Geopolitics of Energy

Sagatom Saha is an energy policy analyst and former visiting fellow at DiXi Group, a Ukraine-based think tank focused on energy-sector analysis. Ilya Zaslavskiy is the head of research at the Free Russia Foundation and a member of the advisory board of the Hudson Institute’s Kleptocracy Initiative.  At this crucial moment of Russian aggression in the Kerch Strait and the five-year anniversary of the Euromaidan Revolution, there is much U.S. policy makers can do to help the country make further progress on its energy reforms. Ukraine will ultimately decide its own fate, but the United States has a strong interest to support an emerging regional ally in three ways: increasing diplomatic pressure, providing technical assistance, and offering financial support tied to specific reforms. Although Ukraine has made more progress in its energy reforms since the Euromaidan Revolution than at any point since its independence in 1991, that progress has been halting. For example, the government moved to close the gap between natural gas prices for households and industrial consumers, reducing subsidies that were a major drain on the national budget. But Ukraine failed to put in place necessary policies to prevent the government from fully reintroducing subsidies. Import prices have increased over the last two years, but household prices have stayed the same, potentially crowding out budgetary priorities like defense and welfare. Inefficiency, corruption, and lack of transparency continue to hamper Ukraine’s natural gas sector. Going forward, Kiev would benefit from advancing energy reforms that would completely eliminate population-wide subsidies. It also needs to complete necessary reforms to attract foreign investors so that Ukraine can produce more gas domestically. The alternative, ceding to populist pressure and oligarchic influence would limit economic growth and risk return to dependence on Russian energy supplies. The choice it makes will determine the fate of the country’s energy and economic security for years to come. On the one hand, Ukraine has ostensibly redesigned its national energy regulator to align with EU energy legislation; in practice, however, there is still no functional body to independently enforce market rules that encourage competition. Meanwhile Naftogaz, Ukraine’s state oil and gas company, remains a virtual monopoly with 75 percent of the country’s natural gas production, crowding out private investment. The lack of government guarantees to prospective investors, independent courts to enforce ownership rights, and fair access to the gas transit system all work in concert to prevent Ukraine from becoming a net gas exporter in the next decade despite having abundant shale gas reserves. Ukraine’s opaque licensing system for gas exploration also prevents many prospective gas producers from entering the market. Paradoxically, it is not what is “below the ground”, but instead the “above the ground” issues that prevent Ukraine, a country at war with Russia, from achieving its own energy independence.  Stakes are high since former Prime Minister Yulia Tymoshenko, who now leads polls for the upcoming March 2019 presidential elections, has centered her campaign on a vow to reinstate subsidies. Observers worry that, unless Ukraine makes substantial regulatory changes in its natural gas sector, Russia could again exploit corruption to subvert Ukraine’ sovereignty. In a paper published by the Council on Foreign Relations, we urge Kiev’s executive and legislative branches to depoliticize natural prices, firmly establish regulatory independence, and carefully dismantle energy-sector monopolies, while judicial branch create a predictable and fair environment for all potential investors. For its part, Washington should make this energy reform a priority in its bilateral relations with Kiev, showcasing to Ukrainian and European investors, among others, to promote development of Ukraine’s domestic natural gas sector. To demonstrate seriousness, Washington should closely coordinate with the IMF and other Western donors for more stringent compliance for loan disbursements and extend its targeted sanctions program against Russian oligarchs to the corrupt Ukrainian ones as well. Second, the United States should pair increased pressure with regulatory and legal assistance. Specifically, Federal Energy Regulatory Commission, the Department of Interior, and State Department should step up their work with Ukrainian partners to design strong, independent regulatory agencies, formulate simplified licensing procedures, and share the know-how needed to develop shale gas resources, collect royalty revenues, and combat corruption.  The United States and European allies benefit when Kiev is a self-reliant, energy-secure Ukraine, capable of standing up to Russian interventionism. Supporting Ukraine’s energy reforms is a low-risk, high-reward strategy for Washington to counter Moscow’s influence at NATO’s border without overcommitting to military options that are not feasible in the region. Completing reform will also enhance unity within the EU Energy Union and integrate Ukrainian gas production, storage, and transit assets into the EU market. With sustained, considered U.S. support, Ukraine can reform its inefficient gas sector into an engine not only for its own economic progress and security, but for the whole of Eastern Europe. A version of this post first appeared on the Atlantic Council’s EnergySource blog.

