On a cold December afternoon in 2001, a black U.S. Air Force C-17 made its descent over the central plains of Kyrgyzstan. On board was U.S. Air Force Brigadier General Christopher Kelly. The mission: to set up an American airbase in Kyrgyzstan. The new base would be one of many U.S. and British military bases placed strategically throughout the region. Kyrgyzstan, like many other nations throughout the area, occupies strategic space on a political chessboard in what has become known as “The New Great Game.” Immortalized by Rudyard Kipling in his turn-of-the-century novel Kim, “the Great Game” described a struggle between the British and tsarist Russian empires over land supremacy in Central Asia. In the 21st century, “the Great Game” has returned; once again great empires are repositioning themselves in an effort to control the Eurasian landmass. At stake are the vast energy reserves of the Middle East and the Caspian Sea, which contain nearly 75% of the world’s oil reserves.
The Great Powers involved—the U.S., China, and Russia—now have troops and personnel based in the region. In Georgia, Russia keeps over sixteen thousand troops with more on the way. As the linchpin country for the export of Caspian oil and gas to Western markets, Georgia has become a mission-critical location for the Russians. If Russia is to profit from the emerging region’s oil boom, it needs to control the strategic ground underneath the pipelines which run through Azerbaijan, Chechnya and Georgia. Chechnya sits on top of considerable oil reserves. Its capital, Grozny, is second in importance to Baku as a one of the biggest oil towns in the former Russian empire.
The U.S. also keeps a military presence in Georgia. Like Russia, those troops are there to protect the Baku-Tbilisi-Ceyhan pipeline. The BTC pipeline transports crude petroleum over a distance of 1,776 km from Azeri-Chirag-Guneshli oil field in the Caspian Sea to the Mediterranean Sea. The new pipeline competes with the Russian-controlled pipeline that originates from the Russian’s Black Sea port of Novorossiisk.
While there remains an uneasy truce between Russian and U. S. forces, there are other battlegrounds for conflict. Up until a few years ago Kazakhstan was considered to be a backward country. That was until it discovered oil. The Kashagan oil field discovered in 2000 represents one of the biggest oil discoveries of the decade. The Kashagan field covers an area 47 miles by 22 miles and is located in the North Caspian Sea, approximately 50 miles offshore from Atyrau. The Kashagan field could hold anywhere from 10-30 billion barrels of crude oil. The oil field faces immense technical difficulties of extracting oil in a harsh climate. It also faces political and geopolitical challenges from competing political powers. Because of these difficulties, oil production, once predicted to begin in 2005, has now been pushed back to 2008 or possibly 2009.
This new oil discovery in Kashagan has ushered in a new and dangerous round in the world scramble for oil and the pipelines that control its flow. The Russian, U.S. and British rivalry over pipelines occupies only one theatre of potential conflict in the region. China, through its state-owned China National Petroleum Corp., has inaugurated an oil pipeline that will run from Kazakhstan to northwest China. This pipeline challenges the geopolitical significance of the Washington-backed Baku-Tbilisi-Ceyhan oil pipeline. Over the next 10 years Kazakhstan will triple its oil production, which will likely force the nation to seek new export routes to free itself from dependence on Russia. To that end, Kazakhstan is looking to China to become one of its major export markets.
The China-Kazakhstan pipeline is one of many strategic moves planned by China to help secure its energy supplies. China is building a new export corridor stretching from Kazakhstan’s oil-rich Caspian basin, including Kashagan, through a series of oil zones in the region that lead directly to China. The pipeline is part of a series of infrastructures that will give the Chinese a secure energy source outside the reach of U.S. carrier battle groups. The pipeline is only one piece of the puzzle; the other is ownership of oil. In October of 2005, China scored a major political coup by successfully completing its $4.18 billion takeover of PetroKazakhstan. China won against competing bids from ExxonMobil.
Established in 1983, USCENTCOM (United States Central Command) was assigned the responsibility to oversee the most volatile territory on the planet for the U.S. military. Its area of jurisdiction is the Middle East, East Africa, and Central Asia. The command was established to defend the oil-rich Central Region as the area’s importance grew as it became the world’s largest oil producing region. CENTCOM has been involved in all major conflicts in the region from both Gulf Wars to recent conflicts in Somalia. Based at MacDill Air Force Base in Tampa, Florida, it is one of the two command centers whose headquarters are located outside its area of operations. Unlike predecessors EUROCOM (Europe Command) and PACOM (Pacific Command), it did not originate from previous theaters of world war like Europe and the Pacific. Its command was an outgrowth of the Rapid Deployment Joint Task Force (RDJTF) set up under U.S. President Carter. The RDJTF concept was to use light, airborne forces that could be deployed rapidly to secure terrain until heavier forces from the U.S. could move in and take over.
With the Iraq War “over,” the War on Terror continues. While the U.S. military’s PACOM has been successful in showing progress towards victory (over what, specifically), rearranging geopolitical alignments that have been effective in countering both old and new enemies in the area, it has also made steady progress in the fight against Abu Sayyaf in the Philippines. PACOM has also closed the gate on Iran from the east with a strategic partnership with India. The War on Terror is also one among many CENTCOM responsibilities. However, CENTCOM has not duplicated PACOM’s success. Hence the March 18, 2007 change at the top with a new commander: a general has been replaced by an admiral. U.S. Navy Admiral William J. Fallon is replacing U.S. Army Lieutenant General John Abizaid, who has retired. Fallon has been one of the U.S.’ most successful commanders in executing U.S. long-range strategic goals, including rolling up terror groups in the Pacific.
