The Global Zeitenwende
How to Avoid a New Cold War in a Multipolar Era
TWENTY YEARS AFTER it burst into international politics with the 1973 crisis, oil remains a strategic commodity critical in the global balance of power. But, looking toward the 21st century, the perspective has changed radically since those days when it seemed that oil power would engulf world politics.
Today, economics is taking precedence over politics. Many exporting countries court the international oil companies that they once shunned. The door that was slammed shut in the 1970s is being reopened. In fact, with the prospect of the opening of the petroleum reserves in Russia and many other countries that up to now have been politically inaccessible oil is truly a global business for the first time since the barricades went up with the Bolshevik Revolution.
In retrospect, the shocks of the 1970s can be seen as the high point of oil nationalism. It was the era when the world economy hung on the comments of oil ministers in the hallways of OPEC meetings and when the wrongs of colonialism were to be set right. It was to be the beginning of the "new international order" a zero-sum game that would see a wholesale redistribution of wealth from the North to the South and a diminution of the international stature of the United States and the other major industrial powers.
Much of that is now history. The oil exporters learned that they needed the importers as much as the importers needed them. The producers may have had oil to sell, but the consumers provided the markets. They could also provide, when needed, security. These developments lead to new questions about the very meaning of security, and what durable relationships are now possible between consumers and producers that will serve the longer-term interests of both. The Persian Gulf War of illustrates both the critical position of oil in the global balance of power and the importance of interdependence between producers and industrial consumers. There is also the increasingly important question of how to reconcile energy use and environmental imperatives.
With the collapse of communism, the global security issues that were uppermost have receded. Regional security issues, however, remain. The world is now shifting back to oil dependence on the Middle East, where modernization and Islamic revivalism are in conflict. Moreover, oil's traditional relationship to other global issues continues. It is intertwined with Russia's transition to free markets and Asia's economic growth. The United States is back on the track of higher oil imports, which means that its foreign policy will remain acutely sensitive to developments in oil-exporting countries.
In the years ahead, the global oil industry will require much higher levels of investment than in the recent past to meet both energy needs and environmental requirements. Politics, which in the 1970s sundered economic links between producers and consumers, is now permitting the reconnection of those links, though on a different basis. Thus, a new dimension of security between exporting nations and oil companies will come from the interweaving of investment, trade and finance. This reconstruction will mobilize the investment necessary to develop supplies for the next century. As a result, producers will be able to tap into the capital, technology and skills of consuming countries while supplying their markets.
IN SEPTEMBER 1973, Japan's prime minister went so far as to predict that an oil crisis would come within ten years. It came in more like ten days, with the surprise attack that launched the 1973 Yom Kippur War, quickly followed by the oil embargo. In fact, the crisis had been building over the previous three years as the world market tightened and oil exporters began pushing up prices and asserting control over the oil resources within their borders. The resulting oil crunch took on the political cast of a battle between South and North.
The 1973 crisis drove prices from $2.50 to $10 a barrel and sent the global economy into a downturn. Then, at the end of the 1970s, revolution disrupted supplies from Iran, creating a panic that drove prices from $13 to $33 a barrel, seeming to foretell a permanent shortage and continuing turmoil.
Within a few years, however, it became evident that the price increases and the specter of shortages were creating powerful counter reactions. Non-OPEC oil development proceeded at a rapid pace. Conservation proved far more powerful than generally expected. All over the world utilities switched from oil to other fuels. Confronted with such developments, the exporters found that they could maintain high prices only through laboriously negotiated production quotas.
OPEC was soon faced with declining oil demand and diminishing market shares. Its share of the world oil market (excluding the former Soviet Union) fell from 63 percent in 1972 to 38 percent by the end of 1985. In one memorable quarter, Saudi Arabia's oil production had slumped to less than that of the British sector of the North Sea. In 1986, in the exporters' quest to regain market share, oil prices collapsed, falling to $10 before recovering to about $18 a barrel.
In the meantime, the consuming countries established security measures that would help moderate fixture crises. These included the International Energy Agency, an international emergency sharing system, increased communications, and prepositioned stocks such as the U.S. strategic petroleum reserve.
