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Power Failure

The energy crunch emerges as the 21st century’s top national-security issue.

On May 2, 2008, Goldman Sachs finally called it: the super-spike endgame in oil has begun. The price per barrel of crude could reach $200 in the next six to 24 months, with continued extreme volatility. The report confirmed what the U.S. Department of Energy chooses to ignore but others have been saying since at least 2005: we have entered a period of “peak oil,” in which demand consistently outstrips global supply, amid growing uncertainty about the price of energy and the availability of reserves.

About a month later, Morgan Stanley warned of a “monumental transfer of wealth to oil exporters, which may last beyond our generation, with important geopolitical and security implications.” Receipts of oil exporters are running as high as several billion dollars per day, with $1 billion going to Saudi Arabia. OPEC’s surplus this year is projected to reach $500 billion, with most of it flooding into sovereign wealth funds—essentially investment arms of foreign governments. At the oil price of $135 a barrel, Morgan Stanley estimated that the stock of the proven reserves of the six Gulf Cooperation Council countries would be worth about $65 trillion. By comparison, the world’s total public equity market capitalization is around $50 trillion.

A glance at the exploding skyline of Dubai tells the story better than reams of market-intelligence reports. We are in the midst of the most massive wealth transfer the world has ever witnessed, and it is driven not by market forces but by an increasingly state-controlled global energy-supply monopoly. Unchecked, this economic shift will result in a radical reordering of the global balance of power.

* * *

The most common explanation for the energy crunch is the widening gap between supply and demand, with the culprit—depending on one’s ideological predilection—being shady oil companies or skyrocketing consumption in the United States, European Union, China, and India. These explanations are partly true but incomplete.

According to EU projections, between 2002-2030, demand for oil in the U.S. and Canada will grow by 34 percent from 19.7 million barrels to 26.3 million per day. The EU will see its energy needs expand 15 percent, and Japan and Korea will consume an additional 11 percent. China’s demand will grow by a whopping 157 percent over the same period—from 4.9 million barrels per day to 12.7 million—displacing the EU as the second largest consumer of oil. India will consume an additional 124 percent.

But there is little direct connection between present demand and the surge in prices. From 2002 to 2007, the price of oil rose $60 per barrel, then last year it jumped another $60. Consumption, while rising, had scarcely doubled.

Focusing exclusively on market demand assumes that suppliers play by the rules of the marketplace. But in an environment in which resources are nationalized, price is not set by the market. Energy producers’ strategic goals and security objectives are driving the supply side of the equation, even as we continue to consider the crisis in pure market terms.

Of course, some of the price increase can be associated with speculation, with the flood of new institutional investors or the collapsing dollar. But the most direct explanation points to persistent uncertainty and fear that the emerging oil and gas supplier monopolies—on a scale unseen until now—have the ability to dictate price at will. The relentless escalation is driven by the anticipation that demand will continue to rise while the already limited supply will be kept low by the actions of government-controlled oil and gas cartels, moving toward a complete disconnect between prices and available reserves.

Since the creation of OPEC, the pricing of oil has been an exercise in market manipulation. The openly stated goal of the organization is to control the world oil market by “regulating oil production and production standards.” Since its inception, OPEC has shown itself to be one of the most prosperous and effective monopoly alliances in history, notwithstanding occasional cases of individual members acting outside the agreed upon production and pricing targets, as in the mid-1990s when overproduction led to the collapse of the oil price. At the time, the first Gulf War and the dramatic increase in the American military footprint in the Middle East made the United States the guarantor of regional security, in the process creating a strong incentive for Saudi Arabia and Kuwait to keep the spigot wide open. The “roaring nineties” of cheap energy and the soaring stock market followed.

In the post-9/11 world, the situation has changed dramatically, in part because of the loss of American credibility due to our inability to destroy al-Qaeda and the Taliban in Afghanistan and in greater part because of the Bush administration’s disastrous decision to attack Iraq. The invasion first took the Iraqi oilfields out of play; later, as the country disintegrated into factional fighting, the Iraqis were able to put back on line only a portion of their degraded oil capacity. The unintended consequence was the strengthening of Iran and Saudi Arabia’s monopoly position.

The world’s largest national oil company, Saudi Aramco, operates more than 9,000 miles of petroleum pipelines throughout Saudi Arabia, including the key 745-mile East-West Crude Oil Pipeline taken over in 1984 from Mobil and used to transport Arabian Light and Super Light from Abqaiq refineries in the Eastern Province to Red Sea terminals for export to European markets. The Saudi-owned delivery chain extends beyond pipelines and terminals, too: Aramco’s shipping subsidiary Vela International Marine has one of the largest fleets of supertankers in the world.