Fallon’s appointment raises the question as to why a Navy man has been appointed to lead a predominantly Army and Marine force garrisoned in the region. The likely answer is Iran. The shake-up at CENTCOM sends a clear message that its failure and its ineffectiveness in prosecuting the War on Terror are a thing of the past. Admiral Fallon may not be able to change or rearrange global geographic responsibilities, but he will bring a singular focus to the morass that the U.S. military faces in the region. If conflict with Iran escalates, he brings extensive experience conducting naval and air campaigns.
Before the attacks of September 11, 2001, the U.S. was conducting military operations in over 170 countries. Today the U.S. military reach constitutes a global military empire whose chief mission has become combating radical Islam and protecting the world’s oil supply routes. Unlike previous empires, America’s imperium is without colonies and without borders. The Cold War years constituted the “garrison era” when large, permanent U.S. military garrisons surrounded the Soviet Union. In contrast, post-Cold War U.S. military features rapid worldwide mobility and the effective dispersion of forces. This strategy is similar to that of the Roman Empire, which built bases on foreign soil and emphasized the rapid strategic reaction of its legions to threats within the empire. Grain from Egypt was to the Romans what oil is to the United States today. Rome needed to station its legions throughout the Middle East in order to protect trade and the vital shipment of grain to feed its population. America finds itself in a similar situation today with the necessity of importing over 60% of its energy needs, which is vital to powering the American economy.
America’s imperium is born out of necessity. Since 1970 the U.S. has been unable to supply its own oil needs. As a result, it has lost control over the price of oil. Initially, the U.S. had been blessed with abundant resources. Its rich deposits of mineral and energy resources, along with its ability to produce and use these basic industrial and energy resources, allowed the U.S. to move from a backward wilderness to become the richest and most powerful nation in the world in less than 300 years. It is minerals and energy that win wars, build factories and form the basis for an industrialized society. Nations that have these resources within their own borders are better off than those that don’t, as they are less economically vulnerable. A shift in geological resource centers brings with it a shift in global economic power. This is the reality that the United States faces: it is forced to import more raw materials in which it was once self sufficient. For the U.S. the era of high-grade energy and resource abundance is gone—thus the need to use its remaining military power in an effort to secure it.
The U.S. is not alone in this effort. With no geological or geographic frontiers to expand, nations must jostle against each other for position and control over the earth’s remaining resources. This jostling could be leading us toward military confrontation over access to energy, water, fertile soil and strategic materials such as uranium—all of which are critical for our survival. As more and more nonrenewable resources are depleted, economic problems and military confrontation become more likely. At present, the fact that we are consuming a diminishing supply of resources is for most people “out of sight and out of mind. “ From politician to citizen, our eyes are “wide shut.” Unfortunately, as we have seen in this new century, we have experienced a series of oil shocks with each subsequent shock becoming more severe. Eventually a permanent shock of greater severity is inevitable. When it arrives it will not be solved by any redistribution plans, economic planning or political posturing. Its arrival could be the consequence of the inexorable depletion of the world’s supply of crude oil. The battle over what remains is only one aspect of the politics of enrgy.
In a remote location 100 miles southwest of Phoenix, CEO of Arizona Clean Fuels, Glen McGinnis is trying to do the impossible—something that hasn’t been done in the U.S. in over 30 years—build a refinery. The last refinery built in the United States was back in 1976. McGinnis faces a daunting task. He needs to raise $2.5 billion: the cost to build the refinery. So far he has raised $30 million, which he has spent over the last six years in obtaining permits and fighting legal battles. The American Petroleum Institute says they are unaware of anyone else pursuing a similar project.
We say NO! to Refineries
McGinnis’ efforts have been heroic. His original site outside of Phoenix has been moved due to opposition from the state, which considered expanding the city’s clean-air limits. However the tide may be turning in McGinnis’ favor as more Americans complain about sticker shock at the gasoline pump. Over the last 25 years the number of refineries in the U.S. has dropped to 149, roughly half of the number of refineries in place in 1981. Since that time, companies have upgraded or expanded their aging facilities with the result that refinery capacity has shrunk by only 10% from its peak of 18.6 million barrels a day. Yet, while our refinery capacity has shrunk by 10%, our consumption has risen by 45%. As a result of this shortfall, gasoline imports from Europe and South America have risen sharply. Gasoline imports now make up 10% of all domestic consumption.
McGinnis’s efforts have gotten the U.S. President’s attention. After visiting the President at his ranch, Crown Prince Abdullah of Saudi Arabia commented that his country could send more oil, but the United States would not have the ability to refine it. President Bush has offered to provide closed military bases for new refineries.
America may be the largest consumer of energy in the world, but its citizens no longer want to have anything to do with its discovery or production. Instead of finding, discovering and refining energy, the country is increasingly looking to foreigners to supply our energy needs, especially north and south of our borders. This is forcing the energy industry to turn to Canada. On Canada’s Atlantic coastline, land owned by Irving Oil, (which supplies fuel throughout New England and the Atlantic coast) is being earmarked for the possible construction of a new 300,000 barrel-a-day crude oil refinery. It would cost $5-$7 billion to build and could be operational by 2013.