This is a guest post by Sophia Lian, intern for Energy and Climate Policy at the Council on Foreign Relations.  Since the collapse of the Soviet Union, Beijing and Moscow’s shared goal of reorienting the Western-dominated global order has led them to cooperate on many fronts, including energy infrastructure and institutional development.  Despite lingering mistrust, the two countries recognize their complementary strengths and have pushed forward in their opportunistic partnership. Much needed Chinese investment in Central Asia, the Russian Far East, and the Arctic will tap vast energy stores and provide institutional support in remote locales.  As Moscow keeps wary watch over increasing numbers of Chinese migrants in its backyard, Beijing is careful to alleviate concerns of encroachment by publicly deferring to Moscow’s leaders while highlighting regional benefits of Chinese investment. In securing a foothold in Russian territory through the eastern stretch of the Belt and Road Initiative (BRI), China is laying the groundwork for future geopolitical plays.  Strategically consolidating Chinese influence through economic development in the Russian Far East, Central Asia, and the Arctic aligns with President Xi Jinping’s more activist brand of foreign policy.  Based on one’s perspective, Beijing has already been treading a fine line between Russian collaborator and competitor. Chinese Collaboration in Russia’s Backyard: Russian Far East, Central Asia, and the Arctic The Russian Far East is a region of strategic importance and historical sensitivities.  This icy region abounds with natural resources and is the site of Russia’s only warm water Pacific port (Vladivostok).  Russia’s coveted possession of a Pacific outpost was realized in the late 19th century when it successfully compelled a weak China to sign over control of the region whose loss China has not gotten over. Against this historical backdrop, Russia has closely guarded its sparsely-populated eastern hinterland, and has until recently rebuffed Chinese business forays into the region.  However, the collapse of its relationship with the West over Ukraine has left Russia little choice but to turn to Beijing for finance and economic development assistance, and Russia’s moment of weakness is opportune for an energy-hungry China eager to diversify its energy sources and enhance its strategic positioning. Economic development has been quick to come to the Russian Far East.  Chinese capital now accounts for 45 percent of the total foreign investment in the regional capital, Khabarovsk.  A little ways south in the port city of Vladivostok, Chinese money has transformed the area into a tourist center, when only a few years earlier both far eastern cities lagged far behind their European Russian brethren.  Similarly, China has taken an interest in Central Asia as a potential hub for expanding Eurasian trade flows and has secured energy development, transport, and infrastructure projects as part of its BRI.  China claims its collaboration in the Arctic will help develop the region’s untouched bounty of natural resources.  In undertaking these projects, however, Beijing contends with Russian territoriality as the Kremlin is weary of privileged Chinese access to areas that could ultimately jeopardize Russian sovereignty. Chinese Accelerating Arms Exports, Development of Traditional and Nuclear Power, and Ownership of Critical Infrastructure Arms Exports: China’s consolidation of geopolitical assets through infrastructure investment extends to the Middle East, Africa, and Europe, which could challenge Russia’s traditional role as a major energy and arms supplier.  Russia’s economy and influence is highly dependent on its energy and arms exports, whose domain its southern “frenemy” has increasingly encroached upon.  While Russia has been developing new weapons systems, China is now poised to become a dominant arms exporter after decades of copying and appropriating Russian technology, and integrating such technology into both its defense and private tech industries.  Moscow’s economy is not as resilient in that its defense-driven economy cannot fall back on civilian demand like China’s economy can (through dual-use technologies).  China is gaining ground in countries with troubled human rights records and has recently been successful in arms sales to several African countries (e.g., Algeria, South Africa, Kenya, Cote d’Ivoire) in addition to continued large sales to regional buyers Pakistan and Afghanistan.  Development of Traditional and Nuclear Power: The Kremlin has made clear its aims to become a dominant energy power in the Middle East and has recently inked several business deals in the region.  