This commentary was published with permission in LIPPER HedgeWorld on December 14, 2006. Tavakoli Structured Finance retains the copyright.

“The situation in Iraq is grave and deteriorating.” —Iraq Study Group

There is a strong possibility that Iraq will erupt in even more chaotic and undeniable civil war within the next year no matter what the United States does. The worst case scenario envisioned in a paranoid nightmare (not envisioned in the Iraq Study Group Report) is a Middle Eastern melee that ignites a sea of oil. If Iran strengthens support of the currently Shiite dominated government, Saudi Arabia and Syria could step in to support the disenfranchised Sunni Arab insurgency, which now includes al Qaeda. The Sunni-practicing Kurds seem to be aligning with the Shiite-dominated government, but they are a wild card and want independence. As Iran continues its nuclear program, a threatened Israel could bomb Iran, Turkey could intervene to quell the Kurds, and the region could erupt in an all-out Middle Eastern war drawing in Lebanon, Kuwait, Jordan, Afghanistan and possibly more countries. The price of oil would skyrocket.

The Iraq Study Group Report offers reasonable suggestions to avoid the nightmare scenario and perhaps even to create a semblance of détente in the Middle East. This would present a much more stable and moderate price scenario for oil. The Report points out that we have done a poor job of management in the Middle East, and we must practice diplomacy for a change. We have not been smart, so let us hope we get lucky.

A Brief Overview of Special Interests

The legitimate government of Iraq, albeit democratically elected by a broad base of the Iraqi population, does not have the resources to perform the functions of government, and will need ongoing assistance from the United States for “some time to come.” Our interest, of course, is in a stable region and a steady supply of reasonably priced oil. But the government of Iraq is so desperate for assistance in quelling violence, its largest problem, that it will probably accept assistance from anyone who offers it.

Iraq in particular and the Middle East in general are prone to sectarian violence. This has roots in historical tribal cultures, self-proclaimed racial differences, language barriers, religious differences and even newly recognized national pride.

The two main religious sects in Iraq are the Sunni and Shiite (or Shiah) Muslims. The Shiites believe that Mohammed’s son-in-law, Ali, was his successor. The Sunni’s believe the Caliphs are Mohammed’s successors.

Shia Muslims make up around 55% of Iraq’s population of 25 million people, and Shia Muslims also make up around 90% of Iran’s population of 68 million people. The Shiites of both countries are strongly linked with cultural bonds.

The Sunni’s, on the other hand, make up around 45% of Iraq’s population and have stronger sympathies and ties with Saudi Arabia’s even more fundamentalist Wahhabi Sunni’s.

Both the Sunni and Shia sects, however, have ties to Saudi Arabia, since it is the home of Mecca and Medina, the two holiest cities of Islam. Saudi Arabia is also the destination of the hajj, a pilgrimage to Mecca, which every Muslim believes is one of the five pillars of the Islamic faith (the other four being professing one’s faith, prayer five times daily in Arabic, giving of alms and fasting during Ramadan). While Muslims have more to unite them than to divide them, the divisions have historically caused bloodbaths.

While most Iraqis are Arabs, some are also Kurds, who consider themselves to be racially distinct from Arabs. Minority populations of Kurds also reside in Iran, Turkey, Syria and other neighboring regions. While Iraqis speak Arabic, regional minority languages include Kurdish and Turkmen among others.

Most Iranians consider themselves Aryans since the majority of the population is Persian. There are several minority groups with the largest minority population being the Azaris in the north. The official language of Iran is Farsi, also known as Persian. Farsi is an Indo-European language that uses Arabic script, and is much simpler for most English speakers to master than Arabic. Iran has many more fluent Arabic speakers than the United States. It has small Arab minorities, it is next to Iraq, its language uses Arabic script, and the Koran is in Arabic. Even when they do not understand the language very well, Iranians pray in Arabic.

