Energy Realpolitik

There appears to be a list of conflicts and other kinds of issues that U.S. President Donald Trump and Russian leader Vladimir Putin touched upon during their meeting in Helsinki, and progress on any of them is bound to be slow. Oil made a headline during Putin’s remarks in the public session: Specifically, Putin reminded the U.S. president in front of the international media that “neither of us is interested in the plummeting of (oil) prices and the consumers will suffer as well” and called out oil as an area for collaboration, as expected. Whether it’s a threat or an offer is always hard to say with the Russian leader. But there are good reasons for U.S. officials to be cautious in the coming weeks and months about looking to Russia for “assistance” in the complicated geopolitics of oil and gas. Like many other conflicts and issues, Putin is promising all sides goods he likely cannot fully deliver. The United States should think longer and harder about what assistance Russia could actually provide to U.S. interests. My view is the bilateral dialogue should stick to more achievable priorities like arms control and improved bilateral lines of communications among top U.S. and Russian military brass to avoid accidental direct clashes. Unilaterally reducing vulnerability to the national security and cyber threats Russia can make against U.S. domestic targets should remain top priority, but oil perhaps belongs on the back burner. The reality is that Russia has made a policy of offering its assistance to national oil sectors under siege, including those who become targeted by U.S. sanctions. That policy has subjected Russian oil companies to all kinds of negative consequences that will hinder their balance sheets and make it more difficult for Russia to play a balancer role in the global oil market down the road. The United States needs to weigh any pledge of oil “cooperation” with America against Russia’s active involvement in troubled oil sectors as diverse as Venezuela and Iran. In the run up to the Helsinki summit, Iran’s senior advisor for international affairs Ali Akbar Velayati met with Putin last week and agreed to $50 billion in oil and gas sector investments. Russian giants Rosneft and Gazprom are in talks with the Iranian oil ministry about upstream investments. Earlier this year, Russia’s Zarubezhneft signed an oil field development deal with the National Iranian Oil Company (NIOC) to refurbish the Aban and West Paydar oil fields. Iran could believe that turning to Moscow will shield its oil and gas sector not only from attack by Arab separatists but also even (perhaps a little more far-fetched, but probably not in the minds of Iranian hardliners) Israel and the United States. The opposite could come to happen. If proxy wars escalate, Russian companies could get caught accidentally in the cross fire. In fact, both Tehran and Moscow alike could lose from deepening their collaborations in Iran’s domestic oil and gas sector. Iran may want to consider what happened to Turkmenistan, whose energy exports were forced into Russia at cheap domestic Russian prices to allow Russian companies to export more of their own gas at higher levels to European buyers. That is one reason many Central Asian countries eventually turned to China for assistance with energy and electricity as the conflict of interest and strings attached were less onerous. For its part, Russia could find that Russian oil workers will be in a vulnerable position to spontaneous local protests and attacks, both inside Iran and Iraq, regardless of the overall tone of high level, government to government interactions. The latest example is Iraq, where angry local protesters lashed out this week at a number of targets but notably gathered to threaten an oil field operated by Russian firm Lukoil. The event, which so far hasn’t resulted in major oil supply cutoff, is a reminder that Iran has the means to punish Moscow on the ground, not only via its proxies on the ground in Syria but also in Iraq, should Moscow cross a redline on any of Tehran’s regional interests.  Iran has threatened that the United States would be mistaken if it thinks Iran would be the “only” country unable to export its oil. Most analysts took that threat to be alluding to Saudi Arabia, which is involved in proxy wars with Iran in multiple locations and whose oil industry has been subject to cyber, drone, and sabotage attacks. But Iran may also want to make sure that Putin knows Iranian proxies can make trouble for Russia (in addition to Saudi Arabia) if Tehran feels double crossed. Moscow could be finding that its “partnership” with Iran is double-edged, constraining its freedom of movement on a host of critical issues ranging from its ongoing operations in Syria to its desire to remain the senior partner in oil market management with Saudi Arabia. From the U.S. point of view, this is highly material to U.S. and Israeli hopes that Russia can be an effective partner. Any Russian promises to help with Syria’s border areas or oil markets could become subject to Iranian backlash and therefore not reliable. In other words, U.S. policy makers could overestimate the value of collaboration with Moscow on Middle East conflict resolution. For Russian oil companies, operations in special assignment regions like Iraq, Venezuela, Libya, and Iran come with extremely difficult operating environments. Local conflicts are disrupting oil production, limiting payments in kind (e.g. oil exports) that were expected to reimburse Russian firms like Lukoil and Rosneft for its massive capital outlays and manpower. Money spent in oil and gas fields in these far-flung places is capital not available to make steady and possibly more reliable profits in Russia’s own domestic oil and gas fields, and it remains to be seen if Russian firms would be able to hold onto the barter style deals, should the governments change in any of the troubled locales. When all is said and done, it remains to be seen whether in the hindsight of history, Vladimir Putin’s deal making in oil over the past year or so will be viewed as triumphantly as it now might appear. In the glare of Europe’s response, the sudden cutoff of Russian natural gas supplies to Ukraine back in 2006 proved a misstep by giving impetus to not only the installation of several major liquefied natural gas receiving terminals in southern Europe and Poland but also giving added stimulus towards a major push towards renewable energy on the continent. Russia’s current moves into troubled states could similarly come back to bite its oil and gas industry, which was already struggling from high indebtedness, limited access to future financing, and the threat of additional U.S. sanctions.