But China is close behind, staking out Mideast energy deals, especially in Iran and Iraq.  The recently acquired 80.1% stake of the South Pars gas field (taking up a 50.1% stake from French energy giant Total, which is withdrawing because of U.S. sanctions) will mean China could become a natural gas exporter in competition with Russian firms Gazprom and Novatek. The competition is direct since Russia views its energy exports as not only a means to needed petrodollars but also as a geopolitical tool to build spheres of energy dependence. China emulates the same ends via its BRI, and more recently through its planned expansion into the nuclear energy export market. China is playing the long game in this regard, and its patience has paid off as the UK has recently given the green light for the Hinkley Point C power station of which an important piece of infrastructure is Chinese.  This is hugely significant as no western country has opened up their strategic infrastructure to a non-ally in this way. Britain’s approval, which brought consternation from the U.S., could jumpstart China’s reach to the rest of the world. Beijing envisions building 30 nuclear plants along its BRI path by 2030, and though Beijing and Moscow collaborate in developing nuclear technology, Russia is sure to chafe at China’s ambitions.  Chinese activity in nuclear power directly competes with Russian natural gas sales to Europe, as do energy associated with other Chinese sources, including wind farms, exports of solar panels, and eventually battery storage. Ownership of Critical Infrastructure: China is also buying other critical infrastructure in eastern and southern Europe and Greenland, further extending its reach to the west.  Deals worth at least $255 billion across the European continent have resulted in almost 360 companies having been taken over and China also is now partially or wholly owning at least four airports, six seaports, wind farms in at least nine countries, and thirteen professional soccer teams.  Last but not least, long considered the world’s largest rare earth producer, China has a chokehold on cheap access to these essential elements, and recently concluded an agreement aligning uranium and rare earth mining activities between the Greenlandic and Chinese governments, giving China almost exclusive control of this domain. Outward Collaboration Over the previous decades, China’s influence has strengthened to the point where it can now challenge traditional hegemons like Russia -- but for now, a partnership is still preferred.  Though Moscow is wary of the myriad Chinese projects being undertaken and of the increasing numbers of Chinese migrants in its backyard, it is currently managing its insecurities quietly since it recognizes the need for Chinese capital and manufacturing expertise to tap undeveloped resources and to build needed infrastructure, partly to counter its souring relations with the West.  The two countries have thus found common cause on a number of issues, from mutual diplomatic support on the UN Security Council, to military reinforcements and economic collaboration.  Naval exercises in the Sea of Japan, South China and Baltic Seas showcase solidarity in areas of tension with Washington.  Of course, these displays are meant to project a united image that is not so sanguine under the surface.  China has, over the years, avoided inconvenient entanglements and has demonstrated its utility as a source of capital, infrastructure, and arms.  Now, stronger and under more expansionist leadership, China’s reach is set to expand much farther afield under its ambitious BRI. For now, China appears willing to refrain from overt challenges to Russia, as Beijing’s immediate need for imported raw materials and desire to focus on its BRI ambitions requires a cooperative Russia. Beijing has tried to ease Moscow’s insecurities about perceived Chinese encroachment by promising economic benefits, and staying relatively respectful of Moscow’s Eurasian security interests while it focuses on economic and industrial development.  So far, the arrangement has worked for both parties and has even led to an interesting turn of events, where Chinese troops were invited to participate in the massive 2018 Vostok war games -- Russian military exercises historically meant to prepare for border confrontations with China.  It is unlikely that Russia suddenly considers its long-time adversary an ally, but the two will continue to outwardly collaborate until it is no longer in either’s interest to do so. Future increases in energy export and investment competition in Europe and beyond could be the first signs of strain in the uneasy relationship.  

