Global Energy Markets: Worse Than You May Think

Speaking at a briefing on global energy markets, organized by The National Interest, a leading authority on international energy issues warned that the United States could face an acute energy crisis-including supply disruptions and price increases t

Speaking at a briefing on global energy markets, organized by The National Interest, a leading authority on international energy issues warned that the United States could face an acute energy crisis-including supply disruptions and price increases to $70 per barrel for oil and $2.80, or more, per gallon for gasoline-in the next few years.

J. Robinson West, founder and chairman of PFC Energy, one of Washington's most influential international energy consulting firms, is a former Assistant Secretary of the Interior in the Reagan Administration and a member of the advisory council of The National Interest.  Former National Security Advisor, Brent Scowcroft, moderated the discussion at The Nixon Center.

Using his essay "The Future of Russian Energy" (in the Summer 2005 issue of The National Interest) as a departure point, Mr. West noted that after 9/11, many were predicting that, to reduce dependence on Saudi Arabia, the United States would increase its reliance on Russia as an alternative source of supply. "I am here to tell you," he declared, "that Russia is not the key to America's energy future." 

The energy sector is being mismanaged in Russia, he observed, and there is no competent bureaucracy to oversee operations.  More broadly, West asserted, the country's political leadership has not set clear priorities for what it wants.  The heavy and inefficient hand of the state is bearing down on the energy sector and little has been done to improve weak management accountability.  Moreover, he said, despite high oil prices, Russian firms are not investing in upgrading existing infrastructure or developing new pipelines and fields.  As a result, PFC Energy's analysts no longer feel that Russian oil production is set to peak at 10 million barrels per day in 2008-they see production reaching a lower plateau much sooner.

In part, due to uncertainty following the Yukos case, foreign investors are still reluctant to come into Russia, West said.  Yet, he added, Russian energy sector managers do not seem to understand that the oil business requires constant reinvestment and take money out of their companies instead.  Gazprom-as a company-is making less now than it was three years ago, when oil prices were around $20 per barrel.

In fact, West argued, one of the curses of the Russian energy sector is the equally high prices for oil and gas- as a result, there is no incentive for the government to reform while money is still flowing in in such large supply.  There is a lot of "gravy" circulating widely instead.  Of course, he continued, these problems are not unique to Russia.  State oil companies hold 77 percent of world oil reserves and high prices are discouraging needed changes (and funding massive public sector spending) in Mexico and other countries as well.

Global energy markets are in a peculiar stage today in which demand is not being dampened by rising prices, West said, creating a situation where-in the absence of reinvestment-there is nowhere for the excess capital to go.  Today's markets are also unique in that what is and will remain a cyclical business does not seem susceptible to the normal cycling down after a price boom.  The price of oil will fall significantly from today's levels again in the future, West asserted, but asking when is like asking a Maine lobster fisherman if he's been a fisherman all his life; the answer will likely be "Not yet." If you ask him if the fog will rise, he answers, "Always does."  Unfortunately, finding the specific answers to these questions that business leaders and policy-makers crave is extremely difficult.

West also noted that the high level of uncertainty in today's energy market is a key driver of high prices.  There are considerable political uncertainties hanging over most of the major producers-including Russia, Venezuela, Iran, Iraq and Nigeria, he explained.

The very real problem of declining production compounds these uncertainties.

In Iraq, West said, the petroleum sector is in a shambles.  The interim government does not have the authority to make binding deals, and the professional cadres in the oil ministry are being replaced by "acolytes of Chalabi."  As a result, he continued, corruption is increasing to such a point that Anglo-American oil firms will not be able to do business in Iraq-leaving the field open to Chinese, Russian or other less constrained companies.

West continued, pointing out that Iranian production is declining as well, and a new team is coming to power that is more prepared to pursue Iranian interests in the region, which could lead to conflict.  This new team is also not interested in international investment and ideologically opposed to the presence of foreign companies, he concluded.  Turning to Venezuela, West described the state oil company as being on the verge of collapse, and the Chavez government as unstable.  Mexican production is about to drop due to aging fields and infrastructure, and the Mexican constitution prohibits international investment in its oil sector.  Moreover, Mexican politicians have been diverting a cash flow out of PEMEX into other projects, leaving little for reinvestment, he concluded.  For politicians, West said, "oil is like plumbing … as long as it works they don't care" about efficient operations or long-term sustainability.  This leads to underinvestment in infrastructure, pipelines, and development of new assets.