money to build 50,000 new homes at a cost of $5.3 billion over the next five years.

The goal is, of course, political. According to the Economist Intelligence Unit, there are currently 46,000 people on the waiting list for government-subsidized housing. One grievance is that newly-naturalized Sunnis from places like Syria and Pakistan are alleged to get priority; true or not, the government hopes that speeding up the pace of modern housing construction will ease the political conflict. (The government is almost certainly wrong, of course.)

In addition to the housing program, the government is planning a 1% levy on salaries to fund an unemployment insurance scheme, plus a tax on employers for each expat they employ, to finance training for locals. In 2009, the government gave expats the freedom to change jobs, with the aim of raising the cost of employing them versus native Bahrainis.

Unsurprisingly, the political effect of the change was the reverse, adding to Shia grievances. For what it is worth, the markets have perceived a big increase in the risk of Bahraini sovereign debt, but they have perceived that for most of the Middle East and North Africa, including Egypt and Morocco. The interior minister, Rashid bin Abdullah bin Ahmed al-Khalifa, has said that his ministry will “speed up plans” to hire 20,000 new employees, and the King has ordered various ministries to increase employment.

For what it is worth, I do not think that the initiatives are going to work. Bahrain needs to address Shia political grievances. My colleague, Victor Menaldo, has a paper showing that Arab monarchies have been surprisingly resilient to political shocks: very worth reading. It’s implication is that Bahrain will make it through, but it isn’t clear that Bahrain fits the model.

So what about Egypt? Well, here I am going to turn the floor over to Victor (and his colleague, Mike Albertus) once more, from their op-ed in USA Today: “Research that we’ve conducted on the relationship between revolutions and democracy demonstrates that less than a majority of revolutions end in democracy. Surprisingly, however, we also find that the democracies that tend to survive the test of time are those born in revolution.”

Finally, Yemen. All I have to say here are that the reports are terrifying. Abandoned ammunition dumps is not a good sign.

People who talk about Bahrain are frustrating me

 It isn’t just Matt Yglesias, but he went ahead again and stated that the United States needs to do more about Bahrain:

If the point of intervening in Libya is to establish a precedent that dictators can’t massacre people to remain in power then the Obama administration needs to toughen its line on Bahrain and Yemen in order to make that work. If the point of intervening in Libya is to have a “demonstration effect” that bolsters the forces of liberalization in the Arab world, then the Obama administration needs to toughen its line on Bahrain and Yemen. ...

The fact that we’re [intervening in Libya] only serves to strengthen the case that we need to be taking the modest easy steps available to us to advance the same goals elsewhere in the region.

What “modest easy steps”?? Cutting military assistance? Sanctioning Bahraini banks? Those are neither modest nor easy, and worse yet, I am at a loss as to why they would work. (Further complicating the Western position is the fact that the GCC is backing the U.N. on Libya.) I am also at a loss as to why we should consider Bahrain’s oppression as being something on the same scale as the Stalinesque massacre that was bearing down on the Libyan rebels. The U.S., right now, is very explicit about our anger at the Bahrainis and Saudis. 

I would like to have somebody lay out the “modest easy steps” that the U.S. government should be taking with regards to the situation in Bahrain. Seriously, I want somebody to convince me that such options exist! But just calling for some sort of magical pixie dust, or demanding even harsher U.S. rhetoric with no thought as to the consequences, that is just dumb.

So tell me, how should the U.S. force Bahrain to compromise?

 Every so often, I get annoyed with people I generally respect. Today Matt Yglesias annoyed me, although, to be fair, it was part of a sullen-but-sensible post about Libya. He began, “So I guess I agree with Jon Chait that the fact that the U.S. isn’t using its influence over the Saudi or Bahraini governments to halt the killing of non-violent protestors there isn’t a reason to decline to intervene in Libya.”

Hmm. More and more observers are noting that Saudi Arabia has openly split with the United States and no longers considers itself a client state. We also know that President Obama effectively ordered the Bahrainis to stop shooting protestors the first time out, and that Secretary Gates told them that they would have to give parliament real power. Bahrain seemed to be following our lead until recently, when with Saudi support they reversed direction and cracked down.

Yesterday, the U.S. openly told both the Bahraini and Saudi governments that they are “on the wrong track. There is no security answer to this.” Presumably right now, a few days into the crackdown, the U.S. is considering out a menu of carrots and sticks to lay before the government in Manama. And normally we would have a lot of leverage. The problem is, with the Saudis against us, it hard to see what levers would be effective ... and it is easy to see some that would be downright counterproductive.

Obviously, he must think that there is something else besides diplomatic pressure that we can do right now that would be neither ineffective nor counterproductive. But what could that be? Honest question: from where I sit, it looks like our imperial contr ... er, influence has ebbed considerably. If that’s correct, then our best hope is to (correctly!) persuade the Bahraini monarchy that the crackdown is against their own best interest.

This sort of sullen refusal to admit the limits of American power bugs me. Matt Yglesias generally does a great job of puncturing American myths about our good-will and omnipotence. Here, though, he seems to be buying into them, but that may just be because I am missing the lever that Washington should be pulling.

Any ideas?

Saudi Arabia adopts the Brezhnev doctrine?

 Once again, Stratfor seems to have gotten things backwards, without ever mis-stating a single fact. Stratfor says, “The Iranian roadmap in the Persian Gulf appears to be off-track as a result of a pretty overt U.S. and Saudi countermove in the region.” Here at TPTM, we say Saudi Arabia just made a mistake, and the emerging U.S.-Saudi split just got significantly wider.

As you all know, the Gulf Cooperation Council (GCC), founded to defend against Iran’s revolutionary Shia politics, today coordinated the entry of troops from the Peninsular Shield Force and UAE police units. Apparently, the Bahraini and Saudi governments considered the local foreign-staffed security forces to be insufficient.

The move comes after a weekend of demonstrations and violence that claimed the lives of two more protesters. The most recent round was severe enough to encourage Sunni lawmakers to ask the King to declare martial law. Of course, as this video shows, the violence ran both ways. These are pro-government thugs attacking students at the University of Bahrain:

Stratfor declares “The GCC countries have made their countermove to Iran’s destabilization campaign and are doing so with apparent U.S. backing.” Reuters says differently. So does all the supporting evidence. Over the weekend, Defense Secretary Gates visited Bahrain. There he said, in no uncertain terms, that the United States wants the Khalifa family to accept a constitutional monarchy. It seems unlikely that Washington had anything to do with the decision to dispatch GCC forces.

The chief barrier to resolving the Bahraini situation is that the royal family is split. The King’s uncle, and Prime Minister since 1971, is the unofficial head of the hardliners. (He may have ordered the first attack on the demonstrators at the Pearl traffic circle.)  The Crown Prince is the leader of the liberal faction in the family, and he has been pro-active in apologizing for the deaths of protestors on national television and meeting with opposition groups throughout the crisis. The King is the moderate caught in the middle. That internal jockeying has made managing the protests more difficult.