The problem with the “energy weapon” is that it is notorious for backfiring. That fact couldn’t have rung truer than this week when it was reported that Germany, a major natural gas importer in Europe, was going to co-finance the construction of a $576 million liquefied natural gas (LNG) receiving terminal in northern Germany. The announcement, billed as a “strategic move,” is the culmination of years of European diversification away from the grip Russia had on Europe’s natural gas market when it briefly cut off supplies to Ukraine in the winter of 2006. It is important to note that back in 2006, commentators were quick to point out that the dispute between Ukraine and Russia did not significantly disrupt Europe’s access to Russian gas and was settled quickly. But the die was cast in the minds of policy makers: Russia held too much leverage. European governments, utilities and private industry responded dramatically. The continent made a crash campaign to build LNG receiving terminals, to promote freer trade in cross-border electricity and natural gas trade, to pass anti-monopoly legislation aimed at Russia’s state firm Gazprom, and to bulk up on renewable energy. More than a decade later, as the U.S. industry prepares a massive wave of LNG exports, Gazprom is sending out the message that its main goal moving forward is to preserve its market share, even if it means sharply discounting its prices. The change in strategy comes in the wake of internal criticism at the highest levels inside the Kremlin that Gazprom suffered market setbacks between 2009 and 2013. After growing steadily since the early 2000s, Gazprom’s market share in European gas markets fell to 23 percent in 2009 in the aftermath of the Ukraine crisis. Market problems continued through 2013 when the state firm started to implement a new price discounting model. That market-oriented response included partial retroactive payments back to customers to compensate them for the gap between natural gas spot market prices and higher oil-linked prices contained in Gazprom’s long-standing contracts. Contract revision demands from European buyers after 2006 has resulted in the volume of spot market and oil and gas hybrid-indexed pricing for European gas purchases to hit over 70 percent of sales, up from less than 20 percent in 2008. In response to these changes in market conditions, Gazprom also postponed indefinitely its Shtokman LNG export project. The origins of Gazprom’s shift were chronicled recently at a presentation at Columbia University’s Center for Global Energy Policy, where Russian energy scholar Tatiana Mitrova told a U.S. audience that the flexibility of Russia’s new pricing and sales regime is a direct result of rising renewable energy installations in Europe, combined with the emerging threat of U.S. LNG exports. The latter prompted the Kremlin to diversify away from reliance on Gazprom for exports with the approval of Novatek’s initiative to develop Yamal LNG in 2013. The project is considered a successful one inside Russia. Gazprom contracts totaling roughly 16 billion cubic meters (bcm) are due to expire in the next few years. Poland, which built an LNG receiving terminal in 2015 with help from Qatar, has already announced it will not be renewing its gas dealings with Russia, likely in favor of U.S. LNG. Lithuania also has a new LNG receiving terminal. It remains to be seen to what extent other European countries will follow suit. Germany’s declaration that it too will expand access to U.S. LNG via a new import terminal is telling, since Germany’s leaders had previously staked out a strident pro-Russian gas position amid U.S. objections to the Nordstream 2 gas pipeline project from Russia to Germany.  Europe’s LNG import capacity stands at 20 billion cubic feet per day (bcf/d) and LNG imports averaged 5.1 bcf/d in 2017. Russian pipeline gas represented 35 percent of total European gas use in 2017, slightly higher than the level Russia’s Gazprom says it seeks to maintain. There is much debate about the price point at which U.S. LNG can compete with Russian gas in Europe, and the numbers vary in large measure given different assumptions about how much of the cost of capital will be recovered for U.S. LNG facility developers and what will constitute the value of the U.S. natural gas to be shipped. If one assumes the $2.25 export facilities fee (or higher) that is embedded into early U.S. LNG export contracts, Henry Hub natural gas spot prices, and ongoing transport costs, U.S. LNG needs a $6.00 to $7.00 million British thermal units (mmbtu) price to be competitive to Europe. This past summer, conditions were positive for U.S. shipments; at liquefaction and shipping costs of around $3.00 to $4.00 per mmbtu and spot prices for U.S. natural gas averaging just under $3.00, U.S. LNG could make landfall in Europe at under $7.00 per mmbtu, in line with comparable prices for other supplies. The spot price for LNG in Southern Europe traded between $7.70 mmbtu and $8 mmbtu this summer, a low seasonal demand time. Southern European prices are currently averaging around $9.50 mmbtu as winter approaches. If global natural gas markets got more price competitive over time, some integrated U.S. players are in a position to compete effectively with Gazprom. That’s because they would be able to lower or waive altogether facilities fees and will have access to gas that could be available on a zero cost, or even negative cost, basis since there will be plenty of stranded gas that is an associated waste product of valuable oil and natural gas liquids production and likely to be flared for no value if markets cannot be developed. On that basis, U.S. LNG can land into Europe at below $2.00 to $3.00 mmbtu. Mitrova estimates Gazprom’s hard Siberian production costs are $0.90 and then it has a $1.20 transport tariff cost for pipeline operations between western Siberia and the Russian border. An additional export duty is imposed by the central government of 30 percent of the sales price. This latter charge could presumably be lowered to allow Gazprom to be more competitive with U.S. supplies. In other words, if a global glut of natural gas were to develop in the coming years as some predict, the price point of U.S.-Russian gas competition in Europe could produce dramatically lower prices than today. The outlines of how U.S.-Russian energy dimensions might spill over into international relations are already apparent as European countries, including now apparently Germany, reassess how to manage their overall energy import mix. Some countries may opt to investigate higher use of renewable energy to politely bow out of the geopolitics of natural gas imports. Ironically, that might leave both U.S. and Russian natural gas sellers to duke it out with China, which is positioning itself as an exporter of solar panels and battery storage to Europe. China is also investing in European nuclear plants. Ira Joseph, who leads S&P Global’s European gas and power energy service, told the Columbia University Center for Global Energy Policy forum that the costs of battery storage could become a determining factor in European natural gas prices down the road. That development, if it materializes, was not anticipated in Moscow when it brandished the energy weapon so briefly in 2006. It highlights that energy security concerns can be a strong motivator for substitution of fuels.

