War by Other Means
Page 30
The historic shift in global energy production is reshaping the geopolitical landscape as well. The United States is in the vanguard of moving the world to much more diversified and oftentimes localized supplies of energy. While renewables, coal, nuclear, and hydro will remain part of the new mix, and even as coal remains the world’s fastest-growing energy source, a dramatic shift is occurring in oil and gas. In addition to its economic benefits, this diversification of supply will diminish the geopolitical leverage that some energy suppliers have enjoyed for many decades. All the great powers will be affected by these developments. Above all, the United States will remain uniquely positioned to use this new geoeconomic instrument to advance its geopolitical objectives around the globe for the foreseeable future.
The New Energy Landscape: Gas Is the New Gas, Oil Is the New Oil
In the early 2000s, headlines featured concerns about “peak oil” and potential new dependence upon imports of liquefied natural gas (LNG). Today we live in a different world.3 During the past seven years, the locus of global energy production has begun to shift away from traditional energy suppliers in Eurasia and the Middle East. New energy resources are being tapped around the world, including in the waters off Australia, Brazil, and Africa, and, to a lesser extent, in the eastern Mediterranean (Israel and Cyprus). The United States, however, has emerged as the leader of unconventional gas and oil production. Fracking is the main driver of this transformation. During the past two decades, energy innovators in North America modernized and combined two technologies whose lineage goes back more than thirty years: the precise horizontal drilling of wells that penetrate bands of shale, and hydraulic fracturing, whereby fluid is injected under high pressure into the rock to create fractures and then release gas or oil when the fluid is extracted. The impact of this production is now defining the economic contours of the new global energy landscape.
Consider the dramatic increase in U.S. natural gas production. As fracking unlocked new energy plays, U.S. Geological Survey estimates of technically recoverable gas in the United States increased by over 680 percent between 2006 and 2013. At the rate of U.S. consumption in 2013, the United States is estimated to have enough natural gas to meet domestic demand for at least eighty-five years.4 Shale gas production rose by over 50 percent annually between 2007 and 2014, a trend expected to broadly continue until 2040.5 In a dramatic turnaround, shale will soon dominate U.S. gas production. Whereas in 2007 shale gas accounted for only 5 percent of U.S. production, by the end of 2013 it represented over 40 percent.6 While terminals were previously being constructed to move foreign gas to U.S. consumers, U.S. companies are now competing to build new plants to export American LNG to the world.
Developments in oil have the potential to be just as significant. Total U.S. crude oil production has risen from 5.6 million barrels per day in 2010 to 9.4 million barrels in March 2015, nearly as high as daily oil production in Saudi Arabia.7 Fracking has generated dramatic increases in American production of Light Tight Oil (LTO) in places such as the Bakken formation in North Dakota and the Eagle Ford and Permian formations in Texas. Between 2008 and 2014, America experienced a 56 percent increase in LTO production—an increase that, in absolute terms, is larger than the total output of each of eight of the twelve OPEC countries.8 The Bakken alone crossed the 1-million-barrel-a-day threshold in December 2013. The long decline in U.S. oil production has been reversed: between 2008 and 2014, overall production increased by 77 percent.9
The United States is poised to become an energy superpower, a position it will likely retain for many years to come.10 Fueled by unconventional gas and oil developments, the United States surpassed Russia in 2013 as the world’s leading producer of oil and gas.11
Significantly, other countries will not easily mimic U.S. unconventional developments. Fracking took off in North America not just because of favorable geology. In addition, a distinctive convergence of factors—capital market financing that supported risk taking, a property rights regime that gives private owners outside federal lands the right to the natural resources beneath the surface, a dense network of private pipelines, a developed and competitive oilfield services industry, and an industry structure defined by over a thousand independent operators and entrepreneurs rather than a monolithic national oil company—provided an environment favorable to the unconventional revolution. While some other countries possess the right rocks, none matches the United States and Canada in this alignment of other factors. While many may well develop these resources, the path to significant production will be longer and more fraught, and most of the risks are aboveground.