The new refinery is part of a regional attempt to construct an energy hub in New Brunswick, which would supply the energy needs of New York and Boston with gasoline, natural gas, and petrochemicals. Liquified Natural Gas (LNG) terminals are being considered in British Columbia for supplying energy needs to the U.S. Pacific Northwest. Other sites are also under proposal or construction in Mexico. BHP Billiton [NYSE:BHP] is planning on building a new LNG terminal near Ensenada, Mexico, south of San Diego. San Diego Gas & Electric, a Sempra Energy Utility NYSE:SRE] is building its next power plant south of the border. Despite growing energy needs in the United States, NIMBY-ism (Not In My Back Yard) has grown stronger and more vocal. Americans continue to crave and consume energy—we just don’t want it found or refined in our back yard.
We say NO! to LNG Terminals
On a warm and pleasant day on October 23, 2006 a large crowd of beachcombers, surfers and celebrities gathered around a Malibu pier to protest a perceived threat to their beachfront community. The catastrophic environmental event was the Cabrillo Port LNG Terminal being proposed by BHP Billiton. BHP proposed building the LNG storage facility 14 miles offshore from a point off the coast from the Los Angeles/Ventura county line. The floating sea terminal would store 73 million gallons of LNG in three spherical tanks 160 feet high. The Cabrillo facility would process the LNG and convert it to gas. Afterwards it would then transport the gas to feed the natural gas networks between Camarillo and Ventura.
All land-based and port-facility-based LNG proposals in California have been thwarted or tied up by environmental suits. Without access to land-based terminals, energy companies have had to revert to offshore deep sea storage facilities, which are more costly to process.
The October 23rd protest event would have gone unnoticed had it not been for its star-led cast of celebrities headed by Pierce Brosnan, Daryl Hannah, Halle Berry, Cindy Crawford, David Duchovny, Tia Leoni, Mini Driver and Jane Seymour to name a few. Another group of celebrities lent their names to a letter campaign to stop the LNG terminal from being built. The list is too long to mention here other than it contains familiar names such as Streisand, DeVito, Harrelson, Sheen, Sting, and Theron. Halle Berry expressed the sentiments of the Hollywood crowd in response to a reporter’s question by answering, ”If one of these gets passed, you’re sure there will be other ones…We have to use our voices and band together to stop this.”
We say NO! to Wind Farms
Last year Texas surpassed California as the nation’s leading wind producer. Gamesa Development USA in Austin plans to invest $100 million in the first of three projects in Jack County, Texas. When the project is completed the company will install 60 turbines capable of producing 120 megawatts, enough power to supply electricity to 85,000 homes. Gamesa and other large producers like FPL Energy (an FPL Group company) [NYSE:FPL] have been encouraged to build by the state legislature. The state mandated renewable energy back in 1999. Now companies like FPL and Gamesa face a new nuisance from neighboring landowners who are suing FPL Energy’s wind project. The suits have support from various environmental and birder groups who oppose the projects on the grounds that nobody is looking at how the birds will react to the project.
The race to build is on as federal tax breaks are scheduled to expire next year. Despite the expiration of tax breaks, large players—such as Goldman Sachs [NYSE:GS] and Berkshire Hathaway [NYSE: BRK.A, BRK B]—are backing wind power. However, just as big money has started to move in on the business side, big money from environmental opponents is also moving in with plans to expand lawsuits brought against power producers.
Another battle is heating up in Washington, D.C. in a bitter fight over a proposed wind farm off Nantucket Sound. The project would put 130 wind turbines off the Cape Cod coast of Massachusetts. In the opposition camp are Mitt Romney (R-MA) Ted Kennedy (D-MA) and the Cape’s congressman, Rep. William Delahunt (D-MA). Senator John Kerry remains undecided.
We say NO! to Transmission Lines
In order to provide clean and affordable energy, America needs to upgrade its electricity grid. No controversy here. The problem is that power producers are finding it difficult to implement such a plan. The GridWise Alliance has been formed among power producers, General Electric (NYSE:GE), the Tennessee Valley Authority and the U.S. Department of Energy as a coalition to promote a stronger grid. Despite the strength of the alliance, they are having difficulty. Building a new, high-capacity transmission line requires erecting new power lines. This is virtually impossible to do without setting off protests, lawsuits and various regulatory delays designed to halt the process.
As an example, a proposal by a company called the New York Regional Interconnect, Inc. (NYRI) is trying to build a 200-mile transmission line from Utica to Middletown, NY to bring more electricity to the region. The NYRI planners state that 80% of the new transmission line would run along existing utility or railroad corridors. After the company applied for a permit to build with the state’s Public Service Commission, state legislators enacted a law designed to block the power line by denying the developers the ability to use the power of eminent domain. Another bill has been introduced to prevent the Federal Energy Regulatory Authority from stepping in if the state denies NYRI the permit.
In Virginia a similar plan by Dominion [NYSE:D] to build a 240-mile power line has run into opposition. American Electric Power [NYSE:AEP] has also met resistance to its plans to build a major transmission line from West Virginia through Maryland and Pennsylvania to New Jersey.