The pattern of maximizing state control over supply is repeated across the region. The National Iranian Oil Company (NIOC) runs all of that country’s oil and gas exploration and production. International companies can develop Iranian oil sources only in partnership with an Iranian affiliate. Likewise, state-owned Qatar Petroleum controls each aspect of Qatar’s oil sector, including exploration, production, refining, transport, and storage. Kuwait’s nationalized oil industry is run by the Kuwait Petroleum Corporation, with its subsidiary Kuwait Petroleum International managing refining and marketing and the Kuwaiti Oil Tanker Corporation running shipping. Bahrain Petroleum Company holds similar sway over everything from exploration to distribution, including awarding exploration contracts to international companies. Since 1979, Bahrain’s natural gas production has also been nationalized. So too in the United Arab Emirates, which controls 8.5 percent of the global oil supply: the largest state-owned company is the Abu Dhabi National Oil Company, with 17 subsidiary companies in the oil and natural gas sectors. ADNOC has the right to take up to a 60 percent stake in any major oil project. Foreign investors are largely limited to exploration and partnering in building pipeline capacity.

Another key development on the road to the cartelization of the global energy supply was the election of Vladimir Putin as Russia’s president. Marking the end of the “times of trouble” in Russia, Putin’s unwavering goal has been to restore the country’s power and international prestige. His strategy was based on an idea that even Russia’s most liberal democrats had advocated for years: renationalization of the energy sector to provide steady government revenue. During the Putin presidency and now under Dmitri Medvedev, Russia reconsolidated state control over its energy sector. Through political pressure, hard bargaining, and the selective use of law enforcement—as in the case of jailing Mikhail Khodorkovsky, the owner of Yukos—Putin and Medvedev have made Russia’s energy resources the critical component of the country’s national-security strategy.

The plan has worked: in 2007, Russia’s GDP grew by 8.1 percent, marking its seventh consecutive year of growth and surpassing all other G-8 members. According to the IMF and World Bank, Russia’s oil and gas sales generated 64 percent of all its export revenue. The government fund set up to manage the windfall was projected in 2007 to be worth $158 billion.

To maximize influence in Europe and the “near abroad,” Medvedev will follow Putin’s renationalization of Russia’s energy with a page from the Arab playbook: the cartelization of natural gas. Russia controls the world’s largest supply of natural gas, with nearly twice the reserves of Iran, the second largest producer. In 2007, Gazprom, a de facto national monopoly, controlled 85 percent of all Russian natural gas exports. This year it will invest over $20 billion in natural gas production and transportation.

By expanding its control over gas resources in Central Asia through a series of pipeline infrastructure deals, Russia has put itself in a position to negotiate an agreement with Iran to cartelize the global supply of natural gas. Once this happens, the lion’s share of oil and gas in the Middle East and Eurasia will be locked into the OPEC/Russia-Iran duopoly. Russia’s dominant position in Central Asia will also allow Moscow to alleviate pressure on its own energy market and to target liquid natural gas for monopoly control, consolidating its domination of the EU gas market. The resulting revenue—derived from prices set in Moscow and Tehran—may prove much greater in the long run than analysts have been predicting, allowing both Russia and Iran to continue to modernize their militaries.

The security implications are potentially devastating for the United States and the European Union. Russia has natural gas reserves estimated at close to 47.9 trillion cubic feet. Add to that the reserves of Central Asia and Iran—Iran holds 24.8 trillion cubic feet—and this new cartel will be able to control the price of natural gas. Russia and Iran are already cooperating over their energy interests. On July 13, Gazprom signed an agreement with NIOC to help Tehran develop its oil and gas fields. In a meeting with Iran’s President Mahmoud Ahmadinejad, Aleksei Miller, CEO of state-controlled Gazprom, pledged his company’s commitment to “be a cooperative partner for the Islamic Republic of Iran.” The Iranian host reciprocated by calling for “expanding ties with Russia in oil and gas as far as possible.” It is also reported that Gazprom will assist in the building of a pipeline to deliver Iranian gas to India and Pakistan. In short, Washington should have no illusions that Moscow would risk its relations with Tehran to support America’s opposition to an Iranian nuclear program.

* * *

American security policy in the 20th century was based on the premise that U.S. global influence could be protected by preserving an open international economic order and by denying any one great power monopoly control over critical areas of the world where resources were concentrated. The policy proved sound, as Western Europe, aligned with the United States, quickly recovered from its World War II devastation, while Asia—save Japan—languished, and Russia proved unable to compete with the transatlantic alliance. The policy stabilized Europe and Asia, saw an unprecedented expansion of market democracies, and in the aftermath of the Soviet collapse helped to reconstitute and reunify Europe. The core elements of the U.S. security map—American financial and industrial power in the Western hemisphere and the technological resources of Europe in Eurasia and Japan in the Pacific—allowed us to act as an offshore balancer in a number of secondary geostrategic regions, including the Middle East. While never a hegemon, the United States was able to balance its commitments and provide security to the key regions of the globe.

Today, the American position and the international security environment are quite different. Formerly the creditor to the world, the United States is now the largest debtor nation, a net importer of capital and energy with a shrinking industrial base. It is engaged in two wars funded through runaway international borrowing. With the accelerated global diffusion of knowledge and technology through internationalized manufacturing, the pivotal points of global stability are to be found in areas that contain the only resource that has not been subject to the competitive pressures of globalization: fuel.