Threatening a price hike might work in the short term, but it would come with serious costs to the kingdom’s reputation as a moderating influence on oil markets.

The longer I write about oil, the more I have become convinced that names and faces can change but the basic storylines repeat themselves. For students of history, it might be tempting to say that this is because each generation of new blood comes without the experiences of the past. But perhaps it is just the nature of oil. The inexorable boom and bust pattern of the oil market follows a geopolitical cycle that has proven next to impossible to break. Geopolitical events of the past few weeks look poised to show both the U.S. president and Middle Eastern leaders how difficult it is, even with so many structural changes in energy markets, to avoid debacles of the past. Famous TV anchor and Saudi media figure Turki Aldarkhil wrote on government-owned news service AlArabiya, “If U.S. sanctions are imposed on Saudi Arabia, we will be facing an economic disaster that would rock the entire world.” The commentary continued, “Riyadh is the capital of its oil, and touching this would affect oil production before any other vital commodity. It would lead to Saudi Arabia’s failure to commit to producing 7.5 million barrels. If the price of oil reaching $80 angered President Trump, no one should rule out the price jumping to $100, or $200, or even double that figure.” He continued, “An oil barrel may be priced in a different currency, Chinese yuan, perhaps, instead of the dollar. And oil is the most important commodity traded by the dollar today.” In larger print, a summary statement warned, “There are simple procedures, that are part of over 30 others, that Riyadh will implement directly, without flinching an eye if sanctions are imposed.” No doubt, rising tensions between the United States and Saudi Arabia surrounding the circumstances of missing journalist Jamal Khashoggi has become an oil matter of rising importance. The escalating incident has laid raw an uncomfortable fact: serving as the central bank of oil requires a steady hand. Global oil markets were already tense upon speculation that the kingdom’s spare capacity, the amount of extra oil production that can be brought online quickly within 30 days and maintained for 90 days, was lower than previously thought. For years, Saudi Arabia has maintained it has the ability to raise production to 12 million barrels a day (b/d) and stay at that level. But analysts have recently said the kingdom may be currently producing almost at its maximum, and would need to make investments to be able to raise production further. Energy Intelligence Group reported earlier this month that “producing beyond 11 million b/d will take significant drilling and require more rigs.” The oil newsletter also reports that the kingdom will be able to add more oil to markets once the repaired Manifa field can come back on line in January 2019. Its expansion at the Khurais field is due to add 300,000 b/d by mid-2019. The Saudi oil minister has stated production is currently at 10.7 million b/d and sources report the kingdom has also sold oil from storage in September and October. Prior to the new U.S.-Saudi tensions, U.S. President Donald Trump had repeatedly expressed frustration over Twitter regarding Saudi Arabia’s wavering hand on global oil markets. Twice in recent months, the kingdom’s statements of intended closer oil collaboration with Russia to support oil prices have been met with marked public displeasure from the White House, prompting the Saudi oil minister to reverse course at recent gatherings of oil producers in a sign that Riyadh viewed its long standing relationship with the United States more critical than its newer ties to Moscow. But in an example of how difficult oil diplomacy can be, oil prices continued to rise on fears that any new supply disruptions could not be physically met by either increases in supply from Saudi Arabia (based on capacity constraints) or from the United States whose production increases are temporarily stalled by pipeline bottlenecks. With oil as the backdrop to new additional strains in the U.S.