Opposition and Negativity Rule the Day
As a country we continue to use more electricity each year as our economy and population grows. No one wants the lights to go out or to be without power if the weather turns too hot or too cold. Everyone is in favor of renewable power, but renewable power requires a grid system to move the power from where it is produced to the end user. You can’t expand your energy base without the transmission network. Transmission is the means that moves power from rural areas where renewable energy can be produced to urban centers where electricity is needed. Everyone wants clean electrical power—just so long as it isn’t visible near anyone’s house, farm, recreation area, public park, or campground.
American opposition to energy exploration and production has grown more vocal. The oil and gas industry, which makes the life we live more enjoyable, has been vilified. Americans now want clean and renewable energy. We just don’t want it in our back yards. Most environmental groups favor solar, wind and other renewables as long as they aren’t built here in the U.S. Hence the movement to get refineries, LNG terminals, wind farms and power plants built in the backyards of our Canadian and Mexican neighbors. While an American company like GE builds nuclear reactors for plants built overseas, none are built here, despite the fact that no one has died from a nuclear accident in the U.S.
We say YES! to Biofuels and Ethanol
What seems to be popular with American politicians are biofuels. The reason is that it comes with backing and support from the farm lobby. The problem with biofuels is that they can be expensive to produce—for example, it requires almost as much energy to produce ethanol as the energy it provides. The cost of producing ethanol largely depends on the cost of corn, ethanol’s main feedstock. It also depends on the price of natural gas, which is used to power the process that turns corn into ethanol. If the price of natural gas and corn rise, the price of ethanol can cost more than the gasoline it replaces.
Last year ethanol and gasoline prices went on a roller coaster ride due to strong demand. The premium spread over gasoline prices widened to more than $1. The premium over gasoline still exists today. Last Friday’s March contract for ethanol closed at $2.06 a gallon on the Chicago Board of Trade. The same March contract for gasoline closed at $1.61 on the New York Mercantile Exchange. While low amounts of ethanol added to gasoline can reduce emissions, when added in larger concentrations, it can raise additional air-pollution problems of its own. As yet, no one has thought through the impact of higher corn prices on the whole agricultural sector from the cost of corn at the supermarket to the cost of corn as feedstock for animals. Then there is the use of water, (not to mention pesticides and tractor fuel) to cultivate the corn.
As our economy continues to expand and as our population grows larger, America’s energy needs will grow as well. It is becoming quite clear that we are likely to face an energy crisis, the likes of which we have never seen before, in the not-too-distant future. As Americans we enjoy the freedom of movement that an automobile brings, as well as the ability to travel by jet to distant places. What troubles us more is the production of energy itself. Refineries can pollute the air. Wind farms are unsightly. LNG terminals and nuclear plants are considered far too dangerous. American energy policy continues in its fragmented form. Currently, our only energy policy appears to be to stop production where possible, cause delays through nuisance suits, build energy facilities in someone else’s back yard, or protect oil supply routes in the Middle East through our carrier battle groups. Nimby (not in my back yard), banana (build absolutely nothing anytime near anybody), cave (citizens against everything), nope (not on planet earth) are all part of our energy landscape—much to our own detriment.
In 1997, an unknown former KGB agent defended a dissertation on natural resource policy at the St. Petersburg Mining Institute. In 1999 the dissertation was defended once again and published in the Institute’s journal. The candidate—unknown to the world at that time—would later be appointed as Prime Minister and later elected President of Russia. His name was Vladimir Putin and his thesis on energy would evolve and become the central tenet of Russian domestic and foreign policy. Putin outlined three themes in his thesis, which help explain the evolution of Russian energy policies.
Three Energy Themes for Putin’s Russia
The first theme dealt with the ways in which natural resources can contribute to the wellbeing of the national economy. In his thesis, Putin identified Russia’s mineral resources, especially its hydrocarbons, as key components in his equation. In order to accomplish this objective, the state must gain control over the resource sector and regulate its development in favor of the state. This objective could best be facilitated by the creation of large state-sponsored firms capable of competing with Western oil companies.
The second and third themes identified in his dissertation dealt with strategic planning and the development of port facilities and infrastructure to facilitate resource exports. Developing and exploiting the resource sector would empower the economy and the state and put Russia back on the road to political power and influence in the world.
Since becoming Prime Minister and then President, Putin has pursued these goals relentlessly. From the arrest of Mikhail Khodorkovskii and the dissolution of Yukos to the evolution of Gazprom and Rosneft, he has turned these entities into national champions.
As recently as 2005, in an address to the Federal Assembly, Mr. Putin called for pre-emptive control over strategic natural resource deposits, defense industry production and infrastructure monopolies. Moving against the oligarchs, the Kremlin has reconsolidated its grip on Russia’s strategic resources and industries. Through Gazprom and Transneft, it continues to acquire new assets and to extend its influence and control over strategic energy resources that extend well beyond Russia’s borders. Dmitry Medvedev, Chairman of Gazprom following the acquisition of Sibneft, stated that Gazprom “…will not only become the world’s largest natural gas producer, but also one of the world’s biggest energy companies.”
Changing the World’s Oil Order through Pricing
In addition to tightening the state’s grip over the resource sector, Putin has also moved on the international front to change the world’s oil order. At present “paper oil” (futures trading) controls the pricing for physical oil through trading on New York and London exchanges. The West may not own the oil, but it controls the pricing of oil through derivatives. One of the anomalies of today’s resource markets is that those who own the assets—whether mineral assets or hydrocarbons—don’t control the price. It is this anomaly that Putin hopes to reverse through a confederation of large producing and consuming states.