Navigating the geopolitical domain surrounding energy is always difficult, but in the lead-up to the U.S.-Russia summit in Helsinki, it is particularly complex. While energy is unlikely to be a first order item for the summit, a number of topics likely to be raised could intersect with energy issues. Senior Russian officials have been vocal about energy related items in the run-up to the July 16 meeting, perhaps hoping that recent oil market volatility will give Moscow a leg up to make the usual pitch about the positive role its energy trade can have in the bilateral relationship. Several energy related topics are likely front of mind for the American team traveling to Helsinki with U.S. President Donald Trump. Here are a few examples: 1. The United States would like Moscow’s help to restrain Iran’s expansive role in the Mideast because it believes that this would help U.S. regional allies and better enable the United States to exit costly conflicts in the region. The subject of the ongoing conflicts in Yemen and Syria is bound to come up at the summit, especially if the United States and Russia seek to open better lines of military to military communication between top U.S. and Russian military leaders. This consultative approach is considered critical to avoiding an accidental escalation of military conflict, the dangers of which have risen in recent years. For its part, Russia will argue it has offered some accommodation on the Iran issue and would like something back in return. First, Russia’s top diplomats announced Moscow wanted to see the withdrawal of all non-Syrian forces from Syria’s southern border areas. That move was taken as a betrayal by some in Iran where MPs accused Russia of being an unreliable partner that would willingly sacrifice Iran to bolster relations with the United States. Then Russia backed an agreement with Saudi Arabia and other oil producers including the Organization of Petroleum Exporting Countries (OPEC) to increase oil supplies. Iran was unhappy that Moscow showed its support for the oil producer agreement, especially given the context of the re-imposition of U.S. sanctions against Iranian oil export sales. President Trump made no secret that a Saudi-Russian agreement to raise oil production was the firm wish of the United States. But paving the way for the U.S. summit wasn’t likely the main reason Russia wanted to see oil prices stabilize at a lower level. Moscow had its own reasons to want to prevent a surge in oil prices. High oil prices make it harder for the Russian government to prevent ruble appreciation which would be bad for the Russian economy. 2. Arms control will be top of mind for the summit. The United States wants to signal its steadfast support for East Europe allies. This topic will trigger mutual accusations of violations in the Intermediate-Range Nuclear Forces Treaty (INF) treaty. While arms control will be a high priority topic, the back drop to any discussion of the INF and missile deployment will circle back to U.S. diplomatic support for Eastern Europe. That, in turn, could trigger a tangent to the United States’ open opposition to Russia’s Nordstream 2 direct natural gas pipeline expansion to Germany. Germany favors the expanded line to enhance its ability to bypass other gas pipeline transit countries like Poland, Belarus, or Ukraine, saying this will promote Germany’s energy security. The United States argues that the pipeline project, which would benefit Germany economically and strategically, could raise Europe’s dependence on Russian energy and weaken the Eastern European countries’ status vis-à-vis Russia as well as potentially shift needed income from the smaller Eastern European economies to to Germany. 3. The United States would like Russia to play a helpful role in negotiations for the denuclearization of North Korea. If past efforts are any indication, energy could be a piece of the economic package North Korea can hope to achieve through a peace treaty. Russia stands to be an important beneficiary of any energy deal that is part of the North Korean negotiations since one obvious option to North Korea’s energy problems could be a natural gas pipeline that would carry Russian natural gas via China to both North and South Korea. It’s not new for Russia to figure energy could be a constructive force to any U.S.-Russia relationship reset. Energy has been part and parcel of several U.S. attempts to improve relations with Russia in the past, as far back as 1993. At that time, the U.S.-Russia summit led to the creation of the Gore-Chernomyrdin Commission to promote economic and technological links, including energy. As part of that diplomatic process, the United States offered up American know how to help Russia revitalize its oil sector. ConocoPhillips was an early mover with its Polar Lights venture, but eventually it and other U.S. oil companies that entered Russia at the time found a host of legal, regulatory, and logistical barriers that turned profitable ventures into losing propositions. The failure of U.S. oil investing in Russia mirrored similar setbacks in U.S.-Russia arms control agreements. In the aftermath of the terrorist attacks of September 11, 2001, the United States and Russia revived their bilateral energy dialogues, after Vladimir Putin signaled that Russia was ready and able to help diversify global energy supplies away from the Middle East. In May 2002, President George W. Bush and President Putin initiated a new high-level dialogue on energy that led to several energy specific summits and new deals for American oil and gas companies in Russia. But soon after billions of dollars of fresh U.S. investment began flowing to Russia, the Kremlin began to renationalize its energy sector, and by 2005, U.S. companies not only faced difficult renegotiations of their oil and gas deals but in some cases, outright arrests of partners and the taking of assets. Obama era proposed resets similarly ran aground after Russia invaded Ukraine in 2014. The United States