This morning, however, the situation got infinitely worse. It is not clear what the GCC troops are there to do. The Sunni deputy chairman of Bahrain’s Parliament, Abdel al-Mowada told Al Jazeera: “It is not a lack of security forces in Bahrain, it is a showing of solidarity among the GCC. I don’t know if they are going to be in the streets or save certain areas  ... [but protesters] blocking the roads are no good for anyone, we should talk. The government is willing to get together and make the changes needed, but when the situation is like this, you cannot talk.”

The opposition is enraged. Wifaq described the arrival as a “blatant occupation” and the Bahrain Center for Human Rights declared, “This is an internal issue and we will consider it as an occupation.” It’s hard to overemphasize the power of the word  “occupation” in Arab politics, given its ties to the Palestinian Territories and Iraq.

The Saudi move — and although the GCC seems to be lined up, the impetus is likely from Riyadh — to shore up the Khalifa family is terribly shortsighted, but comprehensible in context. Bahrain is in Saudi Arabia’s near abroad. The relatively loose laws of Bahrain have allowed it to serve as a Las Vegas equivalent, where Saudis can drink and pursue other anti-Wahhabist pleasures.

Why then are the Saudis so concerned? The Eastern Province of Saudi Arabia, like Bahrain, is majority Shia. If the Khalifa monarchy were to go constitutional, it might embolden Saudi Arabia’s Shia population. The rising tide of popular revolution has made the Saudi monarchy more reactionary than it might be under other circumstances. In other words, the Saudis are as worried about a democratic constitutional monarchy Bahrain as they are about a radical Shia republic. The remote chance of a radical Shia takeover or an Iranian invasion is secondary.

Unfortunately, the intervention just put two cornerstones of American policy in contradiction. The Saudi alliance has been a cornerstone of U.S. policy since 1931. The hosting of the Fifth Fleet in Bahrain has, since 1971, run a close second. The Naval presence, however, requires Bahrain to be stable, under whatever form of government. American policy in Bahrain has recently moved towards support for a full constitutional monarchy as the best way to preserve stability. But the creation of a constitutional monarchy conflicts with what Riyadh considers to be a core interest.

Intervention is a bad short term solution to a long term problem. Even under the rubric of the GCC, the arrival of foreign troops en masse is a profoundly poor idea. Bahraini politics have had a violent undercurrent for the past decade, and the citizenry is not going to take kindly to foreign forces clearing the streets. It raises the stakes between the King and the opposition, and may give the conflict a more overtly sectarian cast. It also adds to the pressures pushing the opposition towards republicanism. Moreover, the economy of Bahrain is going to take a serious hit with Saudi tanks in the streets, and given that it’s mostly financial services, it’s vulnerable to a collapse in foreign confidence. Finally, the move is going to encourage Iran. The former has longstanding territorial disputes with Bahrain and may take the chance to take a swipe at those and claim responsibility for the Shia opposition, which is currently fiercely anti-Iranian.

Far from a clever countermove against a nefarious Iranian scheme, Riyadh has just made a touchy situation significantly worse. An optimistic view has the liberal forces in Bahrain using the breathing spell to create a constitutional democracy. Saudi fears of dominoes prove unfounded, and everyone relaxes. A pessimistic view has GCC troops shooting Shia in the streets. In that case, Iranian covert operations would gain an opening, and the United States would once again find itself trapped on the side of the villians. The Saudi coordination of several longstanding U.S. Gulf allies against American interests is going to require substantial finesse from Washington.

American dependence on Saudi Arabia for diplomatic support and resources can’t be ended over this move, but it’s a bad position for the United States.

How to imply a lie without lying: Bahrain edition

 It is a skill. A Stratfor analyst managed to pull it off. Nothing in the below is false, but it does disagree completely with the internal assessments of the United States chief diplomatic arm:

After Egypt, Bahrain has become the most significant place where street agitation is taking place in the Middle East. ... The country being a proxy battleground for Saudi Arabia and Iran makes it even more significant.

Pro-democracy street agitation is not a stranger to Bahrain ... what is happening is not entirely new. What makes this significant — this latest round of unrest — is that it comes in the context of the overall regional unrest that started in Tunisia and moved to Egypt ...

It’s not just the sectarian dynamic that makes the protests significant in Bahrain. There is also a wider geopolitical contest between Saudi Arabia and Iran that has been going on for several decades and, more recently, since the fall of the Saddam Hussein regime in Iraq.

Since then, Saudi Arabia has been very worried about Iranian attempts to project power across the Persian Gulf into the Arabian Peninsula. And with Bahrain having a heavy Shiite population, this is a cause for concern in Saudi Arabia, as Saudi Arabia is neighbors with Bahrain and has its own 20 percent Shiite population.

From the point of view of the United States, Bahrain is also significant because it is home to the U.S. Navy’s 5th Fleet. The 5th Fleet is one of the key levers that serve as a counter to Iran, or any movement on the part of Iran. It is not clear at this point to what degree Iran is involved in the uprising. There are linkages, but to what degree Iran is playing those linkages is not clear at this point. Nonetheless, it is one of those flashpoints between Shiite Iran and the largely Sunni Arab world, and Bahrain is going to be very interesting in terms of how both sides battle it out in the form of a proxy contest.

Should Bahrain succumb to unrest and the monarchy has to concede to the demands of the protesters at some point in the future, this becomes a huge concern for the security of countries like Saudi Arabia, particularly where there is a 20 percent Shiite population that has been keeping quiet for the most part, but could be emboldened, based on what they have seen in Egypt and now what they are looking at in Bahrain.

Riiight. The above analysis implies that Iran is behind the protests. It also implies that the transformation of Bahrain into a constitutional monarchy would be a de facto expansion of Iranian power. The fact that there is no evidence that Iran is behind the protests does not come into play. Nor does the fact that Bahrain receives a lot of hydrocarbon rents, and a democratic Bahrain would have as much desire to share those rents with Iran as Alberta wants to share its rents with the rest of Canada. (In 2011, the Kingdom of Bahrain expects to earn $5.1 billion from hydrocarbon production, taxes, and royalties.)

There is little doubt that if the United States washed its hands of the Gulf tomorrow, Iran would invade Bahrain the next day. As recently as 2007, Iran floated trial balloons about reactivating its historical claim to the island. And ... well ... $5.1 billion is a lot of money, maybe not for the United States, but for Iran, which has a (nominal) GDP around $335 billion and a government budget around $66 billion.

And it is true that the Saudi government has its own reasons to fear a demo-cratic Shia-dominated Bahrain. The last paragraph of the analysis is spot on.

But jumping from Iranian desires and Saudi fears to some sort of blather about a great game, with intimations that Bahraini democracy would be bad for the United States, is just silly. Moreover, it runs against the perceptions of the United States government. A democratic Bahrain under a constitutional monarchy would be just as much of a threat to the Iranian regime as it would be to Saudi Arabia. (“Look! A Shia democracy! Without an American invasion, and without the occasional car bomb!”)

Given the reality of the situation, I really don’t think there is anything more for the United States to do or say than it already is doing and saying. In short, viewing the situation through the lens of Cold War 1½ would, I think, be a mistake. Analyses like Stratfor’s are misleading without being incorrect, and in a potentially dangerous way.

Thoughts?