In the same years, the oil market became more flexible and transparent, with the development of trading ("oil as just another commodity") and the rise of futures markets. Oil is now carried around the world not only in behemoth supertankers but also in a sea of electronic information that instantaneously sweeps through trading rooms on every continent. While it can take a decade or more to develop a major new oil field, today's markets can swiftly adjust to changes in current supply and demand. For example, oil prices rose dramatically at the beginning of the gulf crisis but began declining in response to adjustments after only two months, as other producers hastened to bring unused capacity back into production. By the eve of Desert Storm, oil prices were actually lower than they had been a half-year earlier, in the weeks before the Iraqi invasion of Kuwait.
THESE CHANGES HAVE brought a dramatic shift in the perspectives of oil exporting countries. They are redefining their relationship with the market and with the international oil industry. For the exporting nations, the essential issue of sovereignty has been answered. They own their resources and determine what happens to them. That was their essential victory in the 1970s. Now undisputed, this fundamental political recognition provides the exporting countries with the flexibility to focus on their longer-term economic interests.
Part of this reflects a shift in the broad intellectual currents in the global economy. In the 1970s the trend was toward increased state control—whether nationalization in developing countries or price controls in the United States. Today, the trend is quite the opposite—toward privatization, deregulation and commercialization. "The God that Failed" is not only the intellectual's adherence to Marxism but the very socialist model embraced as the path to development throughout much of the Third World.
Many of these developing countries are also in an economic bind. Populations are growing rapidly. When combined with flat oil prices, that means declining real per capita income. The OPEC surpluses, which so worried central bankers in the 1970s, have long since disappeared. What is less recognized is the debt burden and the budget and balance-of-payments pressures many of these countries are under. Like many other governments around the world, they need to reduce government spending and deficits. Yet they face political difficulties in making such adjustments. In a world in which oil prices are not even keeping pace with inflation, oil earnings can be increased only through greater productivity and increased output. But that takes significant investment—money that many exporters do not have.
Thus economic imperatives and changing ideologies are moving current and would-be exporting countries to seek the international oil industry's capital, technology and management skills. These countries are showing a new willingness to transfer the risk of exploration and the investment requirements to an international oil industry that is organized to carry such risks and that has the capital—thus preserving limited state funds for investment in infrastructure and societal needs.
Around the world, doors are being reopened. Venezuela, which nationalized foreign companies in 1976, is cautiously inviting them back to develop marginal fields. Argentina, which established the first state oil company in 1922, is now privatizing it, and at the same time is encouraging foreign companies to explore and produce within its borders. Algeria is actively inviting in companies to stem the threatened decline in its oil production and to bolster natural gas output. And Vietnam, no longer on a Soviet dole, has offered some of the most attractive terms to entice companies to explore there. It is already the site of a mini-oil boom and will become the site of a bigger boom once U.S. restrictions on American companies are lifted. China, worried about the adequacy of energy to sustain its economic growth, is opening new areas to Western companies as well.
BUT OF ALL THE DOORS, the biggest and most uncertain opens into the former Soviet Union, where the successor states, particularly Russia, are engaged in what may be described as the most extreme privatization in the world—the privatization of the revolution.
Behind this transformation lies the failure of state enterprise, which is central to the overall collapse of the Soviet economy. Just five years ago, the Soviet Union was the world's largest oil producer, having pushed its production to 12.5 million barrels per day. As an oil exporter the Soviets had been among the biggest beneficiaries of the price increases of the 1970s. The huge windfall in foreign earnings enabled the Soviet Union to postpone economic reform. ("We will never make that mistake again," Russian Prime Minister Viktor Chernomyrdin said recently.) After the 1986 oil price collapse, the Soviet system paid a terminally heavy price for its failure to grapple with reform earlier.
In addition, its stellar production numbers obscured the grave weaknesses—overinvestment in terms of return, poor oil field practices and outdated technology. Most of the Soviet oil production was concentrated in Russia—11.5 million out of 12.5 million barrels per day in 1988. In the five years since 1988, however, production in Russia has collapsed to 7 million barrels per day. The astonishing drop is equal to 60 percent of total U.S. oil production and is greater than the output of any OPEC nation except Saudi Arabia.