Israel’s majority religion is Judaism, and Israel has ongoing tensions with Lebanon, Palestine, and Syria. While the United States is committed to a “two-state solution for Israel and Palestine,” a minority of Israelis does not appear to be committed, and it is unclear how many Palestinians are committed to this solution. Israel and Palestine continue to have land disputes, chiefly due to Israelis having settled on Palestinian land. While some Palestinians do not recognize Israel’s right to exist, some Israelis have not respected Palestine’s right to borders, which suggests they do not recognize Palestine’s right to exist, either. In addition, while the Iraq Study Group Report recommended Israel and Syria renew talks, Israel’s Prime Minister Ehud Ohmert has rejected its recommendation. He indicated Israel would establish a Palestinian state and withdraw from the territories it took in the 1967 Middle East War in exchange for normal ties with the Arab League. On the other hand, he also said he didn’t “see a likely possibility of either American-Syrian or Israeli-Syrian negotiations.” While he can speak for Israel, he cannot speak for the United States, and the United States should include Syria in the report’s recommended “diplomatic offensive.”

Afghanistan is not yet stable. The Taliban is still active and could gain further control. It could once again provide aid to al Qaeda, and the country has increased its poppy production and drug trade. The Iraq Study Group Report calls for more attention and military support.

Within Iraq, the Sunni-Arab insurgency is the most active aggressor against Americans. This insurgency includes al Qaeda, which has morphed into an organization mostly run by Iraqi Sunni-Arabs. Of course the insurgency is also hostile to Iraq’s other violent factions. These other factions include gangs of common criminals, Shiite militias, the primarily Shiite Mahdi Army led by Moqtada al-Sadr, and the Iran-linked Badr Brigade. In oil-rich Kikurk, local Kurds, Arabs and Turkmen vie for power. In Basra and some parts of southern Iraq, Shiites fight each other.

The High Cost of Lack of Intelligence

While the Iraq Study Group Report does a fine job of making recommendations and paints a clear picture of special interests and violence, it also makes it clear we do not understand what is really going on in Iraq: “We rely too much on others to bring information to us, and too often don’t understand what is reported back because we do not understand the context of what we are told.”

In addition to poor cultural understanding, we do not even speak the language. Even after more than three years of war, we do not have many trained Arabic speakers. In the 1,000-man embassy, only six staff members speak Arabic fluently, and only 33 in total are Arabic speakers at all. In the Defense Intelligence Agency, there are “fewer than 10 analysts” with more than two years of experience analyzing the insurgency, and the report doesn’t make clear how many of them, if any, speak fluent Arabic.

It makes me wonder if we’ve turned away fluent volunteers, and if so, for what reason. One of my personal friends, an American-born citizen of European ancestry, speaks fluent Arabic. He was turned down by the Federal Bureau of Investigation (a domestic intelligence agency, it was not included in the Iraq Study Group Report’s language analysis). In a letter sent on the U.S. Department of Justice letterhead he was informed: “Your desire to become associated with this Bureau is appreciated; however, we are unable to offer you a contract as a result of your acknowledged drug usage.” This acknowledged drug usage amounted to trying cocaine twice, LSD twice, and puffing a marijuana joint fewer than 25 times. This occurred in the 1970s when he was in college and possibly an occasion in 1983. Since then, he has been a responsible family man, and he does translation work and writes novels for a living. The FBI would have accepted him had he been able to swear he had smoked marijuana no more than 15 times.

The High Cost of Lacking Charm

Whether we like it or not, important factions in Iraq have ties to Iran. During a “60 Minutes” interview with Mike Wallace on Aug. 8, Iran’s President Mahmoud Ahmadinejad proved he is no one to take lightly. While Mr. Wallace may not have liked Mr. Ahmadinejad’s message, “60 Minutes” might have done its viewers a better service by trying to understand and clarify Mr. Ahmadinejad’s point of view, which is not the same thing as agreeing with it. Instead Mr. Wallace took the judgmental tone of an accuser. Rather than be provoked by Mr. Wallace’s disrespectful demeanor—it is hard to imagine Mr. Wallace using the same tone with President George W. Bush—Mr. Ahmadinejad succeeded in making Mr. Wallace appear to lack civility, and he even seemed more likeable than Mr. Wallace. Mr. Ahmadinejad not only appeared sane, he appeared to be amused at some of Mr. Wallace’s antics. It is clear that Mr. Ahmadinejad understands he holds some very high cards in the game of control for the future of the Middle East.