Political parties in Bahrain

 Bahrain is a near-absolute monarchy founded by, in the words of one of our co-bloggers, “pirates that admired Maria Theresa’s bust on thalers.” In 1971, the British withdrew their protection, and the monarchy chose not to join the UAE. In 1973, it got a constitution creating an elected parliament. In 1975, that constitution was suspended. In 2002, as part of a reconciliation that included a 2001 amnesty for political exiles, a new constitution revived the 40-member elected lower house of parliament. Its powers are limited, however: the upper house is appointed, and the Prime Minister serves at the pleasure of King Hamad, not the Parliament. Prime Minister Khalifa bin Sulman Al Khalifa is the nephew of King Hamad, and has been in office since 1971.

Elections are run by district with a runoff between the top two candidates if nobody wins an outright majority. Political parties remain, strictly speaking, illegal, but the Political Societies Act of 2005 allows for the formation of registered “political societies” which function for all intents and purposes as political parties. The distribution of seats after the 2006 elections was as follows: Wifaq (17 seats), Asala (8), Minbar Al Islami (7), and Mustaqbal (4). New elections were held on October 2010. The results were Wifaq (18 seats), Asala (3), Minbar Al Islami (2), and 17 all-Sunni independents.

Courtesy of Wikileaks, we know what the U.S. embassy thinks of the political organizations currently active in Bahraini politics. Since Bahrain is both a country that I like and made the front page of the New York Times today, what follows is a condesation of “The Field Guide to Bahraini Political Parties.”

Wifaq: the leading Shia party. The leadership consists mostly of people exiled during the unrest of the 1990s, who returned after a 2001 amnesty. The party’s nominal leader is Ali Salman, a mid-level cleric, but the real leader is the country’s most popular Shia cleric, Isa Qassim. Wifaq demands a Westminster-style constitutional monarchy. The party also attempts to combat anti-Shia discrimination, both through legislation and street demonstrations.

Asala: the State Department calls Al-Asala the “Salafist” party. The party itself, however, “says its goals are to increase the standard of living for Bahrainis; strengthen political, social and economic stability; and enhance financial and administrative oversight of the government and industry.” It is, however, adamantly opposed to women’s rights, which are rather advanced in the Kingdom. The State Department had this to say about the party’s leader: “Ghanim Albuanain strikes emboffs [sic] as rational and open-minded, though many of his followers are not.” Most Bahrainis, reports the Department, believe that the monarchy supports the party against Wifaq.

Minbar: the local branch of the Muslim Brotherhood. “Minbar seeks a personal status law that conforms to Sharia and is acceptable to both sects” and “does not allow its female members to stand for election.” As with Asala, it is widely rumored that the monarchy and the Islamic banking sector provide finance. In 2006, it was caught in a vote-buying scandal, although no one was prosecured. (The whistle-blower was a British fellow named Salah Al Bandar, who had been serving as an advisor to the Bahraini government. He was sent home forthwith.)

Mustaqbal: the State Department had only this to say: “The bloc bills itself as the only secular grouping in parliament, though all four members are Sunni. It votes reliably for the government and its leader, Adel Al Asoomi, is close to the Prime Minister.”

There are a few other parties without seats. Wa’ad is a socialist party formed by returning exiles in 2002. It is a strong proponent of women’s rights as is generally moderate, with support from both Sunni and Shia, although its leader, Ebrahim Sharif, courted a bit of an international scandal in July 2008 when he said nice things about Hezbollah. The Al Minbar Progressive Democratic Society (APDS) is the former Communist Party. It won 3 seats in Parliament in 2002, but lost them to Wifaq in 2006. A bigger blow came in 2008, when it lost control of the General Federation of Trade Unions to Wifaq. Al Meethaq won 5 seats in 2002, but lost them to Wifaq and Minbar in 2006.

The Adala National Justice Movement is loud, but not to be taken seriously. “The society initially focused its criticism on the U.K. and Iran, but now devotes all its energy to exposing the horrors of U.S. imperialism. Abdulla Hashim has a real talent for attracting local and international media coverage for his stunts, such as an April 26, 2008, demonstration near the U.S. Navy base here that featured the beheading of a mannequin dressed to represent a U.S. Marine. Despite their media profile, however, Adala has never produced more than 80 people at one of its demonstrations.” Hashim was beaten by a Minbar candidate in the 2006 election.

Finally, there is Haq. Hasan Mushaima, a founder of Wifaq, left to found Haq in November 2005. From the start, Haq has defied the requirements for registration of political societies. Haq opposes the 2002 constitution on the grounds that it rescinded liberties granted by the 1973 constitution. Moreover, the King drafted it unilaterally and (unlike the 1973 constitution) it provides for an appointed upper house of parliament. Haq’s top public goal is a new constitution for Bahrain drafted by elected delegates.

The rest I’ll leave in State’s own words. “Since Haq competes with Wifaq for the same Shi a supporters, Haq gains support whenever Wifaq is perceived as unsuccessful in parliament. When Wifaq is successful, Haq loses popularity. Post [sic] and the public perceive Haq as inspiring many of the small gangs of Shia youth who throw stones and Molotov cocktails at police almost every weekend. Haq has submitted petitions to the U.N., the USG, and the GOB calling for the Prime Minister’s resignation and condemning the GOB’s human rights record. Abduljalil Al Singace, Haq’s public affairs and media specialist, has contacts with U.S.-based and international NGOs and media outlets. GOB officials often assert that the Iranian regime controls Haq supporters, however has yet to provide post with convincing evidence.”

Do you want to know more? One day, Luke will tell you!

The United States and Bahrain: intro

 The big U.S. link with Bahrain is, simply, the Fifth Fleet. We station roughly 3,500 personnel and 16 vessels in Bahrain. My direct contact with the military presence there took place unexpectedly in a bar in the ground floor of a Best Western in Manama. The decor was country-and-western, the music was crunk, the males were mostly off-duty American sailors, and the women were disproportionately from Thailand. Yes, I left immediately; why do you ask?

Bahrain does not provide the use of their territory for free. We currently pay about $9.6m a year for the use of about 66 acres and 15 berths. But that isn’t all: in 2010, we also provided the Bahrain Defense Forces with $20.8 million in assistance; this year’s budget request is for $21.7 million. That comes to a little over $1,500 for every BDF effective; not a small chunk of change. The U.S. presence is governed by a 1992 treaty (T.I.A.S. 12236) ... most of which is classified.

OK. Do we get anything else for our protection? Well, Bahrain has sent troops to Afghanistan: about 125 Bahrainis guard Marine encampments in Helmand. (If you divide all our military aid by 125, you get about $173,600 per Bahraini; a bargain compared to Blackwater.) We signed a free trade agreement in 2006. That agreement (building on an earlier 2001 treaty) included provisions protecting U.S. investments from expropriation. That, plus our help in resolving a border dispute with Qatar, got Occidental a 48% stake in a field that will eventually produce 100,000 barrels per day of oil and 2.5 million tcf of natural gas. Even with a 46% tax rate on oil companies, that will be a lot of revenue. Oxy expects to invest about $1.5 billion in the field. Under reasonable assumptions (say a 10% cost of capital and an $80 oil price), that investment could clear over $830 million a year, which ain’t bad. Try doing that in Ecuador! And since Oxy does in fact pay income taxes to the U.S. federal government, the gain to Americans could come to, uh, about a dollar a year per person.

