1

America's Energy Challenge

America's Energy Challenge

Mini Teaser: If America is to weather the coming energy storm, it must find safer harbors.

by Author(s): Ian BremmerCrispin Hawes

Whoever wins the presidential election this fall must immediately address America's dependence on the Middle East for such a large percentage of the nation's energy needs.

At present, the United States is outsourcing its energy policy to Saudi Arabia. The Bush Administration (like a number of its predecessors) expects Saudi Arabia to act as a swing producer to ensure that oil is available in quantities sufficient to keep the U.S. economy moving at the pace Washington wants. But it is unreasonable to expect the world's largest exporter of oil consistently to define its interests in harmony with those of the world's largest importer. If the Saudis can sell their oil at a high price and hang on to the leverage that comes with being the only nation in the world with enough current reserves to move the world market price, that is what they will do. In fact, that is what they are doing.

America's dependence on oil from the Middle East in general--and Saudi Arabia in particular--leaves America dangerously vulnerable to the mid- and long-term political shocks the region will experience. The Saudi regime is facing a series of tests that will only increase in intensity over the coming years, as a population explosion challenges its ability to provide for its citizens. Unemployment and under-employment are already growing issues that reflect social as well as economic ills. An increasingly youthful population is simmering with frustration but lacks a legal outlet for its dissatisfaction. In Iraq, it is not at all clear that the interim government can safely pass power to a stable permanent government. In Iran, a young, highly literate, well-educated population will eventually challenge the hold the mullahs have placed on social reform. Egypt is likely to experience significant political shocks as Hosni Mubarak's health deteriorates, and the Israeli-Palestinian conflict is likely to percolate for the foreseeable future.

The reality of today's global crude oil market is that it will remain tight for some time to come. Even if the United States were able to import all its oil from outside the Middle East, it would still be vulnerable to Middle Eastern upheavals that would impact global production levels and prices. To reduce U.S. vulnerability to the political shocks of energy-exporting states and the volatility in energy-exporting regions, two primary strategies must be pursued. The first--reduction of domestic crude oil consumption and a shift to alternative fuels--is beyond the immediate scope of this article. In conjunction with this effort, however, Washington must seek to better diversify America's energy sources and incrementally increase the world's crude oil capacity, particularly through a coordinated effort with its allies. To do this, it will have to formulate and implement policies designed to help locate new reserves of oil and gas in regions beyond the Middle East, particularly in the former Soviet Union and West Africa. Indeed, one potential source for an additional amount of oil, Russia, offers U.S. policymakers important opportunities to diversify its energy supply and cooperate with a key regional player in enhancing political stability in some of the most volatile areas of the Eurasian landmass.

An Insatiable Thirst for Oil

The world currently uses around 80 million barrels of crude oil a day, with the United States consuming around 20 million barrels per day (BPD), of which half is imported. At present, daily production matches demand.

The Paris-based International Energy Agency (IEA) has projected an average annual increase in global energy demand of 1.7 percent a year between 2000 and 2030, an increase over current consumption levels of about 65 percent. While the IEA forecasts on the conservative assumption that consuming countries will maintain current energy policies and does not factor in the possibility that new technologies will be developed, there is no question that world demand for energy is rising fast and will likely accelerate in the coming decades.

Crude oil consumption is expected, based on the IEA projections, to reach 120 million BPD by 2030. Crucially, it is projected are that more than 60 percent of the increase in global primary energy use in 2030 will come from developing countries, particularly Asian states. The developing world's share of global demand will rise from an estimated 30 percent in 2003 to 43 percent in 2030, with a resulting slide in the Organization for Economic Cooperation and Development members' share from 53 percent to 47 percent. This surge in the developing countries' use of energy will be driven by their rapid economic and population growth, coupled with industrialization and growing urbanization. China is already the second-largest energy consumer in the world after the United States, and its influence on global energy markets will only increase as economic growth drives demand.