The impact of this decline on the world market has been cushioned by the precipitous drop in Russia's economy, which has drastically reduced its domestic oil demand, and by the reduction in nonhard currency exports from Russia to the other former Soviet republics. Hard currency exports of oil and gas are essential to Russia's economic recovery, as they currently represent half of total hard currency earnings. At current hyperinflation exchange rates, oil and gas earnings are twice Moscow's entire budget deficit.1
Until the late 1980s, the Soviet oil industry was closed to the outside world. Even statistics on the size of reserves were a state secret. While its personnel had high-level skills, they worked with technology 30 or 40 years behind that of the West. Since the late 1980s, Western oil companies have been able to carry out geological research with advanced technologies. As a result, while output continues collapsing, the estimates of the potential have been growing. Reserves, now thought to be three or four times the unofficial number of the 1980s, are in the class of the big Middle East producers. They will, however, be more expensive and less convenient to find and produce than those in the Middle East. Foreign companies are anxious to participate, viewing the geological opportunities to be among the best available in the years ahead. They recognize the many risks and obstacles, and discover more along the way, but they have concluded that the biggest risk would be in not participating.
Foreign investment could make a major difference. It is estimated that investment on the order of $50 billion between now and the year 2000 will be needed to stabilize Russian oil production at its current levels. Otherwise output could fall to as low as 4 million barrels a day, which could be disastrous for Russia. To return to the output levels of the 1980s could require another $50 to $70 billion of investment. Russia does not have resources available anywhere near that size. Clearly foreign investment will have to provide a substantial part. Foreign investment, by bringing in Western technologies, will also substantially improve environmental performance. The end of the communism has revealed a devastating and deadly pattern of environmental abuse. No exception is the oil industry, which is estimated without to leak annually the equivalent of 400 supertanker cargoes from pipelines into the soil.
But significant foreign investment will not occur until the legal, fiscal, financial and institutional foundations are in place, at least to some degree. In turn, that depends on the overall evolution of the Russian political system. The current situation is too volatile and unpredictable for international oil companies to make large commitments.
Another hindrance is the opposition of some Russians to foreign participation. They argue that they do not want to be "colonized" and that the Russian industry can modernize itself and generate its own surplus for investment. If there is Western participation, they say, it should be on Russian terms and Russian terms alone. Missing, however, is an awareness of the international competition for oil investments. Companies can choose between Russia, Africa, Latin America and Southeast Asia—as well as the highly promising oil and gas reserves of the newly independent states of Azerbaijan, Kazakhstan and Turkmenistan.
That investment flows are available is illustrated by the shift of capital out of the United States. In the last five years, oil companies have dramatically realigned their spending away from America to the rest of the world. Driving the shift is the quest for better opportunities, reinforced by increasing operating constraints and environmental barriers to exploration and production in the United States. The shift also means that the contraction continues in the domestic U.S. oil industry.
It is hard to see how the Russian oil industry can be turned around without Western participation. Some progress, in fact, is already being recorded. Recently a Russian official reviewing one American-Russian proposal concluded, "This project will bring us $40 billion in foreign earnings over the life of the project that we otherwise would not have. How can we not go ahead?" Facilitating the involvement of Western companies in Russian oil development in ways that Russians themselves will regard as beneficial and fair is a matter of the highest priority. Such cooperation will not only help support the overall stability of the world oil market. It is also of critical importance to Russia's ability to make the transition to democracy and free markets, which in turn will be one of the key factors in global security.
But the risks also have to be reasonable for the Western investors. That means creating a framework that will give investors confidence over the longer term. Some steps have been taken, such as the developing European Energy Charter, to which, despite its name, the United States is a party. But a good deal more will have to be done.
THE OPENING OF DOORS around the globe points to a competition between countries for investment and a surge in activity by private companies. Yet producers and consumers face a new potential for divisiveness—over environmental policies. In the 19705 the dominant fear was of running out of oil. In the 20 years since, proven world oil reserves have doubled to over one trillion barrels. Today the policies of industrial countries increasingly focus on the environmental effects of energy use, particularly of oil.