In addition, to Oxy, ChevronTexaco got an exploration concession in the formerly-disputed area with Qatar in 2001. (Strangely, so did Petronas, from Malaysia, and some goobers from Calgary. I think we could have complained about that ... except eventually they all pulled out in favor of a Thai outfit. The link has a pretty good rundown of the state of play in Bahraini hydrocarbons.) 

In short, the U.S. gets a base that helps us keep the oil lanes open and contain Iran; in return we get some useful soldiers and some oil concessions, guaranteed by the specter of ICSID. Not too shabby. Viva el imperio; maybe Randy McDonald was right.

What about other parts of the relationship? Well, Wikileaks tells us that the Bahraini government likes to claim that the periodic unrest in the Kingdom is due to Iranian and Syrian machinations, but the State Department isn’t buying it. In 2008, they reported, “Small but violent bands of Shia underclass youth, frustrated with persistent discrimination and what they perceive as too gradual a pace of reform, clash with police nearly every week. The Sunni minority, which rules the country and controls all security forces, has generally acted with restraint, but it takes only one mistake to provoke a potentially disastrous escalation.”

In short, if Bahrain does go up (and it is not clear that it will) the United States will not have been surprised.

Bahrain riots

 As I’m sure that many of you already know, Bahrain is the first Gulf state to experience anti-government demonstrations. The police reaction was swift, if not quite ferocious. If all goes as planned, we will soon have some backgrounders on Bahrain ready to go in a day or two, but right now I just want to point out some context: angry demonstrations in Bahrain are nothing new.

Google “Bahrain riots,” and the first entry is this from 2007: “Riots reinforce Bahrain ruler’s fears.” The second entry is also from 2007:  “Bahrain Riots Continue For Fifth Day.” After that you get a story from 2009: “Bahrain: Riots erupt after arrest of Shiites.” Fourth is a story from last August: “Arrest of Shiite activists sparks riots ahead of Bahrain election.” Then a story from 1956: “11 People Die in Bahrain Riots Over British Rule.”

When I was last there, burning tires were a common sight at night in certain neighborhoods that my hosts would have been horrified to know that I visited. I will be returning in May, and my wife will be joining me.

In short, keep the news in perspective. Events in Egypt have been dramatic, and events in Bahrain for that reason may turn dramatic ... but so far, nothing out of the ordinary for that country.

Saudi and America part ways over Egypt

 Well, yesterday some news broke that was so predictable that I am embarrassed at not predicting it. It turns out that the Saudi government is unhappy with the U.S. decision to use our aid as a lever to prevent the Egyptian army from shooting protestors. It is even less happy that we might now use same to convince the Egyptian army to pack Mubarak off into (not very) early retirement. Dissatisfied with the way that we are running things, the Saudis threatened to replace our support dollar-for-dollar.

Saudi Arabia has deep links with the United States. The above picture was taken in an Aramco compound in the country; it is no coincidence that it bears a frightening resemblance to the view from my brother’s backyard in Coral Springs, Florida. The nationalization of Aramco was uncontentious, favorable to the companies, and served American goals. Only twice have Saudi and American interests substantially diverged: briefly in 1973 when the Saudis embargoed oil shipments, a stand they rapidly reversed; and substantively in the past two decades with Saudi financing for Islamic radical movements. And to be fair, the Saudis have been increasingly helpful in combatting terrorist finance, although their best is not always that good. “We are trying, but if money wants to go it will go,” said Prince Mohammed bin Nayef in May 2009.

The break over Egypt, though, portends a deeper split. The U.S. has decided that it really does not get much from keeping Mubarak in power. The alternative is not really that scary, and might even be better. Riyadh has decided something different. Now, I do not think that Riyadh is going to get what it wants here, but if you want to look for signs of the American empire cracking at the seams, this is a pretty good one.

A second takeaway is that Saudi Arabia doesn’t really care about Islamic extremism. Of course, we knew that already.

Is the U.S. exceptional in its policy towards Arab oil?

 I am a bit confused about what Prof. Quiggin is trying to say here:

The point applies most obviously in relation to oil. The idea that the US can legitimately use its military power to ensure continued access to oil resources rests, in large measure, on the (not entirely unfounded) assumption that those controlling the resources are a bunch of sheikhs and military adventurers who happened to be in the right place, with guns, at the right time. Without the Arab exception, the idea of oil as a special case, not subject to the ordinary assumption that resources are the property of the people in whose country they are found, will also be hard to sustain.

Prof. Quiggin is a very smart guy, and when I say I’m confused, I mean that honestly. The governments of Arab oil-producing states keep almost all of the rents from the oil extracted on their territory; this is just as true of Abu Dhabi, which works with the majors, as it is of Saudi Arabia, where state-owned Saudi Aramco monopolizes production. Moreover, only 9% of the oil produced in and around the Arabian peninsula goes to the United States. Put another way, the U.S. only gets 10% of its oil from the Arab countries of the Gulf. The U.S. gets no oil from North Africa. The U.S. does, of course, use its military power to insure that the oil keeps flowing. But I don’t see that as much different from what the U.S. does with other strategic raw materials, or in regions outside the Arab world.

Matt Yglesias got me even more confused:“Certainly if you were just to look at things in coldly rational terms, the resource-rich country the US should be seeking to dominate militarily is Canada, located conveniently next door. And, indeed, in the first half of the nineteenth century that’s how hawkish American politicians saw things. But it would be politically unacceptable in a modern context to try to bully Canada or Norway into coughing up oil.”

Except ... uh ... how is U.S. policy towards those countries different from our policy towards Saudi Arabia? Canada is not about to embargo U.S. oil; Soviet fleets are not about to blockade Norway. American policy would be rather different if either were true. (And policy was different, when the latter was a real threat.) The oil does belong to the provinces in Canada and the national government in Norway; but ditto in Kuwait and Saudi Arabia and Iraq. What does Matt mean when he implies that the U.S. uses military force to make the Arab countries “cough up oil”?

Quiggin’s main point is about overall U.S. policy towards the Middle East, but I honestly do not what he’s trying to say about oil. Nor do I understand Yglesias’s. Can someone explain?

Iran in Dubai

 What is the Iranian presence in Dubai? Alex Harrowell gives a great answer: house music! Of course, I haven’t been a fan of house music for some time. Either way, I can’t rival that.

 
What I can say is that Dubai still has a thriving small-scale retail sector, composed largely of traders from Iran. The fellow in the above picture who looks a bit like Dustin Hoffman is one of them. He runs a spice shop in the old city. He makes weekly trips back to Iran for products, which he then brings to Dubai. Moreover, Iranians have a lock on almost all the real estate in the older part of town. Note that I did not say ownership. Not only do the Iranians not own the real estate; they don’t even own the businesses, which by law must have an Emirati partner with a 51% equity stake. (Which means less for the Iranians than for other foreigners: see below.) What they do have, however, is managerial control over who can rent. They also have contacts back in Iran, and the ability to access small-scale informal trade finance.

The result is a community that numbers in the hundreds of the thousands (although it is highly mobile between the two nations) and that dominates the old retail sector. They used to be wholesalers, from the day when Dubai was a trading center. Now, with that sector declining (although not as much as you might think, especially in spices) they are reorienting themselves around tourism. After all, once you are sick of the Atlantis and the Burj, and want something that feels more Middle Eastern, where are you going to go?