The core of the failure of current U.S. energy policy is that the only real flexibility in the market is held by OPEC, which not only controls the bulk of global reserves, but most importantly for U.S. policy purposes, most of the world's spare production capacity. At least for the next four years, virtually all the world's additional production lies beneath the following states: Saudi Arabia, the United Arab Emirates, Algeria, Kuwait, Libya, Russia, Kazakhstan, Iran, potentially Iraq and possibly Angola.

Yet OPEC's spare capacity by the beginning of August stood at under one million BPD, all of it effectively in Saudi Arabia. While the United States would like several OPEC member states to develop spare capacity for better-diversified sources of energy for the world market, Saudi Arabia wants to maintain the influence that comes with being the only producer that can make a significant difference in total output--and therefore price. The Bush Administration, while pressuring the Saudi government to do more to fight Islamist terrorism, continues to place inordinate faith in the Saudi royals to act as a "swing producer" of oil. Saudi Arabia has made efforts recently to bring crude prices down from high levels that might encourage greater conservation or investigation into alternative fuel sources, but, unsurprisingly, it is the Saudi interest that is being served here.

It is hard to escape the logic that Saudi and American interests simply are not the same. Saudi Arabia has no incentive to ramp up its production to full capacity. Moreover, the United States has been loath to spend its political capital with Riyadh to send a clear signal that spare capacity must be developed and brought online.

Mature oil and gas fields are being depleted in many producing countries, including Saudi Arabia. Without new exploration and development in the major crude oil production areas, there is no hope of staying ahead of the demand curve.

Developing New Capacity

For starters, an effective U.S. energy policy would press Kuwait to open up its northern fields, regardless of OPEC quotas, something for which U.S. oil companies have been campaigning. The Kuwaiti parliament has rejected such a move, and while the current administration trumpets its influence with the Gulf states, it is not leveraging these ties sufficiently to support U.S. energy policy. Pressing Kuwait and Abu Dhabi to liberalize their oil sectors to expand production capacity would be a good use of Washington's influence in the Gulf.

In some areas, the need to develop reserve supply must be undertaken with more care. The Bush Administration hopes to push Iraqi oil output toward its 1979 level, the output Iraq enjoyed before Saddam's war with Iran nearly bankrupted the country--an estimated 3.5 million BPD. However, as with much of Washington's current Iraq policy, the goal is a short-term one.

Extraction is currently undertaken using exactly the same aggressive methods used by the Iraqi national oil companies through the sanctions period. In the drive to quickly maximize output, these methods risk damaging reservoirs, needlessly limiting the country's long-term reserve base. This is a clear example of the danger of privileging short-term political interests--showing the world that Iraqi oil is back online--over the longer-term interests of both the Iraqi oil sector and U.S. energy requirements.

The United States, however, should provide Iraq the physical security (through more troops if necessary) and immediate investment needed to begin to get Iraqi oil production moving again. This will have the collateral benefit of providing Iraq income for its own reconstruction. Iraq remains at present outside OPEC quotas, and the United States should try to keep it that way.

On Iran, Washington's approach of isolation, rather than engagement, has slowed Iranian output growth, a realistic potential competitor for Saudi capacity. The investment climate created by the U.S. sanctions policy has deterred foreign companies from making much needed investment in oil infrastructure and exploration and has strangled capacity growth. A less rigid U.S. approach toward Iran doesn't imply a "soft line" policy. The United States should continue to support international efforts to keep Iran from going nuclear and to condemn the Islamic Republic's domestic repression and support for terror groups. But the United States and Iran have significant common ground on which a more cooperative relationship could be built: Both countries want stability in Iraq and Afghanistan, and both will ultimately need Iran to produce more oil.

On Libya, the removal of sanctions will have a demonstrable effect on the development of new capacity. The growth of output volumes in Algeria and in West Africa could also represent an alternative source of spare capacity, but the states concerned are currently producing at maximum levels, and any spare capacity is dependent on their adherence to OPEC policies. Although oil production in Angola fell in 2003 because of production problems in the Kuito field, production is likely to resume its upward trend and should reach 1.22 million BPD in 2005 as new oilfields come online.