Up until recent years, gas producers such as Qatar and Nigeria geared up to meet what was expected to be a burgeoning U.S. demand for LNG imports. The shale revolution is forcing these gas producers to deliver to new markets. While these exports first found a home in Europe in 2010 and 2011, they have since been partially redirected to Asia, where the thirst for gas continues to grow, especially after the Fukushima nuclear disaster. Given these opportunities, investors are now pushing forward with permits for new LNG terminals that will enable the United States to begin exporting LNG. While projections vary, most energy analysts agree that such exports would boost U.S. production of LNG within the next decade, contributing to increased global supplies.12 While an integration of international gas markets will require years of infrastructure investments and even then will not reach the same level as global oil markets, increased liquidity and exchange between the North American, European, and Asian markets could help put further downward pressure on prices in Asia and potentially Europe in the decade ahead.
The development of unconventional oil in the United States is having similar impacts on global oil flows. U.S. oil imports have declined steadily in recent years, a result of lowered demand due to the 2008 recession, growing energy efficiency (primarily in transportation), and, importantly, increased LTO production. The United States has begun to “back out” imports, starting with those countries whose oil is closest in composition to LTO. Imports from Nigeria and Angola, for instance, are now at their lowest level since the 1990s. As this trend continues, the east-to-west transatlantic flow of oil will dwindle. Suppliers in the Middle East and Africa will thus shift to selling in Asian markets. In the coming decades, China and India are projected to more than double their current imports of Middle Eastern crude.13 At a very practical level, the number of oil tankers transiting through the India Ocean and the Straits of Malacca to East Asia will increase two- or threefold in the next ten years, accelerated by the shale revolution. While insurers will adjust the risk premium for this altered trade, the question of who should protect the global commons and free transit in these sea-lanes will become increasingly important.
Energy Reshapes the International Geopolitical Landscape
Recent history instructs humility in predicting the future of global energy markets. That said, the North American energy revolution is transforming global energy markets, and we can see the broad outlines of how these economic forces will reshape the geopolitical landscape. Most fundamentally, the North American energy revolution will continue to increase and diversify the global supply of energy and give the United States a new and powerful geoeconomic instrument.
Many of the more dramatic geopolitical consequences of the North American energy revolution rest on the near certainty that substantial additions of U.S., Canadian, and Mexican oil to non-OPEC supply will substantially lower global pricing for oil in a sustained way. Historically, OPEC has used spare production capacity to stabilize the global price of oil. While there is much debate around OPEC’s willingness and ability to use spare capacity to regulate global oil prices, spare capacity will remain an important metric closely correlated with the price of oil on the global market.14 When the market is very tight, oil prices generally spike upward. Such spikes can undercut overall global growth, which eventually leads to reduced demand and downward price recalibrations. In recent years, when there has been a
few million barrels a day of spare capacity in the international system, OPEC has been able to manage the overall price of oil around $90–110 per barrel. In mid-2014, however, it appeared that OPEC was beginning to rethink its priorities. Since mid-June 2014, the price of Brent crude oil has fallen by nearly 25 percent, going from a high of $115 to below $36 a barrel—the lowest oil price since 2009, and an unexpected decline that has led the Energy Information Administration to issue a downward revision of U.S. oil production estimates to 8.8 million barrels per day in 2016.15
Most analysts predict that prices will drop further before recovering—possibly dipping as low as $20 per barrel, which is the breakeven cash cost for highly levered high-cost U.S. shale producers.16 Much of the downward pressure on oil prices traces to a shift in OPEC strategy.17 OPEC’s decision to maintain its production ceiling of 30 million barrels per day throughout 2015, even in the face of soft demand and a glut of excess supply, marked a clear shift away from prioritizing price stability in order to compete for shares in the global energy market.18 Analysts at Goldman Sachs further suspect that OPEC production will exceed that quota of 30 million barrels per day, extending the downward pressure on prices. Indeed, Saudi Arabia, Iraq, and Russia all produced in 2015 at the highest level for many years, and this was before Iran returned to the global oil market.19