 
The Iranian community in Dubai predates the Revolution by a long while. In the 1880s, the Iranian government began to impose special taxes and Persian laws on the Qawasim Arab merchants who had settled on Iran’s coast. A British political agent had arrived in the town of Lingah in 1881, and in 1887 the city’s Arab ruler declared himself under Ottoman protection, but neither did much good. The upshot was an Arab-Iranian emigration to Dubai in the 1890s. (Or sort-of Arab; it isn’t really clear.) A second wave settled in the 1920s, when Reza Shah raised taxes again and required schools to teach Farsi instead of Arabic. A third group followed during the Second World War, avoiding the sanctions that the British clamped on occupied Persia.

One advantage of the long-standing migration is that (according to Christopher Davidson) there are approximately 40,000 Emirati citizens of Iranian descent … which makes things much easier for the newer waves of Iranian merchants. Simply put, they can easily find an Emirati partner whom they can trust.

There is also the more-organized presence the Alex talked about: the Iranian ships, and the like. And there are attempts to deepen the links even further: I am in contact with a group trying to build a gas pipeline across the Gulf. But the small-scale presence is what you most notice, in the merchants and jobbers and patrons in Filipino-run cigar bars. Some of whom, Randy will be interested to know, weren’t really Iranian. Nope, they Canadian by birth and upbringing and very North American in speech and bearing. They’d gone to Dubai seeking adventure on the basis of old family contacts, found jobs in the modern financial and consulting sector, met stunningly gorgeous Persian women, and married them. In the meantime, they make bad hip-hop and live large, at least as long as the banks keep paying their salaries.

I suspect that they’ll wind up back in Toronto eventually, but who knows? The Filipinos run a mean cigar bar.

Dubai, incorporated: hiring and firing

 Dubai laws make it very easy for a company to hire whomever it needs from abroad. There are some attempts at Emiratization, but they are nowhere near as serious as in neighboring Abu Dhabi. In the free zones, in fact, they don’t exist.  Upshot? Dubai is one of the few polities in the world (with Abu Dhabi perhaps being the other) where the conceit of comparing the country to a company actually makes sense.  Non-citizens make up 96% of the labor force, and their residence permits are directly tied to their jobs.

 
The Dubai government charges fees for labor permits, but doesn’t view them as a source of income. The upside for Dubai is obvious. Production and construction costs are more like Shanghai than Seattle. Firms can recruit in a global labor market, and offer salary premiums to skilled workers over what they would get in London or Paris without raising their own labor costs. The resulting growth creates a wonderful cycle: since firms in many industries like to near other firms in the same industry, growth begats growth, and the owners of Dubai real estate (e.g., the ruling family) make a boatload of money.

It gets better. First, Dubai doesn’t pay the costs of educating all those workers; nor does it have to worry about their retirement. They come, do what they do, then go home. Governments in places like the Republic of the Philippines or the United Kingdom subsidized their education and will handle their old age. Second, the labor force drops in downturns. No worries about the social cost of unemployment. For example, the Indian embassy to the UAE reported that 20,000 seats on flights to India had been “bulk-booked” by Dubai employers for March 2010. The workers are flown out the same day they get fired because, in the words of a British construction site manager, “a lot of them commit suicide and we don’t want that on our hands.”

At this point, the answer to Barry’s question is obvious: the work system isn’t messed up at all. An auction of work permits would be the equivalent of a direct tax on labor. It would make as much sense for the Dubai government to auction off work permits as it would for the developer of a suburban business park to charge rents based on the number of employees.

 

Of course, you get some weird results. Consider the Emirate’s population pyramid. The female side resembles a somewhat exaggerated version of many large cities, which show a bulge of childless people in their prime working years. (American cities have high birthrates, and are often exceptions to this pattern. Brooklyn’s pyramid, for example, is a real pyramid.) The male side is just strange, driven by South Asian men working on construction sites and (much less so) Filipinos working as semi-skilled labor. (I have heard more than one Westerner here say flat out, “The Filipinos saved this place.”)

 

About 22% of the population (as of 2005) lives in “collective housing,” e.g., labor camps. They most resemble a dusty version of California-style dingbat apartments with less parking and no graffiti. By law, the employer’s name has to be emblazoned on the side of the building. They are a bit hard to find ... in the sense that you will have to work to convince the average cab driver that you aren’t confused and really want to go. That said, other than the signs proclaiming “Visitors are not allowed in the camp” there is nothing stopping you.

 
Sadly, I can’t find the photograph of the Chili’s logo.

 
The upshot is a development model that really is akin to a real estate development company. The unanswered question is how much that model will have to change. Eventually the construction boom will come to an end, but the social problems from that will be channeled to Bangladesh. Similarly, as other posts have already discussed, the free zone model is also going to come to an end, most likely (I’m told) via the implementation of a VAT. (As oil and real estate returns dwindle, the Emirate will need tax revenue to sustain public services, which the businesses in the free zones rely upon.)

What I do not know is how the model will develop. No American city has ever tried anything like it; only five large metropolitan areas in U.S. history have ever gone above 40% foreign-born: Detroit between 1870 and 1900, New York and Chicago between 1870 and 1920, Miami-Dade after 1980, and Los Angeles after 2000. In fact, no major American city is that high today: for Miami and L.A. you need to cheat, and consider only the central counties ... which to be fair do contain two and ten million people respectively. (Toronto metro went over 40% in 2001, but I do not know the historical figures for Canada. Vancouver did not, in neither 2001 nor 2006. Immigrants, after all, have Canadian babies.) Moreover, the Emirates make getting citizenship almost impossible. 

In other words, they ruthlessly send the jobless home and offer no real path to citizenship. Maybe that can be maintained forever.

 
Or maybe the little cricketeers outside my window will have other ideas. 

Dubai in debt

 On November 25, 2009, Dubai World announced that it intended “to ask all providers of financing to Dubai World and Nakheel to ‘standstill’ and extend maturities until at least 30 May 2010.”  The problem was Nakheel, the real estate arm that had (among other things) created the artificial Palm and World islands. Nakheel had $4.05 billion in debt coming due on December 14, and it couldn’t finance it. Stands to reason that Nakheel was overleveraged, right?

Well, not really. According to Nakheel’s June 2009 filing, it possessed $20.0 billion in liabilities against $40.0 billion in assets, which isn’t bad at all. Of those assets, $30.7 billion were “properties under construction.” Since Nakheel acquired land for free from the Emirate’s government, those costs were actual construction costs, and didn’t reflect overheated land values. Sounds good, very responsible. They could sell the properties for a full third less than they cost to construct and still be solvent.

The problem was cash flow. Sometimes nobody wants to buy gold-plated bidets at any price, whether at cost or ⅔ of cost or whatever. On a gross profit of $175 million for the first half of 2009, Nakheel took impairment costs of $3.3 billion. Now, that might be theoretical — but cash flow from operations was negative $948 million in the same filing.  That is not good when you’ve got a lot of debt coming due and a world financial system in the midst of freezing up. In normal times, Nakheel might have been able to brazen through, even with the 50% decline in Dubai property prices between September 2008 and September 2009. This was not a normal time.