and Europe imposed sanctions on Russia in response, creating problems anew for the few U.S. oil companies that were still remaining on the ground in Russia. This time around, sanctions are top of mind when it comes to energy relations between the United States and Russia. Russian Energy Minister Alexander Novak visited U.S. Treasury Secretary Steven Mnuchin during his visit to Washington D.C. in late June. Reports say the meeting focused on sanctions, which for obvious reasons, the Russians would like removed, and the Nordstream 2 pipeline which Washington has threatened with possible new sanctions. Treasury, at the urging of Congress, has played a pivotal role in showing the Kremlin that it is not out of U.S. reach when it comes to economic levers. The United States targeted Russian aluminum firm Rusal and others with sanctions back in April to punish Moscow for malign activities, such as interference with U.S. elections, and amid suspicions that the Kremlin was behind the murderous use of nerve gas in the United Kingdom. The U.S. imposed April sanctions against Russia caused $12 billion in losses for Russia’s fifty wealthiest oligarchs. With both of Russia’s largest state-controlled energy companies, Rosneft and Gazprom, carrying huge corporate debt loads, further sanctions against those entities could be a major hassle for the Kremlin, which would be forced to intervene, possibly triggering more acrimony and rivalry inside President Putin’s inner circle.    From its side, Russia is likely to argue that it has been accommodating to U.S. priorities on Iran and oil prices and try to leverage those actions as evidence that the United States should offer concessions to its concerns. That means the United States will have to think carefully about how energy intersects with other priorities ahead of the summit because it will be tricky to both discourage Moscow from an aggressive posture on U.S. hacking, on military positioning in Eastern Europe, and on arms control and still reap the benefits of its cooperation in the Middle East and oil markets. Keeping items compartmentalized and in different buckets might seem feasible at first glance. The United States still achieved successful détente with the U.S.S.R. during the Cold War, for example. But as the U.S. summit with Russia approaches, better definition of priorities when it comes to energy will be necessary. Some items are already creating inconsistent messaging; for example, asking European nations to veto the Nordstream 2 pipeline to avoid over-dependence on Russia while at the same time, encouraging Russia to sell more oil to Europe to replace Iranian barrels and elsewhere to lubricate the oil market. Backing a Russian natural gas pipeline to the Korean peninsula could also seem untoward both to European advocates of Nordstream 2 as well as to U.S. exporters of American liquefied natural gas (LNG) who have been making headway lining up long term supply contracts to South Korea. The U.S. advance team to the summit will have to align competing interests to prepare more consistent messaging for Russia on these various energy elements, even if energy isn’t going to be in the top three topics for deeper discussion. Lack of clarity could muddy U.S. effectiveness in discussions or worse, leave Russia with geopolitical advantages it has shown it will exploit to divide the United States from its allies. Russia is likely hoping that energy exigencies will create an opening for it to gain concessions from the United States in other areas. The fantasy that Russia could somehow provide the United States a big lever against Iran in Syria and elsewhere may have initially clouded U.S. judgement over what is possible. Iran is unlikely to go quiet into the night, as it has made clear recently with threats against international shipping, regardless of how Moscow plays it. The United States needs to seek substantive discussion on other areas that don’t involve Iran, to avoid having the summit success reduced to empty promises on cooperation between the United States and Russia regarding Iran, when in reality, Moscow cannot likely impose sustainable constraints on Iran’s military actions, even if it wanted to. When discussing the topic of Europe, the United States should keep in mind China’s massive energy and other critical industry investment expansion into the continent. That could be a more fruitful topic that is putting Russian leaders on a back foot. To date, the real challenge to marketers of Russian oil and gas to Europe has not been U.S. LNG exports which are only just starting (U.S. energy sales to Europe are still a negligible volume compared right now to Russian natural gas sales which have been on the rise). It is renewable energy which is the bulwark of Europe’s energy independence from Russia. China could become the major actor in Europe’s clean energy future and that will influence both long run U.S. and Russian links to the continent as it has in Central Asia. The United States has been downplaying expectations for the Helsinki meeting, noting the fact that it is taking place is an improvement to escalating tensions. Preparations for a summit will likely force U.S. policy makers to square the circle on apparent inconsistencies in U.S. international energy diplomacy. Given the wary eye of Congress, the Trump administration is unlikely to offer Russia any sanctions relief until when and if Russia demonstrates substantive results on the ground. The United States should also be cautious about trying to orchestrate future participation of American oil and gas companies in Russia as a possible diplomatic carrot. The history of such initiatives is spotty at best, and it only takes one reckless unexpected action by Moscow to force Washington to press companies yet again to cut back on any progress on energy cooperation that could be made in the short run. A cautious approach to talk of energy cooperation would be wise at this juncture until more progress is made on higher priority issues.