For all its talk about the need to develop West African reserves to counter-balance the Middle East, the current administration has not helped Angolan efforts to fund the expansion of capacity. While there are serious reasons to be concerned about governance issues in Angola, the U.S. approach has left the Chinese as the most important new actor in the sector.

All this potential new capacity from OPEC countries and in West Africa will not cover the expected expansion in Asian demand over the next ten years. To make up the difference, the United States must look toward Russia and the underexploited and underexplored fields of the Caspian and Siberia.

A Eurasian Energy Strategy

The so-called new "Great Game" in the Caspian region--the competition between the United States and Russia for influence and resources in Central Asia that began with the end of the Cold War--is over. It ended in a draw. Russia was not able to monopolize the region's energy transportation links; the construction of the Baku-Ceyhan pipeline, in particular, ensures that not all Caspian oil will cross Russian territory on its way west. At the same time, Russia's gas monopoly, Gazprom, still controls the transport of Central Asia's gas, which, as in Soviet times, will pass through Russian-controlled routes.

Moscow cannot prevent limited American political and economic influence in the Central Asian area of the former Soviet space. But given the traditional economic and political dependence of the local Central Asian governments on Moscow, Russia will remain a central player in the region for the foreseeable future. Neither Moscow nor Washington gains much from further geopolitical gamesmanship.

If there is nothing to be gained by rivalry, there is plenty to be gained through partnership. For the energy-dependent industrialized West, bringing more of the Caspian region's considerable reserves to market is vitally important. Given America's current range of security commitments around the world, it is more important than ever that Washington develop a strategy to increase and diversify its energy supply.

Russia's global market power is seriously limited by the lack of sufficient export capacity in the Transneft pipeline system. The total export capacity of the system is about 3.85 million BPD, but 350,000 of those barrels are used for exports of Kazakh crude, and another 300,000 BPD of capacity sits idle because of an 18-month-old Russian embargo on pipeline exports through the Latvian port of Ventspils.

One million BPD are exported by rail, a relatively expensive way to export oil, because there is no available pipeline capacity. But the situation is actually worse than that. Most of Russia's 1.6 million BPD of refined product exports are, in fact, value damaging. If there were enough pipeline export capacity for crude oil, most of these 1.6 million barrels would be exported as crude rather than product. So, assuming that the Ventspils embargo eventually ends, the Transneft system is roughly 2.5 million BPD short of current needs.

As part of an integrated global energy policy, the next presidential administration should push for an ambitious pipeline development policy with Russia, in the same way that previous administrations actively lobbied for the development of the Baku-Ceyhan pipeline in the 1990s. At the moment, there is no real movement on such a strategy.

Russia too has much to gain from a cooperative relationship with the West in the exploration, exploitation and transport of Caspian-area energy reserves. The technology and investment the West can provide are crucial for the realization of Russia's plans to maximize profits from exceptionally high oil prices, as the non-energy sectors of the Russian economy struggle to become more competitive. In addition, the Kremlin has so far accepted the temporary presence of American soldiers in Central Asia, because these troops provide Russia a nearly cost-free buffer against any Central Asian unrest that might threaten Russia's southern flank. A mutually lucrative energy development partnership with Russia in the politically volatile Caspian region could lead to broader and deeper cooperation in the development of oil reserves in Siberia and the Russian Far East and the construction of a vitally important new pipeline from Siberia to the Pacific.

The states of the Caspian region badly need the political and security stability that will attract continuing investment in the development of its energy resources. The zero-sum notion that there is a certain amount of oil for the regional powers to fight over is dangerously shortsighted, particularly at a time when the world's hunger for energy is growing so quickly and ever more pipelines and export routes are needed to get supplies to market. There is more than sufficient market share for Russia, Azerbaijan and Kazakhstan to guarantee each of them substantial national revenue. What is needed is a dynamic, well-coordinated partnership that profits from local comparative advantages and economies of scale to get untapped energy resources to the markets that need them.