The nationalization and cartelization of the global energy supply is returning us to a security paradigm reminiscent of the 19th century, when physical control of resources took precedence over the market. The Middle East, Russia in conjunction with Central Asia, parts of Africa, and parts of Latin America are today the four pivots of this new geostrategic energy map.

The inability of the United States and Western Europe to resist the trend toward monopoly control of energy resources—in combination with the more recent failure of both the Clinton and Bush administrations to change oil consumption in the United States—has exposed the U.S. to an unprecedented security risk. By not reacting to the creation of OPEC and allowing the use of the “oil weapon” after the Yom Kippur War, Western countries permitted the open energy market to be dismantled.

According to received wisdom, in the new globalized economy, producers and consumers are equally tied to a shared marketplace. But state behavior today strongly suggests that physical control of energy sources trumps all. Today most of the largest reserves, from Saudi Arabia to Mexico to Russia, are run by oil companies that are nationalized or whose majority stock is owned by government. The full spectrum of state power is deployed to ensure maximum control over supply, and economic powerhouses such as China, India, and Russia are adapting to the new geostrategic game. China’s neocolonial expansion into Africa is a case in point.

On the U.S. side, there is also a growing realization that control of supply is essential to energy security. The ongoing noncompetitive negotiations between the Iraqi government and Exxon-Mobil, Shell, Total, and BP to develop and maintain that country’s oil fields are presented by the media as defying the nationalizing trend, but they are in line with the actions of other states seeking to secure supply.

* * *

The seemingly straightforward answer to the current energy crunch would be to break the stranglehold of the monopoly suppliers by drilling for more oil and natural gas at home. President George W. Bush and Sen. John McCain have recently called for reversing the 27-year ban on offshore drilling. It is estimated that by opening up new drilling on federal land and coasts we could add about 3 million barrels a day to the current U.S. output of some 5.1 million—a significant boost to domestic supply as we develop alternative energy sources.

But we should not delude ourselves that we can drill our way out of the current predicament. Without a commitment from national suppliers in key oil producing states to increase output, as well as major improvements in energy efficiency worldwide, added supply in the U.S. would not significantly lower the price of oil. More importantly for U.S. national security, oil is only one part of the unfolding global energy squeeze and cannot be treated in isolation.

As reported by the McKinsey Institute, pressure is rapidly building in the natural gas and electricity markets as well. Almost three quarters of all natural gas reserves are located in the Middle East and Eurasia: Russia, Iran, and Qatar hold 58 percent of global reserves. Back in 2004, the Energy Information Administration projected natural gas consumption worldwide would increase from 100 trillion cubic feet to 163 trillion cubic feet in 2030. More importantly, according to the report, while in 2004 Organization for Economic Co-operation and Development (OECD) countries accounted for 40 percent of global natural gas production and 52 percent of consumption, in 2030 they will produce 27 percent and consume 43 percent of global output. To put the numbers in perspective, 30 key market democracies will increase natural gas production by only 0.4 percent annually on average, while their consumption will grow at 1.2 percent each year. By 2030, more than one-third of the natural gas consumed by OECD countries will have to be imported.

In the electricity-generation sector, the United States finds itself in an especially difficult situation because of decades of neglect, especially in the area of nuclear power. Since the 1979 Three Mile Island incident, building nuclear plants in the United States has been all but politically impossible. Most estimates also find that prospects for expansion of hydroelectric power are limited, as most high-elevation water sources of electricity have already been dammed. And the lead times needed to build coal-fired plants are crippling: obtaining a new permit for a coal-fired plant in the U.S. takes five years on average. With the prices of oil and natural gas soaring worldwide, oil- and gas-generated electricity will inevitably lead to higher electricity prices, further undermining the competitive position of U.S. industry.

Today the triple pressure of foreign government-controlled access to oil, the skyrocketing price of natural gas, and the insufficient power-generation sector makes energy the central national-security issue for the United States. And the deteriorating situation in the Middle East only compounds stress on the already precarious supply chain. Those anxious about the current combination of high demand and limited supply should consider the impact of a wider war in the Middle East. With oil soaring toward $300 a barrel, there would be no security issue on the horizon other than energy.

In the new security environment, the United States has a choice: continue on the current path of energy dependence in a non-market-driven pricing environment—with ever-greater balance of payment problems, deindustrialization, transfer of national wealth to the oil producers, and gradual loss of sovereignty—or push with all available government and industry resources to move away from fossil fuels.

After four decades of arguments that globalization has all but obliterated traditional realist concerns about resources, we are about to learn again that there is no substitute for controlling your energy supply. For the United States, an energy policy that makes us independent of foreign energy sources should be our most critical national security goal. We simply cannot continue to transfer hundreds of billions of dollars every year to buy a commodity whose price is arbitrarily set by foreign governments, and in the process bleed the national wealth it took America two centuries to accumulate.
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Andrew A. Michta is professor of National Security Studies at the George C. Marshall European Center for Security Studies in Germany. The views expressed in this article are those of the author and do not reflect the official policy or position of the George C. Marshall European Center for Security Studies, the Department of Defense, or the U.S. government.

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