 
The IMF put together a handy time series on the cost of insuring debt from the government of Dubai and Nakheel. There are two interesting things and a mistake in the time series. First, it looks like the markets didn’t pay any attention to Moody’s. Second, they paid a lot of attention to Sheikh Mohammed bin Rashid Al Maktoum. (Strangely, the first turned out to be right and the second wrong.) Third, the $10 billion support package wasn’t really a support package from Abu Dhabi. Rather, the Emirate of Dubai sold $10 billion in bonds to the central bank of the UAE and used the revenues to backstop its public entity debt. The actual bailout didn’t come until December 14, when Abu Dhabi stepped in to lend Dubai World $10 billion to pay its sukkuk.

 

So where to from here? Well, there is a lot of debt coming due over the next few years. In millions of U.S. dollars: 

	Dubai Holding	Dubai World	ICD
2010-Q1	$ 600	$ 1,199	$ 3,250
2010-Q2	$ 2,933	$ 3,140	$ 294
2010-Q3	$ 0	$ 0	$ 0
2010-Q4	$ 295	$ 140	$ 920
2011-H1	$ 0	$ 4,455	$ 1,544
2011-H2	$ 3,161	$ 2,192	$ 6,044
2012-H1	$ 500	$ 0	$ 3,702
2012-H2	$ 330	$ 4,592	$ 2,191
2013-H1	$ 260	$ 1,000	$ 1,222
2013-H2	$ 246	$ 550	$ 2,640
2014-H1	$ 1,511	$ 0	$ 154
2014-H2	$ 632	$ 350	$ 1,957
Beyond 2014	$ 4,621	$ 4,534	$ 4,357

The Emirate of Dubai certainly can’t pay it. The government is in already in deficit. It will need to raise taxes to maintain basic services and pay the interest on the $18.7 billion that it currently owes — yes, the UAE central bank wanted interest, and lots of it. Raising taxes even further to support the development companies seems, well, not that likely.

 

Dubai could default, but that would pose a bigger problem. First, as readers of this blog certainly know by now, sovereign immunity basically doesn’t exist in the United States or European Union. Creditors could go after any and all Dubai-owned assets used for “commercial purposes.” Dubai has already started “ringfencing” its bad debts, for example by listing DP World on the London Stock Exchange as a separate entity, or transferring Nakheel’s overseas property holdings to Istithmar World. Those strategies, however, depend on laws in the U.S. and E.U., and so they have limits. (Judge Griesa would have a field day.) Second, Dubai depends on debt. An Argentine-style strategy would wreck Dubai’s entire development model.

	Disclosed debt	Other liabilities	Total  liabilities
Dubai World	$ 26,219	$ 7,866	$ 34,085
Dubai Holding	$ 15,090	$ 4,527	$ 19,617
ICD	$ 28,275	$ 5,655	$ 33,930
Dubai government	$ 18,700	$ 0	$ 18,700
Other Entities	$ 1,885	$ 0	$ 1,885
Total	$ 90,169	$ 18,048	$ 108,217
Total (ex-government)	$ 71,469	$ 18,048	$ 89,517

It’s a problem. But it isn’t necessarily a killer. First, Abu Dhabi knows that world markets will be rocked if Dubai entities start defaulting. Since Abu Dhabi has invested billions and billions in those very markets, it has an interest in making sure that Dubai debts are restructured in an orderly fashion.  In fact, the Abu Dhabi government has stated that it will continue to “support Dubai in its efforts to achieve a viable position.” Second, of the $22 billion in Dubai debt that the IMF estimates has been affected by the standstill, $12 billion consists of syndicated loans and $7.5 billion of individual loans, with only $2.5 billion in bond issues. The prevalence of bank debt makes restructuring easier, since Dubai can assemble and talk to a small group of creditors. Finally, Dubai may have overbuilt, but there is still a reason for there to be a city there: it probably isn’t going to go the way of Detroit. With debt-to-asset ratios around 50% (pre-crash) the city-state’s public development entities will probably be able to find some combination of debt restructuring and price cuts that keeps them solvent.

California didn’t go away after 1873, Panama remained a great place for a canal after 1888, and Miami remains a very nice city in 2010, for some values of “nice” anyway. The go-go days may be gone, but I suspect that a major trading center will remain.

 

Then again, that trading center may be rather smaller than the current one. This will, finally, bring us to Mr. Cotter’s question in the next GCC post.  Until then, any questions, criticisms, requests, or ideas?

Dubai, Incorporated

 State capitalism is an interesting term. What does it mean? Some definitions, like Rothbard’s, include everything outside perfect laissez-faire. Most Marxist definitions include everything other than complete Soviet-style central planning. Finally, others effectively define it as a synonym for crony capitalism or resource nationalism. None of these definitions strike me as particularly useful.

But state capitalism exists. When I parse the Potter Stewart definition inside my head, I wind up with a a system in which profit-maximizing state-owned companies operate in ostensibly competitive markets. I say “ostensibly,” because both profit-maximization and competition exist mostly in the eye of the beholder.

 

The Emirate of Dubai is the epitomy of state capitalism. The state’s investments run through three holding companies: Dubai Holding, Dubai World, and the Investment Corporation of Dubai (ICD).  Sheikh Maktoum directly owns Dubai Holding, while the latter two are formally owned by the government of Dubai … of whom Sheikh Maktoum is the absolute ruler. All three holding companies have real estate arms charged with developing land granted to them by the emirate. ICD’s Emaar Properties developed the Burj Khalifa, while Nakheel created the offshore Palm and World developments on reclaimed land.

Dubai built its airport in 1960 — over the objections of the emirate’s British advisors — and then borrowed against oil revenues to expand it to handle jumbo jets in 1968. The airport (separately from the airline) directly generates a lot of ancilliary economic activity: landing fees, retail sales, warehousing, maintenance, etcetera. The airport generates even more indirectly … not least the tourist industry. Things like the Burj Khalifa might seem like wasteful ego-driven expenditures. And they are. But they’re also the sort of over-the-top more-Vegas-than-Vegas kind of thing that draws in the tourists, along with the indoor ski slopes and the “seven-star” hotel. Visitor expenditures made up another 8% of GDP.

 
In 1985, Dubai established Emirates Airlines. At the time most air travel between the Gulf and other points was handled by Gulf Air. Mohammed Al-Maktoum worked secretly with Maurice Flanagan, a former British Airways executive who had run the Dubai National Air Travel Agency, to launch the airline with $10 million in seed capital. The Sheikh supplemented that with subsidies Flanagan estimated at $90 million, including two barely-used Boeing 727s, help with aircraft purchases, a training building, and $64.7 million in other off-the-books investments. As you all probably know, the investment paid off: by 2007, Emirates flew 119 aircraft to 101 destinations in 61 countries, earning a profit of $1.4 billion.  Think about that number for a second.  In 2007, the profits from that one enterprise alone contributed 2% of Dubai’s GDP. And 2% is a minimum estimate: Emirates’ total turnover came to $9.6 billion … 15% of GDP. (Obviously, not all of that number accrued to Dubai — but even a quarter would put the airline’s direct contribution at 4%.)