A host of industrial world policies has singled out oil as the product whose use is to be discouraged. To the exporting countries, these policies disadvantage the product central to their national incomes. "Petrophobia' is the label given to this trend by Saudi Arabian Petroleum Minister Hisham Nazer. "Oil," he has said, " has been made the culprit."2
The conflicting interests are embodied in the controversy over broad-based energy taxes, such as the come-and-gone BTU tax in the United States and the European Community's would-be carbon tax. For the industrial countries, such taxes raise revenues that contribute to closing yawning budget deficits and meeting environmental goals. To the exporters, however, such taxes mean a reallocation of revenues, or economic "rent," between producers and consumers, thus damaging the exporting countries' main source of national income.
Last year, EC countries earned about $200 billion in taxes on the 11.8 million barrels per day of oil products they consumed. This is nearly three times the $74 billion that the oil exporters earned selling a similar amount. The Italian treasury alone earns as much in its tax take on 2 million barrels a day of consumption as Saudi Arabia earns in producing more than four times as much oil.3
The drive for increased energy taxes has two effects on oil exporters. First, it makes them question their pricing strategies. Second, and of longer-term significance, it makes exporters question the value of investing in capacity necessary to support a growing oil demand that the industrial countries are trying to discourage.
Yet vigorous environmentalism is a reality that all participants in the international petroleum industry must recognize. Oil has been a business of technological change since the first well was drilled in Pennsylvania in 1859. Increasingly, the technological effort will be applied to meet the environmental agenda. The investment and technology that will be required—whether in production or in refining cleaner products—provide a new dimension in which the interests of producers and consumers will coincide and cooperation will be essential.
OIL DEMAND, left stagnant or declining by the 1970s' oil crises, only began to grow again after the 1986 price collapse. By 1989, world consumption finally regained the previous record level of 1979, and is continuing to grow. Indeed, if Russia is excepted, world oil demand is currently increasing at 1.8 percent per year, even in the midst of a weak global economy.
But the pattern of growth has changed. Demand is rather flat in North America and Western Europe, reflecting, among other things, the growing use of more efficient automobiles. In these nations the oil industry is preoccupied with the costs of staying in business. The U.S. oil industry is estimated to be facing $152 billion in costs and investment over the next 20 years to meet environmental standards.4
Demand growth is elsewhere—reflecting economic advancement in the developing world. The new prize is Asia. Economic "miracles," sustained growth, and rising incomes require energy. Many of these countries are swiftly applying higher environmental standards. But they do not want to be impeded from striving for higher living standards. Over a decade, Asia will require in excess of a trillion dollars of energy investment to support economic growth.5 Oil demand will increase by five million barrels or more. By early in the next decade, Asia will be consuming more oil than North America. This means a shift in the oil market s center of gravity and that the Asian countries will come to play a bigger role in investment and oil trade, commensurate with their stakes.
Despite continued conservation, global oil demand could be 15 to 20 percent higher a decade from now. The trend could, of course, be changed by the considerable research and development efforts to find alternatives to oil, particularly in transportation. Yet, as things are today, oil is more than economically competitive—something that would have seemed unlikely in the era of the oil crises.
The years ahead will see an economic and environmental competition among energy sources, a technological horse race in which tens of billions of dollars will be wagered. To date, oil is proving to be environmentally competitive, keeping up with or even running ahead of new standards, albeit with considerable investment.
Natural gas, once the unwanted by-product of oil production, is now oils biggest competitor and becoming the premium fuel around the world. A great deal of the financial resources of the "oil and gas industry" will actually be going into natural gas. It is an environmentally attractive fuel; some even call it the "politically correct" energy source. A decade from now there is likely to be a vigorous and diversified international trade in natural gas. Natural gas is not a significant competitor in transportation, where oil reigns supreme. Rather, the battle for markets will be played out around the world in electric generation, where the emphasis will very much be on environmental attributes.
But there is a question mark over oil supplies. A U.N. embargo has excluded Iraq from the world market since it invaded Kuwait. As a result Iraq has forgone more than $40 billion of oil earnings since August 1990. At some point, however, Iraq will meet U.N. requirements and will reenter the world market with substantial exports. And when it does, prices could well sag for a time.
As it is, OPEC countries continue to argue over quotas. Still, the market balance is very different from the conditions of a decade ago. Even factoring in Iraq, the world oil market is operating at about 92 percent of production capacity, quite different from the 1980s, when it was down to 80 percent. Today's market is reminiscent of the balance in the 1970s on the eve of the first oil shock.
