THE SWEET PERFUME wafting over northern Iraq does not come from the wildflowers that speckle its rumpled plains in spring. It is the smell of oil and it is everywhere, flaring at wellheads, sloshing from the tanker trucks that grind up potholed roads to backyard refineries in the Kurdish hills and fuming from their chimneys. Nor is this the oiliest part of Iraq. That lies in the deserts to the south where it literally seeps from the ground. In fact the whole of Iraq sits atop seams and pockets of the sticky stuff. There is plenty to go around, if only the Iraqis could agree to stop shooting each other.

There is plenty for other Arabs, too. Taken together, their 19 countries hold some 46% of the world’s total proven oil reserves (as well as a quarter of its natural-gas reserves). The ones with the most have it doubly easy. Saudis or Kuwaitis spend just $3 to tap a barrel from their most accessible wells. Small wonder that their oilmen scoff at looming competition from America’s fancy frackers and shalers. The technical wizardry of the modern drilling techniques that may soon make America self-sufficient in energy can push the cost of extracting a barrel well beyond $100.

The Arab world’s hydrocarbon riches are unevenly shared. Saudi Arabia alone holds the bulk of all reserves. Just eight Arab countries have actually grown rich from energy exports, though some of them spectacularly so: in the tiny emirate of Qatar some 14% of households are dollar millionaires, a higher proportion than in any other country. Divided among its 250,000 citizens (the other 85% of Qatar’s population of 2.1m are foreign workers), the tiny emirate’s GDP comes to $700,000 per person. Average incomes across the Arab Gulf states are around 50 times those in Yemen, Sudan and Mauritania.

This may change. Poorer Arab states are not about to become new Qatars, but many, such as Yemen, Tunisia, Sudan and Egypt, already export oil or gas, and the lingering energy paupers are doing better too. Morocco, until now completely reliant on imports, pins high hopes on offshore exploration that is just getting under way. Its Atlantic shelf shares the same promising geology that oil companies in Mauritania are already exploiting. Much of this potential lode skirts the long coast of the Western Sahara, where sovereignty remains contested despite four decades of de facto Moroccan control. But there may be plenty in undisputed waters, too.

A wobbly balance

Huge gasfields in the eastern Mediterranean also sprawl across maritime borders. Egypt has been tapping its patch for years, with Israel following more recently. Lebanon has untangled itself from internal bickering. Some day Gaza should have a share of the crowded territory’s only resource aside from people. Perhaps in the future the other part of Palestine, the West Bank, will also profit from the small deposits of crude oil that Israeli firms have found under its hills. Even Jordan may at last be able to stop begging its neighbours for fuel. If oil prices hold steady above the $100 mark around which they have fluctuated in recent years, the shale oil that sits under 60% of Jordan’s surface will become commercially viable.

That is a big if. In 1999 this newspaper speculated that oil prices might collapse to $5 a barrel. Instead they soared, peaking in 2008 at $145. The world’s current mix of political instability in oil-producing zones and surging demand from Asia leads some to think that despite expanding oil production worldwide, a wobbly balance between supply and demand might be maintained. But experience suggests that high prices sustained over long periods encourage massive investment in exploration and improved yields from existing infrastructure.

That is what happened in the 1970s, when high prices spurred energy conservation and made it cost-effective to produce in places like Alaska and the North Sea. The resulting oil-price collapse in the 1980s lasted a long time, despite rising Asian demand and supply shocks such as the eight-year war between two of the biggest exporters, Iran and Iraq. Arab producers were badly hit. GDP per person in Saudi Arabia and Libya shrank by a third and took 20 years to regain its 1981 level.

A similar price fall today might not seem as threatening to the bigger Arab producers. Over the past decade they have racked up surpluses approaching the size of the combined GDP of all 19 Arab states, $2.9 trillion. About half of that is sitting in sovereign-wealth funds or foreign-currency reserves. But many governments, wary of unrest, have also raised state spending to potentially unsustainable levels. The so-called fiscal break-even point (the oil price needed to balance exporters’ budgets) is currently over $80 for Saudi Arabia and $110 for Algeria, which relies on energy exports for 70% of its government revenue.

Both governments could simply cut spending, though that involves political risks. They could also try something else: raise local energy prices. Throughout the region, the combination of big resources and patriarchal politics has made a hash of economics. The Arab hydrocarbons industry as a whole generates about $750 billion a year, but nearly a third of that, $240 billion by the IMF’s estimate, is frittered away on energy subsidies for Arab consumers.

In Saudi Arabia, for instance, petrol costs under $0.20 a litre. Local consumption already eats up a quarter of Saudi oil output, and on current trends could devour all of it within 25 years. Domestic oil consumption across the Arab world last year rose by 5.2%, the highest rate in any region. In the Gulf states it has been growing at an annual 6% since 1980.

Rich countries can afford this, though not indefinitely. For poor countries the subsidies have become ruinous. Yemen’s government, for instance, spends the equivalent of 6% of its GDP on keeping fuel prices low, more than on health and education combined. Most of this goes on diesel, which feeds the water pumps that irrigate the country’s most important crop, qat, a pleasantly narcotic shrub that keeps millions quiet.