Long-Term Fixed Contracts
It was this era of long-term supply contracts that made the oil markets less liquid and embargos possible. This is actually what happened when OPEC (Organization of Petroleum Exporting Countries) made the decision to embargo the U.S. in 1973-74 following U.S. support for Israel following the Yom Kippur War. Since most oil contracts were fixed and prearranged, the failure of a producing state or group of states to honor their deliveries to a particular consumer state made embargoes a devastating economic reality. The embargoed state would then find it necessary to find replacement oil from third-party traders or arrange for the diverting of other oil shipments from other states. This process carried additional risks of time delays, complicated logistics, as well as an escalation of costs. The economic pain caused by the 1973-74 embargo forced the United States to contemplate seizure of Middle East oil fields. The embargo was eventually lifted and the plans for invasion were never carried out.
Deregulation Leads to
Short-Term Paper Contracts
As North Sea and the North Slopes of Alaska oil production came on line, more and more oil startups moved oil production to the spot markets controlled by trading in New York and in London. As oil exploration exploded due to higher prices, the newer oil startups moved their production to the spot markets where they began to undercut the price of more established producers. By the mid-1980s the short-term spot markets on the New York and London exchanges had grown in importance and began to dominate the trading in the world’s most valuable commodity. Eventually most exporters of oil dropped their long-term commitments in favor of the new market-oriented arrangement and eventually this arrangement became the status quo.
This arrangement has been predominant since the early 1980s. OPEC and Russia control 85% of the world’s known oil reserves, but it is the West through its futures exchange, which controls the price.
Nearly all of the world’s oil has merged into a giant, fungible oil pool accessible to all through freely-traded oil markets. Therefore, today, if the flow of oil is interrupted in one part of the world, it can easily and instantaneously be replaced by oil from another part of the world. As an example, when the flow of oil and natural gas was interrupted in the U.S. due to the 2005 hurricanes, the country was able to replace the lost production by buying in the open markets. Within weeks following the hurricanes, oil and refined gasoline products began to arrive at U.S. ports; within a month, the price of oil and gasoline began to drop to pre-hurricane levels. This was made possible through spot market exchanges, which allowed the U.S. to buy oil and gasoline from a virtual global pool of oil into which nearly all exporters sell their oil.
The Return of Long-Term
Producing states—from Russia and the Middle East to Africa and Latin America—are beginning to move a portion of their existing production over to long-term contracts. Most of these long-term contracts are with the East as oil producers move to diversify their oil supply away from contracts with the West. As new production moves offline through long-term arrangements, Western oil companies’ participation in oil exploration, production, and the upgrading of the energy infrastructure is being thwarted by the nationalistic policies of producing states.
The Rise of Resource-Based Corporate States
All of this pricing finagling is occurring at a time when the demand for oil is surging and the growth in oil supply is diminishing. The world’s oil infrastructure is aging and badly in need of upgrading. Yet there is very little evidence that real global oil expenditures are increasing. National oil companies have become the world’s real oil titans whose loyalties are to the state and not to the markets. At the same time that demand is growing, the world’s spare oil capacity is shrinking and the sources of supply are becoming increasingly unstable. As Western oil companies are being excluded from the exploration and production of oil in producing states, we are also seeing the rise of the resource-based corporate state. Examples of this transition would be Venezuela and Peru. The rise of the resource corporate state brings with it the closure of traditional free market investment by Western oil companies and by oil market speculators.
This new, radically altered world is forcing producers and consumers to change loyalties. In a world of tight oil supplies, both producers and consumers are seeking strategic arrangements that secure stable and reliable demand and supply relationships. Consumer nations are becoming anxious over securing supply and as a result are moving away from free-trading oil markets. They are attempting to enhance their energy security by locking in private long-term supply contracts. This heightened insecurity of consuming nations in regard to energy resources is driving domestic and foreign policy decisions.
New Alliances Are Being Formed
The emerging economies of Asia—with huge appetites for oil—can ill afford to take chances with energy security. Energy supply is crucial to maintaining their economic growth. That is why throughout much of Asia and Eurasia we see the growing trend of private state-to-state agreements between these nations and the oil producer states. These new arrangements bypass the traditional global oil markets, again shrinking the free-trading global oil supply.
Not a week goes by where we don’t see additional evidence that the old world oil order is reversing in favor of a new confederation of producing and large consuming states outside of the West. China and India continue to secure long-term supply contracts with oil exporters Russia, the Middle East, Africa, Latin America and Canada. A complex web of interlocking alliances and ties based on energy is beginning to emerge in what author W. Joseph Stroupe has called the Russian Rubicon (Resources Underwriter-Based Importer-Inclusive Confederation). The confederation Stroupe writes about in his book Russian Rubicon is not a cartel of producing states. Rather it is a multinational confederation of sovereign producing and consuming states cooperating together toward a common goal of energy security. It is a new international political entity that is balanced, self-contained and self-sufficient which operates under complementary symmetry. This new confederation composed of both key producers and key consumers deals within itself for the vital and complementary needs of both producers and consumers. The confederation is informal yet formal in its arrangements through symmetrical bi-lateral agreements between producing and consuming states. There are also new signs of formal agreements in the spheres of the economy, energy, security, politics, geopolitics and military among its member states. 