-Saudi relationship over other matters, President Trump told supporters in a highly personal reference at a rally last week, “King, we’re protecting you. You might not be there for two weeks without us. You have to pay for your military.” The escalating rhetoric between Saudi Arabia and the United States is bound to harken back to memories of past colossal oil debacles of 1973 or 1979, for those old enough to recall those turbulent times. My book with Rice University econometrician Mahmoud El-Gamal has a chart on page 35 in chapter 2 that might give solace to U.S. policy makers. It shows how U.S. real per capita gross domestic product recovered quickly in the 1980s while that of Saudi Arabia collapsed and did not start recovering until the mid-2000s. But there is another lesson in my book as well. National oil companies (NOCs) that face a geopolitical collapse take years, if not decades, to recover, if they recover at all. Today, there are many NOCs at risk simultaneously, whether from war, international sanctions, financially destabilizing policies of populist leaders, or via anti-corruption campaigns that have left some important NOCs rudderless. That situation has lowered the resilience of oil markets, even with the positive role of U.S. oil and gas exports and emerging oil-saving digital technologies. The reverberations would be large if an erratic U.S.-Saudi relationship or any internal Saudi domestic political or economic issues were to damage the future operational efficiency of state oil firm Saudi Aramco. That said, the United States has shown on many occasions that it has many other values that supersede oil, including international norms of behavior, free democratic elections, and freedom of speech. U.S. sanctions against Russian metals firm Rusal and its officers will be one such case. Those sanctions were imposed by the Trump administration despite a large impact on global aluminum markets and Russia’s important role in oil markets. In a prior Republican administration, justice for the families of victims of Pan Am flight 103 took priority over oil holdings in Libya. Generally speaking, history has judged taking a stance on democratic principles in precedence over oil positively, even when outcomes are less than positive in the immediate aftermath. Virtually no American historian looks back on 1973 and suggests the United States should have backed down on its foreign policy to avoid an oil embargo. More disagreement exists on whether U.S. support for the Shah of Iran’s top down modernization program, implemented via massive repression across Iranian society, was smart or misguided. Active U.S. support for the Shah’s nuclear power aspirations and its Bushehr nuclear plant still haunts U.S. national interests four decades later. Much is at stake in the current escalating diplomatic crisis between Saudi Arabia and its long-time ally and backer, the United States. So far, oil traders appear to be assuming cooler heads will prevail. History would suggest that this sentiment might be mistaken. Middle East conflicts, once begun, tend to spiral towards disaster, regardless of the hard work of well-meaning diplomacy. Let’s hope this one proves to be the exception. 

Through an initiative known as the Asia Super Grid, or ASG, the countries made plans to build an ocean-floor power network to connect their electricity grids and enable a cleaner and more efficient pan-Asian electric power system.

Background reading on the future of the global nuclear trade and the commercial opportunities and national security risks that it presents to the United States.

President Trump has targeted Germany over its supposed dependence on Russian natural gas, and the proposed Nord Stream 2 is dividing the EU. What’s in store for Europe’s pipeline politics?

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.  