If oil prices remain low for a sustained period of time, every government in the world that depends upon revenue from hydrocarbons as the mainstay of public finance would be under domestic strain. Countries as diverse as Vietnam and Indonesia in Asia, Russia and Kazakhstan in Eurasia, Colombia, Venezuela, and Mexico in Latin America, Nigeria and Angola in Africa, and of course Iran, Iraq, and Saudi Arabia in the Middle East would all feel such a shock.20 Each country has a different capacity to endure such a blow, depending on the duration of the lowered prices, the structure of its economy, and its institutions and their ability to absorb fiscal cutbacks. Some of the biggest losers from falling oil prices are countries not especially friendly to the United States and its allies, such as Venezuela, Iran, and Russia. As Harvard professor Martin Feldstein notes, “These countries are heavily dependent on their oil revenue to support their governments’ spending … [and] even at $75 or $80 a barrel, these governments will have a difficult time financing the populist programs they need to maintain public support.”21 But when oil prices plummet, all such countries are enduring the shock at the same time, which magnifies instability throughout the international system.22
While policy makers should consider a scenario in which multiple energy-producing countries are experiencing fiscal strains and corresponding political instability, they should also focus in particular on the implications for countries that have used their energy to influence geopolitics, usually in ways counter to American interests.
Russia is the country that has the most to lose from the U.S. energy boom in the next decade. While it has large amounts of its own shale oil in Western Siberia that could be developed over the medium and long runs, the more immediate impact of the unconventional revolution will serve to weaken Russia across several dimensions. First, the shale revolution in the United States (and, over the very long term, perhaps in Europe) could eventually diminish Russia’s ability to use its energy resources to geoeconomic ends. The unconventional revolution will not completely free Europe from Russia’s influence, as Russia will remain the continent’s largest supplier of energy under almost any energy scenario. Russia supplies Europe with both Urals crude, oil products, and natural gas; all three are under pressure in terms of volume (with higher U.S. exports) and price (because of excess supply). But in the decades ahead, European countries—particularly those in the east—should become less dependent on Russian energy and thus less vulnerable to Moscow’s geoeconomic coercion.23
With the United States ending its forty-year ban on exporting crude oil in December 2015, U.S. crude oil exports could eventually develop into an important check on the longstanding Russian monopoly over European energy supplies.24 It is not as if Washington could route U.S. crude exports toward its desired customers; like any other export, these crude exports would be sold by private companies looking to maximize profit. Still, increased access to U.S. oil by European consumers would allow these countries a potential alternative to Russian oil (currently Europe obtains about 30 percent of its oil supply from Russia). Similarly, Europe’s ability to look elsewhere for oil supplies would make Russia compete harder in the global market, diminishing revenue from sales to neighboring European countries.25
Even if the unconventional revolution is limited to the United States and Canada, the extra gas in the market should—as it did in 2010 and 2011—give European countries more leverage in their negotiations over price with Russia.26 If Europe continues with its efforts to integrate its natural gas market, builds more LNG terminals capable of accepting imports of natural gas from the United States and elsewhere, and extends its transmission infrastructure, the diversification of supply alone will increase its energy security in general; it will certainly give Europe greater options for managing crises such as when Russia discontinued gas supplies to Ukraine in 2006, 2009, and 2014 in the midst of the Russian interventions in Crimea and eastern Ukraine.27 Moreover, if divisive EU domestic politics permit, the development of indigenous shale resources in Europe—seeking to replicate the U.S. production boom—could help the continent stem its decline in overall (conventional) gas production and could further buffer countries such as Ukraine and Poland from Russia’s energy-induced coercion.
Second, Russia could also face politically destabilizing consequences of a sustained drop in oil prices, and lower oil prices will also drive down Gazprom’s oil-linked gas export price. With crude prices slumping below $40 at the end of 2015, hitting a seven-year low, and the ruble under severe pressure, Russia’s expectations for economic growth in the period ahead are dismal.28 Without energy largesse to maintain Russia’s highly personalized political system, Putin could find his influence diminished, creating openings for new political developments. As other nations in the area observe this decline in Russian resources and perhaps domestic stability, Moscow’s power and influence in its near abroad could be substantially weakened.