The United States, the European Union, China, Russia and the other littoral states of the Caspian should view the Caspian area as a single integrated energy marketplace. Together they should begin a comprehensive "Eurasian energy dialogue" that will bring together the major outside investors--especially the United States and the European Union--with the region's key actors, including Russia, Azerbaijan and Kazakhstan.

Joint projects that combine the skills, resources and assets of Western, Asian and Russian firms can bring energy deposits online that would otherwise remain in the ground. Tension and rivalry between China and Japan over access to Russian oil and gas can be eased by a more transparent and cooperative approach to the development of Caspian energy resources and the inclusion of China at the highest levels of the energy dialogue.

Washington must resist the temptation to bring its Persian Gulf strategy, in which the United States jealously guards its regional hegemony in order to deter and contain any potential rival, to the Caspian. While the dangerous potential competitor in the Persian Gulf, Iran, has no interest in any partnership with the United States beyond the most pragmatic situational cooperation, the Caspian's regional heavyweight is Russia, a nation with which the United States and Europe reasonably expect to enjoy close relations, and which the United States cannot and should not attempt to isolate.

What Lies Ahead

In an election year, and with oil prices at record levels, the goal of energy independence is going to get a lot of airtime. It should, because fuel efficiency, conservation and the development of alternatives to fossil fuels are key aspects of any long-term strategy to safeguard the integrity of the U.S. economy. An integrated energy policy would recognize also that domestic energy efficiency measures will have only a limited impact unless achieved in tandem with parallel improvements in consumption efficiency in other major consumer nations. In particular, the United States should promote greater energy efficiency in major developing economies, such as China and India, that are expected to contribute most substantially to global demand growth over the coming decade.

But over the next decade, Washington will continue to have to look abroad for increased energy supply capacity. The reality is that while conservation and the development of alternative sources of energy will take an increasingly important role in changing the balance of America's domestic energy consumption, particularly in power generation, the transport sectors of the economy will remain for the foreseeable future dependent on products refined from crude for 95 percent of its fuel.

In addition, the next U.S. president--whether George W. Bush or John Kerry--should be less reluctant to deploy the Strategic Petroleum Reserve (SPR) to support lower prices. The failure to use the SPR in January 2003 to combat the impact of the Venezuelan strike--ostensibly because the administration was safe-guarding the reserve in anticipation of the conflict with Iraq--is a key underlying factor in the cycle of crude price movements that have now risen to well above $40 per barrel. The next administration should be ready to use the SPR to protect U.S. interests and to encourage the Saudis in particular to act as the swing producer.

Fuel-switching--the practice of substituting one fuel for another based on price and availability--should be promoted as a fundamental part of energy policy. Global natural gas reserves are far more widely dispersed than viable crude reserves, allowing significant production in North America and Europe, although the Middle East and North Africa do contain large exploitable volumes. The development of liquefied natural gas (LNG) facilities is moving forward, but the aggressive expansion of Asian demand for crude oil make further progress both in these facilities and the process of generation conversion essential. The development of LNG production facilities in the Middle East offers a new administration a range of opportunities for policy development towards states with massive gas reserves, such as Algeria, Libya and Tunisia.

But beyond all these policy options, which promise to help only at the margins or in the long-term, the next president must diversify and increase incrementally the sources of supply around the world. He must limit the vulnerability inherent in depending upon a single source of meaningful overcapacity--Saudi Arabia--to stabilize world energy markets. Enhancing energy-supply diversity and global capacity should be one of the driving forces in the formulation of our future security policy generally and should provide a guiding "principle of action" in our bilateral relations with foreign energy suppliers.

Ian Bremmer is president of Eurasia Group and senior fellow at the World Policy Institute. Crispin Hawes is director of Middle East and Africa, Eurasia Group.

Essay Types: Essay