At first glance, last week’s Vienna Group meeting—that is the Organization of Petroleum Exporting Countries (OPEC) plus non-OPEC producers including Russia—seemed to have resolved some thorny issues. The producer group confidently announced it would increase oil production to stabilize the global oil market. Iran, which had previously threatened to boycott any agreement in protest, appeared to acquiesce to the joint OPEC production increase communique. That may have seemed like a win for the Trump administration, which had hoped to box Iran in to the negotiating table on a host of issues, including conflict resolution in Yemen and Syria, when it cancelled the nuclear deal and reimposed sanctions on Iranian oil exports. Iran had suggested OPEC take a more strident stance on the U.S. policy. Not unexpectedly, U.S. Gulf allies, under pressure from U.S. President Donald Trump’s tweets and back door diplomacy, offered a moderate approach, which will include significant production increases by Saudi Arabia, among others. For those who might construe Iran’s relatively mild public statements following the OPEC session as a sign that Iran had no real cards to play, a glance at regional conflicts might indicate otherwise. Immediately following the OPEC meeting, Syria’s army, which has a history of on the ground collaboration with Iran, broke a standing cease fire agreement with the United States and Russia and advanced on the southern province of Daraa. At the same time, Iranian-backed Houthi rebels from Yemen fired missiles into the Saudi capital city of Riyadh. Both could be taken as a sign that pressure on Iran to deescalate its participation in regional conflicts isn’t producing immediate results, increasing the probability that the Trump administration will actively press allies to buy less oil from Iran.  These events raise important questions about what Tehran’s response will be in the coming days and months and what leverage the United States really has to alter facts on the ground. Granted, a twitter report suggested that Iran was unhappy with Russia’s collaboration with Saudi Arabia at OPEC and Russia’s stated posture on southern Syria. Ironically (or maybe not ironically at all) the whole complex situation could be an oil win-win for Moscow. Russia’s deal with Saudi Arabia to increase oil production achieves multiple benefits for the Kremlin. It demonstrates a willingness to consider U.S. interests but at a low cost to Russia. It helps preserve Russia’s long run influence on Saudi Arabia. And the chances that Russia will lose revenue as a result look slimmer, if Iran is dissatisfied with the situation. Russia is likely making a good bet that frustration in Tehran could lead to an escalation of Mideast conflicts, which in turn keeps oil prices lofty, giving Russia even more money since it is increasing its export volumes. A disappointed Iran could also be less apt to participate in conflict negotiations with the United States, leading to tighter sanctions enforcement, which ultimately reduces competition to Russian oil and gas companies from Tehran in long term natural gas markets for Europe. In recent weeks, French firm Total, which is likely pulling the plug on its South Pars natural gas project in Iran as a result of U.S. sanctions, ventured to Russia to sign a deal to participate in Novatek’s LNG-2 Arctic gas project. Europeans firms that are no longer active in Iran are also partners in the controversial Nord Stream 2 natural gas pipeline proposed to extend from Russia to Germany. That begs the question: What next moves make sense for Iran? The Iranian government remains under pressure from its own citizens, who took to the streets again in large numbers this week. But even with this intense internal pressure, it’s hard to see the logic behind the belief that the Iranian regime might simply just fold its cards on its regional ambitions. Even if Iran would consider reopening political negotiations with the United States and its neighbors to satisfy popular domestic sentiment—protesters have been chanting their government should spend more money at home than abroad—the ruling hardliners will likely want to gain negotiating leverage before doing so. That conflicts, for example, with the thesis that the battle for the Yemeni port of Al-Hodeida could set the stage for successful peace negotiations. Iran has many tactics at its disposal via its regional proxies and via asymmetric warfare that could be utilized to make its own interests appear more salient. Oil prices jumped back up again early this week despite reports that Saudi oil production is surging to 10.8 million barrels a day (b/d), partly on news of an oil production snafu in Canada. But realistically, that loss of Canadian barrels was small at 350,000 b/d and temporary through July. More likely, markets are jittery because it’s hard to construct a narrative on how Iran, Saudi Arabia, the United Arab Emirates, Israel, Russia, and the United States will navigate conflicts on the ground in the coming months.   

This is a guest post by David R. Mares, the Institute of the Americas chair for Inter-American Affairs and professor for political science at the University of California San Diego and the Baker Institute scholar for Latin American energy studies at the James A. Baker III Institute for Public Policy at Rice University. Mexico’s energy reform has taken important first steps but to come to full fruition, several additional critical reforms remain to be designed and implemented, including another constitutional reform. The task of adopting and implementing new reforms is all the more difficult because not only did the government of Enrique Peña Nieto oversell the short-run benefits of the package of reforms, including energy, adopted at the beginning of his term but also his administration is linked with other, broader political failures, including corruption scandals and the mishandling of the economy. Peña Nieto’s missteps have wrested credibility from the political system and make it unlikely that a mainstream candidate could put together a governing coalition with sufficient political support to adopt the next stage in Mexico’s energy reform. That’s why a political outsider would be more uniquely positioned to further energy reform, should that be a credible political choice. Once Andrés Manuel López Obrador (AMLO) wins the election, he could have the credibility to put together a coalition with the support of the Mexican people that could justify the next stage in Mexico’s energy reform.  