Although political considerations and producer-consumer relations are very different from the 1970s, a tight oil market is vulnerable to shocks in a way that an oversupplied market is not. Projecting into the next century, one sees no shortage of potential crises that could affect world oil supplies, with dangerous consequences. Future crises could arise from the Middle East, as in the past. Since the fall of the shah in 1979, Iran's population has grown from 39 million people to more than 60 million. Its policies in the future are uncertain, torn as they will be between Islamic militancy, both at home and abroad, and economic self-interest. A number of other countries are feeling the pressure of political Islam and social turbulence. But future crises could also arise from events in other parts of the world, such as some kind of disruption in the former Soviet Union.
If a disruption occurred in a tight market a few years from now, perhaps at a time of economic growth around the world, the effects could be quite sharp, both as measured in inflation and recession and in terms of raising international tensions.
Such risks underline the continuing need to assure an adequate "security margin" that can absorb such shocks. Moreover, considerable new production capacity will have to be added to support a growing world economy, but the timing of those additions is uncertain. What happens to oil prices, with all that they signify for the world economy, depends very much on the relative timing of demand growth and investment in new production capacity.
Where will the additional supplies come from? Not from the United States, where oil production has fallen by a dramatic 25 percent since 1986 and is continuing to decline. The domestic U.S. oil production industry is deeply depressed, and the U.S. oil services industry, which is the global leader, is also under heavy economic pressure. U.S. oil imports are likely to continue rising in the years ahead. Some of it will come from oil development that is being encouraged by more open investment policies around the world. As Russia struggles to stem its economic decline, at least two of the newly independent republics, Azerbaijan and Kazakhstan, will become important players in world oil market.
Much of the new supplies will come from the Middle East, in particular from Saudi Arabia. In 1972 the Middle East provided 42 percent of world oil (excluding the Soviet Union); by 1983 it has declined to 27 percent; today it is 32 percent, and will probably rise to 45 percent by 2003. This means that production capacity in the Middle East will rise from 18.3 million barrels a day to 28 million barrels a day. In light of the political and social forces in the region, and the potential for yet another surprise or two in the decade ahead, security of supply will be a continuing concern for importing countries, even as the exporters continue to worry about "security of demand."
There is no single answer to these two security questions. Rather, the best bet for stability in a changing world arises from a global pattern of investment and trade in which security is enhanced by the diversity and density of economic and political links and by the commonality of interests in an environmental age.
In the years ahead, relations between producers and consumers could become strained again if, for instance, economic and demographic pressures mount in the exporting countries, or if political instability becomes pervasive, or if ideology again shifts, or if changes take place in the balance of power of the kind for which Saddam Hussein bid. Or, for instance, if the exporting countries come to see the implementation of the environmental agenda in developed countries as an assault on their main source of national income.
Yet even as the Cold War division between East and West has lost its significance, so economic progress is also erasing the division between North and South that was once so intense. Today, producers and consumers have a common interest in the technological advances needed to keep oil environmentally as well as economically competitive. The global energy supply system itself has become much more flexible. Over the last two decades, both producers and consumers have learned powerful lessons that reinforce their mutuality of interests and recognition of interdependence. Those lessons in themselves are a form of security. They constitute a major element in a framework that can help buffer whatever surprises may lie ahead. (c)
1 Daniel Yergin and Thane Gustafson, Russia 2010-And What It Means for the World, New York: Random House, 1993.
2 Hisham Nazer, "The Development of the Environment and the Environment for Development," speech, Houston, TX, February 1993.
3 Joseph Stanislaw, "Ecotaxes and Oil Prices: A New Battle?" Cambridge Energy Research Associates, Cambridge, MA, 1993.
4 National Petroleum Council, U.S. Petroleum Refining: A Report to the U.S. Secretary of Energy, Washington, 1993. Forty-six billion dollars is estimated to be spent on existing facilities to meet existing requirements; $106 billion is for costs and investments either for new facilities or to meet anticipated requirements.
5 Cambridge Energy Research Associates, "Energy Investment to Meet Asia's Economic Growth," Cambridge, MA, 1993.
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