U.S. presidential jawboning about oil prices has continued to grab headlines this week, with President Trump telling Fox News on Sunday that the Organization of Petroleum Exporting Countries (OPEC) is manipulating the oil market and “better stop it.” The statement followed a previous tweet explicitly confirming a phone call with King Salman of Saudi Arabia regarding the kingdom’s agreement to put even more oil on markets than announced last week to counter turmoil inside Iran and Venezuela. The U.S. president’s unconventional approach contributed to an almost $2 drop in the price of international benchmark Brent crude Monday, as market psychology appeared to shift. That will likely be viewed favorably from the White House. But the transactional discussion offered on U.S. television that oil producing allies should offer accommodative oil export policies because “we are protecting them” laid bare a quid pro quo that could be problematical down the road given recent escalation of regional proxy wars. The United States may be encouraged by ongoing protests in Iran but turmoil can be unpredictable, and U.S. national interests can vary in certain respects from those of its allies. Close study of recent pernicious effects of cyclical swings in oil prices lends itself to sympathy for President Trump’s frustration. Given the circumstances of the financial turmoil and oil price collapse that followed the oil price spikes in 2008 and 2014, it should be pretty unnecessary to have to remind kings, presidents and emirs that an unstable oil market is bad for everyone, including their own people. For all the talk about resource wars, no shots were fired over oil when prices were rising in 1973, nor when prices hit $147 in 2008. That’s probably because for all of the handwringing about the oil “weapon,” commodity prices eventually correct themselves naturally like gravity, even in the face of politically inspired cutoffs. For OPEC, history seems not to be a teacher. Fuel switching, new drilling techniques, and structural destruction of long run demand reassert themselves when oil prices go up. That was certainly the explanation of the price collapse in 2014 to 2016. Moreover, in the future, countries like the United States and China are increasingly more likely to invest in alternatives rather than go to battle over resources either diplomatically or literally, especially in today’s digital revolution, where the potential for success is so high. The fact that few countries are willing to spend a trade chit on Iranian oil is a sign that times have changed. Oil producing countries are under budgetary pressure but, at least in the case of the Gulf countries and Russia, not enough to reverse course on high military spending and foreign adventurism. Venezuela should be the poster child for what could go wrong when governments raid the coffers of their national oil companies. The sad truth is that such suffering doesn’t actually seem to lead to regime change, just more repression. U.S. neoconservatives don’t seem to be learning that lesson either.   That said, I believe oil prices have entered a new phase where the traditional features like business cycles and geopolitics that normally dictate the ups and downs of oil prices are now intersecting more integrally with structural technological change. Digital disruption could bring a long run downward trend in energy costs over the coming decades, but that doesn’t necessarily mean “lower for longer” oil prices will be true for any particular month or year. If anything, digital innovation could be making the swings of the oil boom and bust cycle worse by shortening the time scale between up and down oil price phases. Private oil companies can bring new oil fields online with a rapid pace. Demand saving technologies are also readily available. To the extent that digital innovation does both simultaneously and seals a negative fate for individual national oil companies that cannot compete effectively in this new global context, it could bring higher oil prices at sharp intervals as oil supplies get disrupted from places where new investment is lagging, like Angola and Venezuela. In recent years, many important national oil companies (NOCs) have found themselves a victim of deteriorating budgets or violence—industries in Libya, Yemen, Syria, and Venezuela have been decimated. NOCs in Mexico, Brazil, and China have succumbed to localized corruption problems. The list is likely to expand over time. During periods when a major oil supplier goes down, OPEC (or some other group of oil exporters) are bound to find themselves with market power. That is why a volatility thesis based on the idea that producers can no longer interfere in markets is also likely incorrect for the time being, and the U.S. administration is smart to think about how to handle manipulation. Volatility can still come from exporter consortium attempts to goose prices. It may just be lumpy as technology continually improves to make itself felt and more frequent as digitization of everything from oil well development to energy efficiency gains pace. But