The return of the long-term oil supply contract, which undermines the free oil-trading markets, is only one ominous trend. The other emerging trend is that consumer states, in addition to locking in long-term supply, are also taking equity stakes in the energy industries of producing states. By taking an equity stake in the producing states’ energy industry, they are reinforcing control over their long-term supply contracts that make it difficult for producing states to reverse their policies. This locks up oil supply for the confederation; at the same time, it denies that same oil to the global oil markets.
Moving Away from the U.S. Dollar
Another ominous trend that threatens the U.S.-based, free-trading oil markets and dollar hegemony is the emergence of rival resource-based market exchanges denominated in currencies other than the dollar. Various states like Russia, Iran, and Venezuela are seeking to price oil in currencies other than the dollar. These leading oil producers have already taken steps, beginning with their central banks, to diversify out of their dollar reserves. These steps are being taken to mitigate losses of a sharp dollar decline or collapse. The second stage of this developing trend is the preparatory steps that are now being taken to launch new regional bourses for trading in oil. In addition to oil, Russia is also considering adding trading in strategic metals. In preparation for a new bourse, Russia took steps last year to make the ruble convertible. In his State of the Nation speech given on May 10, 2006 Putin stated the following:
In my address of 2003, I set the goal of making the ruble convertible. I must say the (outlined) plans are being implemented…The ruble must become a more widespread means of international transactions. To this end, we need to open a stock exchange in Russia to trade in oil, gas, and other goods to be paid for in rubles. Our goods are traded on global markets. Why are they not traded in Russia? 
Competing exchanges for oil trading around the globe could gradually undermine the dollar’s influence as the world’s reserve currency. In essence, what is occurring is that the dollar is losing its international position to a group of currencies. The advent of new resource exchanges denominated in currencies other than the dollar located in Moscow, Tehran and Caracas instead of New York and London likely will only hasten its demise. These new oil exchanges constitute new oil pools that will be separate and distinct from the oil pools that are maintained by the New York and London exchanges. These new exchanges will compete for and reduce the western world’s dominance over the pricing of natural resources. As this process accelerates it could open up the floodgates for a massive move out of the dollar. Under this scenario, oil prices would rise in the U.S. and thereby force America to pay more for the oil it imports. It would also add to inflationary pressures as the U.S. would no longer be able to export its inflation, since the dollar would be replaced by other currencies in the pricing of natural resources. With the global dollar-denominated oil pool reduced by long-term contracts and competing exchanges, our true energy vulnerability will finally be exposed.
A New “Cold War” on the Horizon?
What we are seeing unfold here is the beginning of a new “Cold War” where energy resources could be used as weapons of political leverage. Putin continues to exploit Russia’s strategic oil and gas export supply chains and extend its international diplomatic influence and power. It has gained control over key infrastructure supplying oil and natural gas into Western Europe. Energy exports are at the core of Russia’s foreign policy. Evidence of this energy muscle-flexing can be seen in its developing hegemony over European, Asian, and former Soviet Union states. It is moving to control export infrastructure transits throughout the region and has used withholding natural gas as a political weapon. Russia is attempting to wrestle control of existing oil and gas pipelines throughout the region by blocking development of non-Russian-owned pipelines that transit through Azerbaijan, Kazakhstan, Turkmenistan and Uzbekistan. It has demonstrated that it is willing to do all that it can to destabilize countries along the pipeline route. Russia has positioned itself with sufficient control over energy infrastructure in Europe and is now in a position to reward or punish client states depending on the concessions or acquiescence of its customers.
It has also been successful enticing major IOCs (International Oil Companies) into making capital investments in Russia’s energy infrastructure, but at a price. The government has used taxation and environmental concerns to its advantage, leaving very little in the way of profits or control for the IOCs. Both Royal Dutch Shell [NYSE: RDS.A] and ExxonMobil (NYSE:XON] have made substantial investments in the Sakhalin field only to see Russian companies Gazprom and Rosneft manipulate themselves back into controlling positions. Other IOCs have suffered similar problems after making substantial investments. Total [NYSE:TOTAL S.A.] and TNK-BP [TNK-BP] are facing alleged environmental violations. The Russian government’s accusations appear to be used to manipulate the government’s take from the project, or in some cases, outright asset expropriation.
While Russia has relied on foreign investment to rebuild the country’s energy sector, investment in Russia comes at a great risk. It is difficult for companies to make an investment in a country where the rule of commercial law can be so easily flouted for political expediency.
At a time when energy resources are becoming more valuable, energy security has moved to the forefront of geopolitics. As Russia and other eastern states form alliances, the old oil order is being undermined. In its place is a new confederation of producers and consumers tied economically and politically to a new oil order. This new order is challenging the old market structures that are dominated by markets in New York and London. Supporting this transition to a new order has been the rise of the resource-based corporate state. The vast majority of the world’s strategic supply of oil and natural gas has fallen under their dominion. These new resource-based corporate states now dominate the Middle East, Latin America, Central Asia and Africa. They dominate or control close to 85% of the world’s oil reserves. The days of western paper control over the world’s most valuable resource asset are coming to an end. Power is shifting back to the owners and producers of resource wealth.
On April 2, 1980, Congress proposed and President Carter signed into law (P.L. 96-223) the WPT (windfall profit tax). The law imposed an excise levy on domestic oil production, taxing the difference between the market price of oil and a predetermined base price. The base price was derived from 1979 oil prices with annual adjustments for inflation. Virtually all domestic oil production was subject to the tax. A complicated taxation tier emerged based on the age of the oil well, the type of oil produced, and the amount of daily production. Each tier had its own tax rate and its own base price. Tax rates also varied by category of producer with independent producers paying a lower tax rate than integrated oil companies. Tax rates ranged from 15% to 70%.