The cost to Egypt is just as heavy. The government’s subsidy bill is $18 billion, again far higher than its spending on public schools and hospitals, and almost precisely matches its 11% budget deficit. That might have been fudged in the past, since most fuels were produced by state-owned firms and the cost of subsidies was implicit rather than paid in cash. But with local consumption growing rapidly, Egypt has lately become a net importer. Its central-bank reserves have dropped from $36 billion to $16 billion since the revolution in February 2011.

The IMF reckons that in two out of three Arab countries energy subsidies account for more than 5% of GDP

The IMF reckons that in two out of three Arab countries energy subsidies account for more than 5% of GDP, whereas food subsidies in the region average only 0.7%. It is true that in places like Egypt cheap transport has encouraged mobility and cheap power has favoured investment in energy-intensive industries such as fertilisers and cement. But the benefits tend to be skewed to the owners of factories and gas-guzzlers. The IMF estimates that 50% of the energy subsidies go to the wealthiest fifth of the population in Sudan and only 3% to the poorest fifth.

Rolling back the subsidies is a tricky business, but it can and must be done. Some countries, such as Jordan and Yemen, have already taken painful measures and so far survived the consequences. Libya, too, has been surprisingly bold for a country where petrol has been cheaper than water for a generation. Its current budget provides for sharply higher petrol and electricity prices and a shift in the subsidies to monthly cash transfers of about $500 per citizen. “It sounds like a lot, but this will actually save the government a ton of money,” says Faisal Gergab, chief economist at the Libyan Investment Authority.

For two years the IMF has been dangling a $4.8 billion loan package in front of Egypt. This could unlock billions more in multilateral and bilateral aid, but it is conditional on budget reform, which in turn depends on fixing the worsening energy muddle. Egypt’s next government will have to knuckle under, no matter how unpopular that may make it. And so, eventually, will countries such as Saudi Arabia. “Now is the time to reform,” says Joe Saddi, the chairman of Booz & Co, an American consultancy with a strong base in the region. “They have the money and they have the time.”

Among friends

Mr Saddi has another suggestion: that Arabs should integrate their economies. This is not a new idea. Before the first world war, Mr Saddi notes, people and goods moved freely across Arab borders. The Arab League was founded in 1945 to strengthen regional ties. In the 1960s and 1970s many joint institutions were launched to exchange aid, expertise and investment among Arab states.

Those hopeful times saw a first big wave of migration to the Gulf. In those early years of the oil boom, its bounty was seen as best shared among brothers. Fellow Arabs received the bulk of Arab development aid and made up some 72% of the Gulf’s expatriate labour force. Libya, Iraq and Algeria were also important destinations for migrant workers.

These days fellow Arabs account for barely a quarter of the Gulf’s expat workforce, and not just because Asian workers will accept lower pay. For political reasons, Gulf monarchies have expelled large numbers of other Arabs from time to time, such as Palestinians from Kuwait and nearly a million Yemenis from Saudi Arabia in the 1990s. New campaigns today, under the guise of rationalising labour markets or prosecuting people who have outstayed their visas, are targeting Shia Lebanese in Kuwait to punish Hizbullah and suspected Islamists in the United Arab Emirates. As many as 300,000 Yemenis in Saudi Arabia also risk expulsion as part of a plan to open more jobs to Saudi citizens.

Arab borders remain more jealously guarded than those in most other parts of the world. True, countries such as Egypt, Iraq and, more grudgingly, Jordan and Lebanon have generously opened their doors to hundreds of thousands of Syrian refugees. Most Arab countries still insist on visas for those from elsewhere in the region, although some restrictions have been eased.

Open wider

Some irksome barriers remain. Unbelievably, the 1,000-mile-long frontier between Morocco and Algeria, countries that have similar populations and living standards and are culturally, linguistically and historically close, has been sealed for the past 19 years. Few people in either country even remember why their governments shut it (Morocco accused Algeria of involvement in a hotel bombing in Marrakech that killed two tourists). Opening it up would let poor border towns revert from their current concentration on smuggling to more legitimate trade. More important, access to Algeria’s cash-rich but goods-poor market could quickly add $2 billion a year to Morocco’s more dynamic private-sector economy, economists say.

Given the vast disparities in wealth, opening all Arab borders is not a realistic option. But there are certainly benefits flowing among Arab nations. Remittances from the Gulf to other Arab countries are currently worth about $35 billion a year, supporting whole villages in places such as Upper Egypt and Sudan. In 2009 remittances made up 16% of Jordan’s GDP. According to the World Bank, the Gulf states have been the world’s most generous donors of aid as a share of GDP. Most of this has gone to fellow Arab states, often at crucial times such as after Israel’s devastation of Gaza in 2009.

In the peak year to date, 2008, direct investment from the Gulf states in the rest of the region amounted to $35 billion. Firms such as Qatari Diyar, the UAE’s Emaar and Kuwait’s Kharafi Group have launched giant property developments in many Arab capitals as well as in tourist destinations along the Red and Mediterranean seas. Private Gulf investors are also putting a lot of money into stock exchanges in cities such as Casablanca, Cairo and Amman.

There could be much more of this. “It’s a perfect match,” says McKinsey’s Kito de Boer. “The Gulf has about $1 trillion to spend, and that’s about what is needed in regional investment.” The trouble lies with the investment climate in receiving countries. And that is a matter of politics more than economics.