if and when another major producer goes down (this time likely Iran), those left standing may attempt to garner some short-lived revenue as OPEC just did on the backs of Venezuela’s collapse. In the current upward business cycle, which has been stronger than expected, OPEC has certainly been able to jack up prices temporarily, unfortunately in all likelihood ensuring current global economic prosperity won’t last for long. For Russia, a culture that experiences long suffering of everyone together, instituting a downward global economic cycle could feel cathartic. For Iran’s hardliners, the temptation to push prices too high through acts of violence is likely a reflex to proving to others (read, American neocons) that they are still a force to be reckoned with. In the grand scheme of things, blowing things up to raise the price of oil will hasten the return of low oil prices which hurts the Iranian economy. Iran’s government has been preaching solidarity towards a resistance economy, albeit that message is looking increasingly uphill. Still, exigencies being what they are, the United States needs to be prepared to consider policies beyond calling upon Saudi Arabia, whose oil industry has struggled in recent years to add extra capacity. It is yet another reason why the United States should stay the course on advanced automobiles and other energy efficiency policies as well as modernizing the U.S. Strategic Petroleum Reserve. Rising U.S. oil production is not the same quality of oil as that of the Middle East, Venezuela, and Mexico so net flows in and out of the United States are necessary based on the current equipment in the U.S. refining industry which was designed to run imported oil. Sadly, recent consolidation of the SPR has left the United States in a worse position to help U.S. Gulf coast refiners. That problem needs to be revisited next time oil prices cycle down.   By the way, I am not conceding that the structural lowering of energy costs through digitization won’t be material. But it could entail a multi-year process. Every time oil prices go up, as they inevitably will repeatedly in a cyclical fashion, the deployment of new advanced technologies will accelerate accordingly, not only because we are in a period of revolutionary technological change, but also because other imperatives, like climate change and energy security, will give forward looking governments even more compelling reasons than the oil cycle to diversify away from oil. The United States needs to take that on board in considering its long run economic competitiveness. The U.S. Department of Energy’s new program for regional energy innovation, while underfunded, is a good start. Energy producing countries are starting to consider this digital structural change in their official thinking because the higher oil prices go, the more likely China and India are going to hasten policies to eliminate future oil demand, raising the chances of lower oil demand by the time 2025 or 2030 arrives. Governments are putting the infrastructures in place to ban the sales of internal combustion engines. European populations and their capitals care about climate change but renewable energy has also lessened the exposure to Russian energy. China is considering a ban on gasoline cars as part of its industrial policy. OPEC officials can say officially that they don’t believe in the peak oil demand narrative but a rise in oil prices above $100 now makes it all the more plausible than a drop to $20. At $100 a barrel, a ride sharing app that calls forth an electric ride will increasingly make sense in a world where new technologies are driving down the costs of solar, batteries, and even natural gas and clean coal. I am guessing that Saudi leaders understand this long run oil cycle threat. That is why they keep talking about decadal agreements with Moscow to stabilize oil prices. That’s good news for Vladimir Putin. But not because he believes he can ameliorate the oil cycle. He is just guessing that being the senior partner in an OPEC-like grouping will restore Russia to the stature it deserves. He is likely correct about that. It’s getting him yet another reset summit with the United States as energy has done several times before. The bad news for U.S. jawboning on the price of oil is this: There are two ways to get out of this painful pattern of oil price shock repetition and neither is likely to happen any time soon. Oil producers could start by spending more of their oil cycle windfalls on economic reforms, education, food and water security, and not buy as many armaments. For its part, the West, China, India, and ASEAN could make sure digital innovations like advanced and autonomous vehicles, drones and online shopping lower the oil intensity of their economies instead of the opposite effect so that economic growth does not promote as sharp an upward oil price cycle as in the past. I am not optimistic about either of those two things happening right away. For the time being, it will be hard for any of the parties concerned, to eliminate the oil cycle, including the U.S. president.