At the time the tax was passed the U.S. was running a large budget deficit. Tax sponsors anticipated their own tax windfall as the price of oil was projected to rise. As a tax scheme, the WPT was a complete failure raising only $79 billion in revenue over in its eight years of existence. The WPT had other unintended consequences. Domestic oil production fell to its lowest level in 20 years, while demand continued to rise. As a result the U.S. increased its reliance on foreign oil supplies. According to the American Petroleum Institute, foreign imports went from 32% to nearly 40% during the period.
In August of 1988 Congress agreed to repeal the tax. Like many taxes designed to deal with transient phenomena, events had overtaken the levy. It had failed to raise the projected tax revenues, it added to the domestic cost of producing oil, and it reduced the supply of domestic oil, making the country more dependent on foreign oil. In the end, even The New York Times was urging its repeal.
That was 1988. With oil prices rising from $20 a barrel in 2001 to today’s prices, which range from the high $50s and low $60s, Congress is once again raising the issue of a Windfall Profit Tax on U.S.-based oil companies. Since 2005 the issue of a WPT has been back on the political agenda. U.S. Senator Dick Durbin (D-IL) sponsored a bill to impose an additional tax of 50% over a baseline price of $40 per barrel of oil.
Durbin isn’t the only politician proposing a new WPT. Speaker of the House Nancy Pelosi (D-CA) has also proposed levying a new excise tax on U.S. oil companies. The recent spike in oil prices over the last few years has set off a stampede of populist politicians eager to assuage the anger of consumers over the high price of gasoline. What enrages the public and consumers are the raw earnings figures of big oil companies. In this regard ExxonMobil (NYSE:XON] has become the new poster boy for big, bad oil. While the raw earnings numbers sound huge, when compared by proportion to sales they are unexceptional. Oil company profits have ranged from 7-11% of sales. These percentages compare to technology and financial companies, whose net profit margins are two to three times higher than the average oil company’s. During the most recent quarter Intel [NASDAQ:INTC] had net profits of 15%, Google [NASDAQ:GOOG] 32%, Citigroup [NYSE:C] 20%, Apple [NASDAQ:AAPL] 14%. By comparison ExxonMobil (NYSE:XON] had profits of 11%, Chevron Texaco [NYSE:CVX] 8%, and ConocoPhillips [NYSE:COP] had profits of 8%.
In addition to lower profit margins per dollar of sales, returns on invested capital over longer time frames are even more telling. Analysts at Goldman Sachs have noted that returns on invested capital in the oil and gas sector from 1970-2003 were far less than the U.S. industrial sector during the same period.
The Tax Foundation has raised two issues for lawmakers to consider before they rush to hike taxes on oil companies:
(1) Do oil companies pay too little in taxes compared to profits?
(2) What was the effect of the last windfall profits tax enacted in 1980?
In answer to the first question, they found that over the past 25 years, oil companies directly paid or remitted more than $2.2 trillion in taxes—including excise taxes, royalty payments and state and federal corporate income taxes. Taxes paid amounted to more than three times what they earned in profits during the same period according to the Bureau of Economic Analysis and the U.S. Department of Energy.
As the following graph illustrates, the government— and not the oil companies—has been the largest beneficiary of oil revenues. Taxes paid by oil companies have been consistently greater than their profits. If consumers are upset with gasoline prices they should look to government as the cause. The U.S. consumer pays an average of 45.9 cents per gallon in gasoline taxes. This figure is far greater than the profits earned by companies who find the oil, refine it, transport it, and sell it. In addition to fuel taxes, oil companies also pay royalty and excise taxes.
Finally, there is the question of the viability of a windfall profit tax. According to the Congressional Research Service (CRS), the WPT depressed the domestic production and extraction industry and increased America’s dependence on foreign oil. As a revenue-raiser for government, it proved to be a major failure. It was originally forecasted to raise more than $320 billion in revenue. Instead the government collected only $79 billion in additional taxes. The WPT raised fewer revenues than projected, depressed domestic energy production, and increased our dependence on foreign producers. In the end it was the American consumer and domestic oil companies who were the big losers. Because of its failure, the WPT was eventually repealed.
Yet despite its failures, 20 years later it is once again being proposed as a means of punishing oil companies. However, as the facts above illustrate, over the past 25 years it has been government and not oil companies who have profited most from rising oil prices. In addition to its many failures, the WPT would only worsen our dependence on foreign oil. It would discourage domestic production, increase our dependence on foreign oil, and enlarge our trade deficit while contributing nothing in the way of moving the U.S. closer to energy independence.
Demonizing Big Oil
As America’s energy needs continue to grow, the country is becoming increasingly dependent on foreign oil imports from raw energy to refined products.
At the same time the U.S. must now compete with other countries whose appetite for energy is growing faster than our own.
Instead of punishing Big Oil, we should be worried about their ability to provide us with the energy we need. Like it or not, the American economy runs on oil. Renewable energy will not replace oil as our primary source of fuel for at least several decades. Even then, that assumes we can get beyond the Nimby problem in this country.