While this may sound like unequivocally good news to the United States and other Western governments, they must consider that a weakened Russia is not necessarily synonymous with a less troublesome Russia. The most that policy makers contemplating the longer-term face of U.S.-Russian relations should count on a surlier, more volatile Russia. Particularly if more nationalist political forces are the ones to succeed Putin or if Putin becomes even more aggressive, Russia could seek to secure its influence over its “near abroad” in more direct ways, as it did with Georgia in 2008 and Ukraine in 2014.
The unconventional revolution in energy will also have overall negative implications for Gulf energy producers and their ability to wield influence in the international system. Although less vulnerable than Russia in the short term, the Gulf monarchies, led by Saudi Arabia, must also be concerned about significant and sustained price troughs. To be sure, rising U.S. output will continue to reduce U.S. oil imports from the region, but the fact is that Middle East supply has not loomed very large in the overall U.S. petroleum picture for some time now, and it should be clear that America’s geopolitical stake in the Middle East will not diminish because of the North American energy revolution.29
While Riyadh will most likely continue its attempts to play a stabilizing role in international energy markets, it now faces constraints on its ability to reduce production that it did not have in the past. Saudi Arabia has responded to the Arab uprisings and instability in the region with significantly increased public spending at home, combined with economic and security assistance to its neighbors. The kingdom’s break-even price for oil—where its budgets would balance—was roughly $70 per barrel in 2010, then jumped to $85 per barrel a year later, and reached $104 in 2015.30 High birth rates in earlier decades mean t
hat an extremely young population is demanding more education, more health care, better infrastructure, and—most importantly—more jobs. Absent significant changes such as plentiful natural gas discoveries or price-driven efficiency improvements, rapidly growing domestic energy demand to support such economic development means that Saudi Arabia could reach its own “peak export” scenario in the 2020s, when it begins to consume more energy than it exports.31
Riyadh is well aware of these demographic pressures and associated economic ones and is pushing hard to diversify its economy. Analysts warn that Saudi Arabia’s long-term fiscal position is not sustainable, and prolonged slack in the price of oil will eventually test Riyadh’s ability to maintain the public services that are an important basis for the regime’s legitimacy. But this would take many years, given the kingdom’s enormous insurance policy in the form of another geoeconomic instrument: its roughly $700 billion in holdings of foreign exchange reserves.32 Thus, a world marked by lower oil prices, while hardly foretelling the end of the Saudi monarchy, would represent increasing domestic strains in the kingdom with uncertain outcomes. It would also render Riyadh potentially less able to compete as aggressively in contests for geoeconomic influence, especially should the Saudis no longer find themselves in a position to extend massive, predictable sums to finance their preferred regimes in Egypt and elsewhere in the region.
Even greater challenges could come to Iran’s ruling regime. Iran’s decision to enter nuclear negotiations might well not have happened were it not for the shale revolution which managed to replace sanctioned Iranian oil exports with U.S. LTO and avoid a spike in oil prices (although the prospect of U.S.-EU sanctions and denial of SWIFT payments may have been even more consequential).33 With the July 2015 completion of a nuclear deal with the permanent members of the UN Security Council and Germany, and—if the deal is implemented—the prospect of some sanctions relief within a year, Tehran intends to increase its oil production from its July 2015 level of about 3 million barrels per day to 4 million barrels per day by mid-2016.34 And its longer-term goal is even more ambitious—by 2020, Tehran hopes to raise its production levels to roughly 6 million barrels per day, even higher than before the sanctions took effect. While these projections are probably overly optimistic and would require some $100 billion in foreign investment, Tehran will have considerable new energy revenue to enhance its power projection capabilities in the region. In addition, this surge of Iranian oil exports will be one further factor in downward pressure on global oil prices over the medium term.35