On Nov. 29, the day after a leaked White House memo suggested Washington lacked confidence in Iraq’s Prime Minister Nouri al-Maliki, a meeting between Messrs. Bush and al-Maliki, and Jordan’s King Abdullah was canceled. Instead, separate bilateral meetings occurred, and Messrs. Bush and al-Maliki met the next day. While the reason for the change was never made clear, the memo’s timing was clearly a blunder.

It would probably kill fewer of us if our leaders were more charming. When people feel you are interested in their point of view, it usually inspires them to explain themselves. The time to be critical is when you are evaluating the information you gathered.

The Iraq Study Group Report makes clear that we need a diplomatic offensive involving other leaders in the Middle East. Up to now we appear to have spurned some diplomatic advances, such as President Ahmadinejad’s letters. While we may find his approach unorthodox, we may have to entertain the possibility that there is some merit in a more open response. This would require us to acknowledge that while the United States may be the most envied and most powerful nation on earth, we are not the only powerful nation in the world, and we might even have a few lessons to learn from other powerful nations.

While we view the situation in Iraq as a perilous one, so do many Middle Easterners. While we want stability in the region, so do most Middle Easterners. We tried going it alone, and we are failing. Extending a hand to other leaders and nicely asking for their ideas and their help may help us understand a situation that the writers of the Iraq Study Group Report make clear we do not.

The report calls for us to enlist the support of Iraq’s neighbors, and a complete about-face in our diplomatic demeanor will be required for them to even engage in talks with us much less take our change of policy seriously.

The High Cost of Lacking an Oil Plan

While Iraq is capable of producing 3 million to 3.5 million barrels per day of oil, it only produces 2.2 million barrels per day (down from the pre-war level of 2.5 million barrels per day), exporting 1.5 million barrels per day. The production infrastructure needs attention and it needs greater investment. In fact, it needs a new metering system so it can be properly measured.

Since oil currently makes up 70% of Iraq’s GDP, it seems as if we would have had a plan for securing oil production and distribution. Instead, the report says that perhaps 500,000 barrels per day of oil are being stolen. The chief cause of this theft is not violence, it is corruption.

The future of Iraq’s oil is uncertain. The Iraq Constitution allows the federal government to manage existing oil and gas fields, but it doesn’t have the resources to provide management for its population. New energy resources, however, are owned by “the peoples of Iraq in all the regions and governorates,” should they survive the sectarian violence. There are ongoing debates about how to move forward and how the oil wealth will ultimately be distributed. In other words, the populace is arguing over a resource they cannot yet manage and cannot yet make safe.

According to the Iraq Study Group Report, we are spending $8 billion per month on this war, and have spent $400 billion so far, yet our intelligence is poor and our means of getting it is hampered by poor planning. The ultimate cost may be as high as $2 trillion, not to mention the lives lost.

There is a plausible threat of further costs due to oil price surges if the Middle East erupts in chaos. Global oil supplies could drop and prices could surge. Even if that does not happen, there is the possibility that Iraqi oil production could either be further disrupted, stolen in larger quantities, or both. Even in the best-case scenario, Iraqi oil production will not increase and will not be secure in the near future. All of this suggests continued upward pressure on oil prices.

Afterword: The U.S. government estimated the Iraq War would cost $50 to 60 billion. The Costs of War Project at Brown University showed the Iraq War took more than 190,000 lives and cost $2.2 trillion as of March 2013, ten years after the war’s start. It estimated combined costs of the wars in Afghanistan, Iraq, and Pakistan at more than 330,000 people and $4 trillion.

See also:

“Iran Approach Must Avoid Past Mistakes” – HedgeWorld (Reuters) – June 12, 2006

“Do Not Accept Bolton’s Interpretation on Links with Iran” – Letter to the Editor, Financial Times – April 11, 2007

Read finance articles by Janet Tavakoli