The energy world of today is much different than the energy world that existed 40 years ago. The 1960s was the era of “Big Oil” where the international oil companies had access to 85% of the known oil reserves worldwide.
Today only 16% of the world’s oil reserves are accessible to international oil companies. The rest of the oil is either owned and controlled by state entities or is restricted or entirely cordoned off. According to T. Boone Pickens, “you don’t have an infinite number of prospects to drill anymore.”  As oil was nationalized in the ‘60s and ‘70s, U.S. and British oil companies accounted for less of the world’s oil production, having fallen from 27.8% of the world’s oil production in 1979 to just 14% by 2004. Today the international oil companies don’t even make the top 10 list of largest producers. The majors are struggling to keep up with demand. They are also having difficulty replacing their existing reserves. Reserve replacement for the six major oil companies will fall short of replacement over the next five years according to John S. Herold, Inc.
Finding and producing oil is getting more problematic. There are technical difficulties, there is competition from national oil companies, and the oil terrain is becoming more hostile. Governments are demanding a bigger share of the profits. Even then there are no guarantees that original contracts will be honored after substantial investments have been made. Witness the struggles of ExxonMobil and Royal Dutch Shell regarding their Sakhalin Island investment. The Russian government has been using taxation and environmental regulations to insure the IOCs make little or no profit on their investments. Currently Gazprom and Rosneft are working themselves back into controlling positions at Sakhalin.
Who Fills The Gap?
With more of the world’s oil reserves off-limits to IOCs and their production in decline, who fills the gap? With much of the global oil patch off-limits, it shouldn’t matter as long as someone brings the oil to market. However, the problem becomes one of priorities. International oil companies are much more efficient at finding and extracting oil and gas. They are also better at innovating and developing technology. Western oil companies are motivated by profit and return on investment. National oil companies are driven by a different agenda. Their motivation is political rather than commercial. For many oil producing companies, the national oil company is a cash cow for social programs. This is most evident in Venezuela and Iran where oil production has fallen by 46% and 43% respectively. The result is that OPEC production has fallen from 38 million barrels a day in 1979 to roughly 32 million barrels today.
So where does all of this leave us? The world we know is a world that runs on oil. Energy is the ultimate resource—essential for life and the driver of every industrial economy. Imagine life without it. There would be no lighting, air conditioning and heating, indoor plumbing, ovens to cook food, mechanized transportation, medicines or computers. All of these creature comforts are part of our modern energy-intensive world. Yet, we assume that the energy will be there when we need it. It is a dangerous assumption to make at a time that the world’s energy producers are struggling to keep up with demand. Again, energy demand continues to grow globally while global oil production is struggling to keep pace.
According to the chief economist for International Energy Agency (IEA), Faith Birol, spare capacity is going to remain limited despite new production coming on line from past discoveries. “Washington based PFC Energy Consultants estimates that the world is consuming oil at more than two times the rate of discovery of new supply. Conservation and efficiency gains have already saved billions, but they have not been enough to offset sharply rising demand from China and India.”
The real “inconvenient truth” that the world and especially the United States face is that we are running out of cheap energy or even worse—we may be approaching peak oil. Some think the problems are political and remain an above-ground risk. Some think the problems are rising exploration and production costs, shortages of equipment and personnel, lack of new technology to develop difficult-to-produce reservoirs (Chevron’s Jack well) and restricted access for IOCs. Others think the problem is geological (rapid oil depletion). As David Cohen at The Oil Drum puts it “Should an irreversible peak in world oil production become evident before 2015, contrary to optimistic estimates made by CERA (Cambridge Energy Research Associates) and ExxonMobil, it will not matter what the reasons were, or who was right or wrong.”
A Crisis Approaches
Time is running out and we are drawing closer to our next energy crisis. It is a crisis brought on by the conflict between rising global demand for energy and our growing inability to supply that demand. Despite the ominous signs all around us, our nation’s leaders and experts remain in denial concerning it. We have gone from a Republican to a Democrat-dominated Congress. In the transition nothing has changed. The U.S. has no real energy plan that focuses on domestic energy production of oil or gas, renewables or the expansion of our energy grid. For the past 30 years the United States has been losing control over its energy supply and thereby making its economy ever more vulnerable to external political and economic factors. If our economy is to grow, then we must have access to energy. If we are unwilling to explore, refine or build new sources of energy, then what country can we rely on to supply it?
Our leaders have made several errors in judgment in assuming oil will remain plentiful, no alternatives are worth pursuing, and that somehow OPEC will be able to meet the world’s increasing demand for energy. They ignore the fact that despite hundreds of billions in investment, Saudi Arabia has been unable to increase its production capacity over the last two decades. As Matt Simmons writes in Twilight in the Desert, at some point, large oil prospects will vanish completely and reserves will dwindle. Oil products will become much scarcer and less affordable. When oil supply peaks, the world will be forced to ration its use in one way or another. Competition for oil will escalate.
The question remains whether that competition is orderly and peaceful or strewn with conflict. Securing adequate oil supplies was an important element in all of the major wars of the last century and dominates conflicts in this new century. The United States—and the rest of the world by extension—is facing the biggest energy crisis in history. It is a crisis that we are completely unprepared for and one our leaders or the media are unwilling to acknowledge. From politician to citizen, our eyes remain wide shut.
Kleveman, Lutz, The
New Great Game, Atlantic Monthly Press, September 2003, p.1
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