And then there are the free zones. I’ve already mentioned Jebel Ali, but there’s also the Dubai International Financial Center (DIFC). The DIFC has a special legal regime modeled on the United Kingdom, allows for 100% foreign ownership, and guarantees no taxes on profits or income for fifty years. (Inasmuch as that guarantee means anything in an absolute dictatorship.) Then there’s Dubai Media City, which offers a similar deal to firms in media and marketing services, printing and publishing, music, film, internet-related activities, video games, leisure and entertainment, broadcasting and information agencies. Running free zones has become an export industry. The Orangeburg Industrial and Logistics Park in Santee, South Carolina, won’t be able to offer the same range of tax breaks as the Dubai zones, but it will offer whatever the State of South Carolina can provide over two square miles. Ditto, Economic Zones World is neck deep in the Indian government’s attempt to emulate China’s “special economic zones” and has sunk a lot of capital into trying to turn Djibouti into a second Dubai.

So what’s the catch? Simple. The Emirate leveraged the oil money into the financial center, the port, the free zones, and the tourists in part by real estate profits ... but mostly by actual leverage. As the cost of running the government inescapably grew, taxes + profits generated from real estate provided the necessary income. Unfortunately, once the rate of growth in the value of real estate slowed — reversed, actually — the system became unsustainable.

That said, Dubai Incorporated has one advantage over other places that have tried similar development models (everywhere from Singapore to, well, the State of California), which is that it can treat most of its labor force the same way that a real company would. That, however, brings us to Barry Cotter’s question (and eventually Randy’s) and another post.

Questions, comments, requests? I am going to make a strong effort to get around to them.

Build it and they will come

 Dubai received a boatload of oil money. Still, that boatload wasn’t quite enough to float the immense edifice that is the modern city. (I take a perverse delight in metaphor mixing.) It needed to be leveraged.

 
There were two ways to do that. The first was to leverage. More on that in a later post. The second was to build the city the same way the United States built the railroads: ahead of demand, and financed by land grants.

The idea was fairly simple. The emirate sat in a great location and had a first-mover advantage over its competitors. As of 1971, Abu Dhabi and Qatar had chosen to move slowly, Bahrain faced Iranian hostility, Oman had to fight off the Popular Front for the Liberation of the Occupied Arabian Gulf, and South Yemen had gone Communist. Everyone had been held back by the British, especially poor South Arabia ... geographically-speaking, Dubai (as a transshipment port) should probably be in Aden or Djibouti. So the government built the transportation infrastructure, which increased the value of the land around that infrastructure. It then started to rent land to ancilliary enterprises. The profits from land development went to build more infrastructure and subsidize the overhead costs of running the city. They also went to subsidies for international businesses, which received cheap rents and tax abatements.

 

The above chart shows the government’s income in constant 2009 dollars using UAE price deflators. (Since the UAE had a fixed exchange rate over the period, the calculation is fairly straightforward. The use of a deflator matters, however: UAE inflation has far outpaced American over the period.) The “other” category is made up primarily of land sales, rent taxes, user charges, and other fees. To give an example, in 2009 road tolls generated 17% of all government revenue, and airport charges an additional 6%.

What did the government spend it on? See below the fold.

Oiled up and ready to go

 Barry asks about the labor system and oil, Randy wonders about the Iranian presence, and Peter asks if there is any worry about Saudi Arabia going kablooie. Let’s start with oil. Dubai was built on oil.

You’d be surprised at the number of people who don’t realize that. Yet it’s the truth. The Emirate of Dubai may never have been an oil producer on the scale of its neighbor in Abu Dhabi, but the Maktoum family got the initial income it needed to realize all of its massive development plans from the discovery of black gold.

In a sign of the ongoing decline of the British Empire, London failed to prevent Dubai from giving an offshore exploration concession to an Anglo-French consortium in 1952. They weren’t very successful, so the Emirate granted a second concession to Conoco in 1963. Conoco formed the Dubai Petroleum Company (DPC) to operate their concession, buy a half-interest in the earlier Anglo-French one ... and sell further interests to Texaco, Sunoco, and a German company you’ve never heard of. Three years later DPC struck oil about 55 miles off the coast.  Production started in 1969. (The coolest thing was the giant half-million-barrel underwater open-bottom tank that they used to store the stuff. You woulda thought somebody might have realized that oil and water don’t mix before then.)

In addition to royalties, the Emirate acquired a 32.5% share in the company, and its revenues skyrocketed. By 1975 it earned $1.7 billion (in 2009 dollars, using the UAE deflator) from oil and gas. At its revenue peak, in 1981, it earned a hair over $7.5 billion. That is a hell of a lot for a place with a national population of ... either 25,000 or 100,000, depending on how you define it. The green line shows revenues income, while the orange line shows production.

 

The oil revenues income financed the investments that turned Dubai into the trade hub of the Middle East. The Arabian peninsula is very well placed for a place to transfer cargoes from Asia into Europe-bound ships and vice versa. Similarly, it is a good place to hub flights. Emir Al-Maktoum channeled the oil money into building Port Rashid — against the advice of the emirate’s British advisors — and then Jebel Ali, an even bigger Bronx-sized port complex big enough to service a Nimitz-class aircraft carrier. Dubai built an airport in 1960 (also against British advice), but it was debt mortgaged by oil money what expanded it to accomodate jumbo jets in 1968. Ditto, it was oil what financed the creation of Emirates Airlines in 1985 and all the rest of that good stuff.

Of course, as you can see from the graph, the oil money started to run out in 1981, and the actual amount of oil being pumped out itself started to fall a decade later. So what was Dubai’s business model after that? A subject for another post … and a way to get to the other questions. Keep ‘em coming.

In Dubai

 I have just spent the bulk of the last two days writing approximately 3,526 words about Dubai’s recent economic travails. Dubai, as none of you will be surprised to hear, is a deeply strange and somewhat disturbing place. I will be putting up a few posts as the moments of procrastination seize me over the next few days, during which what I really need to do is write about 7,000 words on Mexico’s oil expropriation.

So, is there anything in particular that you, gentle readers, are curious about regarding the place?

 
Yes, that is a Christmas tree.

Nuclear power in the UAE

  The below picture does not show a nuclear power plant.

 
While cooling towers can bear a resemblance to the onion domes, I suspect that the nuclear reactors that Korea will build in the UAE will not be as pretty.

The Korean victory in the UAE bidding process came as a huge surprise to Areva, the French nuclear conglomerate. They had the EPR design ready to be rolled out. President Sarkozy had pulled out all the stops. France had a military base in the country and was training Emirati troops. The President had visited Abu Dhabi. Areva could offer a long-term fuel contract, delivering fresh uranium from its mines in Niger (enriched, of course, in France). Moreover, Areva could accept used fuel and reprocess for reuse it at its plants in La Hague and Mercoule. France meant nuclear. It had to happen.

Yet suddenly the South Koreans came out of nowhere. Huh?

I’d been wondering that myself. So I asked some fellows I know in the Abu Dhabi government. They gave me a simple answer. The Koreans offered a cheaper price, guaranteed that price, and offered a long-term service contract. The Korean price came to $3.64 million per megawatt for a 1400 MW reactor. The French offered something similar, but they refused to take on the risk of cost overruns. When pushed to offer a fixed-price turnkey project, they came back with a price of $5.45 million per megawatt for the 1650 MW EPR design.  Now, Areva’s ability to guarantee fuel for a decade or two is a big advantage ... but Areva will sign such contracts with anyone. No need to buy one of their reactors. In fact, the Koreans already have a 10% stake in Areva’s new mine in Niger, which guarantees supplies to their domestic plants under long-term contracts.

Does the deal make sense for the UAE? The UAE government takes a rather long-term view, so a 5% discount rate seems reasonable. (For comparison, EDF uses an implicit discount rate of 13% in its investment decisions.) Assuming that the reactors manage to reach the 89% capacity utilization reached in the United States, the Korean price implies a capital cost around $23 per megawatt-hour. Fuel costs about $4. Operation and maintenance costs are harder to know, but the word is that the Koreans offered to run the plants for their useful lifetime (presumably 40 years) for roughly $5 billion each. That implies a cost around $11 per megawatt-hour, which is in line with the $8 estimated by the OECD for South Korean reactors. Total cost, $39 per megawatt-hour, assuming that Kepco absorbs the inevitable cost overruns.

What about the other options? At those prices and discount rates, nuclear is competitive with coal. Coal costs quite a bit in peripheral areas — $19 in Finland, for example, and $20 in Japan (per megawatt-hour of electricity produced) — and in a world where the United States has begun exporting the stuff to China via the Panama Canal those costs are unlikely to decrease.  The capital costs of your typical coal plant come to about $11 per MWh, but political pressures would almost certainly drive the UAE to purchase the most advanced “clean coal” technology, which would push the cost up to $20. (No, it isn’t that clean, but it emits less carbon by dint of burning the stuff at higher temperatures.) Adding in the O&M costs from the Japanese coal plants (which use high-temperature furnaces) drive total coal costs up to $50 per megawatt-hour.

The rub is gas. Gas is cheap. Capital costs are tiny; less than a quarter of nuclear. Fuel costs are relatively high in most of the world, except the UAE, where Qatar stands poised to export endless amounts of the stuff via the Dolphin pipeline.

Why choose nuclear over gas? Abu Dhabi is making a strategic calculation, not an economic one, at least not in the short term. Perhaps they think that the local price of gas will rise, either due to increasing demand or because the cost of making LNG for export will fall. Perhaps they are making some sort of inexplicable calculation about foreign exchange. Perhaps they are taking a long-term bet on nuclear power. Or they might simply think that Qatar will be unable to supply them with the quantities they will eventually need for electricity generation at any price, considering that the UAE isn’t their only GCC customer.

I honestly don’t know, although I am trying to find out. What I do know is that they aren’t making a political calculation ... otherwise they would have gone with the French.

Should I add some graphs and charts?  

Dubai bailout, nothing to see

  No, really.  Here’s the opinion of a Saudi Arabian banker on the Dubai default, dated November 27th:  “We believe that Abu Dhabi will come to the rescue… but like all rescues it would have a price. In that case it may well be first of all a political price.” Why did they believe that Abu Dhabi would rescue it’s neighbor?  Simple:  ADIA, Abu Dhabi’s sovereign wealth fund, has enough assets that if it seemed like bailing out Dubai world might preserve market values, then ADIA had enough of a stake in those markets to make the bailout a paying proposition.  Saudi did too, but Abu Dhabi, unlike Saudi, could more easily extract political gains in addition to the economic returns from a bailout.  

Thus, the bailout.  Stocks still seem to have reacted well, despite its wholly predictable nature.  Ni modo.

Speculation in world oil markets?

  I report; you decide.

Now, these figures don't include stocks of refined oil products.  Perhaps speculation is easier in final products linked to the price of crude, rather than crude?

These figures don't include Chinese stocks, which are available but are also a bear to download and input.  They do include stocks held overseas, or on tankers.

Of course, Chinese stocks aren't the only missing figure.  Oil producers can speculate by leaving oil stocks in the ground:  e.g., cutting production.  That said, I'm not sure that's interesting; we already know that production declines will drive prices up.  

So can we see evidence for or against speculation in these graphs alone, or do we need more data?  I'm sure I was sending a signal to the Saudi photographer who took this picture; I'm just not sure what.

There is no bloody resource curse already

  So there are these people out there, notably the Oracle of Flat, talking about how high oil prices lead countries to do all sorts of crazy things, like take stuff or invade their neighbors or build weird shit. Which is a problem, see, because except for the building of the weird shit the real world just doesn't fit the model. 

Above you’ve got an example of weird shit.  Ditto to the right.  But what about the neighbor-invading or stuff-taking?  Well, I don’t have a whole lot to say about neighbor-invading at the moment, but there is some stuff-taking in the news: the Bolivarian Republic just cancelled all its oil service contracts.  That’s a form of stuff-taking, yet, as the great and immortal Onyx once said, but wait it gets worse!   The government also intends to nationalize the contractors’ assets.  That is stuff-taking of the purest form, which the “resource curse” models predict isn’t supposed to happen when oil prices are low.  After all, the government is supposed to need the service companies to keep production up.  And yet, here we are.

“Oil service companies” are at-their-simplest basically oil companies that extract petroleum for a fixed price on behalf the owner ... in Venezuela’s case, the government.   With nationalization of the oil services, the government gets a threefer:  the assets, the value of future payments, and the value of all unpaid bills.  But it loses the companies’ ability to run and maintain the assets and opens itself up to arbitration and lawsuits.  It also loses future investment.  Oil companies will tolerate expropriations-that-weren’t, like the Bolivarian Republics’s so-called “nationalizations” up until now.  They have less patience over the real thing.  It’s a particular problem for Venezuela because its wells tend to have a half-life around three years.  Without continual new investment, production will decline.

I’m not sure what Chávez’s motivation is, although I can speculate.  I am sure, though, that this is another sign that the whole petropolitics idea is worth a lot less than a gallon of crude, even at current prices.  Sure, it might be possible to take the political resource curse theories and mash them to fit recent events in Venezuela, but then you would wind up with a theory that predicted that governments nationalize when prices go up and they nationalize when prices go down; or that they nationalize when they don't need foreign technology and they nationalize when they do.  In other words, you would get a theory that predicted that the governments of oil producing states should always nationalize at all times. 

The proper word for such a theory?  Worthless. 

From the Country that Brought You the Katipunan

The city of Jeddah, in Saudi Arabia, commissioned a great deal of public art.  The sculptures are more-or-less abstract, quite playful, and rather weird.

When I was last there, after a very luxurious trip across the country, I was thoroughly sick of being wined-and-dined.  Since Jeddah is one of the few places where a vaguely Arab-looking man in Western clothes can walk around unnoticed, that's what I proceeded to do.  That led to an impromptu basketball game with a group of Filipino expats. I automatically blurted out "Kumusta-ka!" when their car pulled up in front of me as I watched other people toss a ball around on some public courts, and an invitation to play naturally followed.

So when they told me that the below sculpture had, in fact, been designed by a Filipino, I was not surprised.  I have also been unable to stop laughing.

And a close up:

Brought to you by the country that named its first independence movement the "KKK."  I am not surprised, and I am still laughing.