Whether he will do so remains an open question, but the next stage of the energy reform is unlikely to happen without him. Stage III of the Mexican Energy Reform The first stage of the energy reform in Mexico was President Calderon’s 2008 reform that was designed to strengthen Pemex without breaking Pemex’s monopoly position. After a fractious national debate, the reform was adopted because it was promised it would make Pemex an effective national oil company. The failure of that reform led to stage two in Mexico’s energy reform, which was the constitutional reform instituted under President Peña Nieto. This constitutional reform was intended to make Mexico’s energy sector more efficient and able to meet the power, gas and oil needs of a growing economy, with a small nod to generating more clean energy. By design, it allowed Pemex to lead the process by permitting the national oil company (NOC) to select the best properties for its own exploitation in Round Zero before opening the bidding process to companies other than Pemex. The first auctions for oil and gas blocks did not go well, partly due to falling oil prices and partly because terms reflected Mexico’s relative inexperience with auctions. However, more recent auctions have gone extremely well. Foreign capital has committed to investment over the life of their contracts of almost $150 billion, and some new fields have already been discovered. Winning bids including seventy-three companies from twenty countries attest to the interest in Mexico’s energy future. There’s been less success in developing the infrastructure to get new energy and more imported energy to end users and the government has not solved the theft from Pemex oil pipelines or Pemex’s CAPEX and its pension liabilities. Given Pemex’s dominant position, the company needs to develop a better business model. To generate capital, it needs to take the steps taken in Brazil, Colombia, authorized in Peru, and maintained in Argentina after the renationalization of YPF: privatize some stock in the NOC. The sale of the stock would require a constitutional amendment, but would not put Pemex in the hands of private equity holders and its stock price would provide a basis for evaluating how well Pemex was reforming. The government and Pemex have already modified the weight of the Petroleum Workers’ Union on Pemex’s governing structure and balance sheet, but the pension obligations that were made with Pemex need to be restructured and funded through other mechanisms. Building a New Political Coalition for Energy Reform While these necessary reforms have a technocratic nature, they cannot be adopted by technocrats or political leaders by simple decree. The first two stages of Mexico’s energy reforms rested on the backs of strong political coalitions behind them. The next stage will also require a political coalition. Unfortunately, the political system that generated the first two reforms has been discredited in the eyes of the Mexican people by actions both within and outside the energy sector. The clearest sign of disappointment with the process is AMLO’s widely expected victory in a few weeks. AMLO represents a new political coalition. López Obrador will need to convince that new coalition that when his government continues to attract private capital into Mexico’s energy sector, the benefits of a strong and efficient energy sector will benefit the Mexican people and not go into the hands of corrupt officials or the economic elite. His restructuring of Pemex needs to emphasize that the company is a means to promote the country’s interests in a rejuvenated energy sector, not to benefit oil workers and the PRI party at the expense of Mexican society. So What Will AMLO Do? The three pillars of the Mexican economy over the past decades have been manufactured exports under NAFTA, remittances from Mexican migrants to the United States, and oil exports. AMLO has an ambitious agenda for generating public goods as well as rewarding the groups who supported his victory. The income earned from manufactured exports under NAFTA will likely stagnate, if not actually decrease, even if NAFTA is successively renegotiated, and could decrease more substantially if NAFTA is terminated. Remittances have probably peaked because Mexico’s demographics and growing economy result in fewer Mexicans going to the United States for work; U.S. policy will likely enhance that decline. Oil exports have fallen as reserves and production have been falling, and it will take up to ten years for significant new reserves to be discovered and produced. Those efforts will require companies following through on their promised investments as well as new investment.  AMLO will need an energy sector that generates revenue during his six-year term and credibly paves the way for greater future benefits that will be distributed to the Mexican people. Such nationalist messages could strengthen his political coalition as he implements his reforms of what has become an illegitimate political system. AMLO’s political discourse radicalized when López Obrador and half the Mexico electorate believed that he had been deprived of previous presidential election victories in the extremely close and controversial election in 2006 and a close second in 2012. But when López Obrador was mayor of Mexico City from 2000-2005 he was pragmatic, worked with the private sector, and was perceived as an effective leader. Analysts say lack of technology and funds required to modernize Mexico’s oil sector could lead to an additional output plunge of 700,000 b/d by 2020, unless the next administration takes some definitive action. Output is expected to rebound slightly this year and is currently averaging 1.9 million b/d, down roughly 5 to 10 percent from 2017. Pemex is targeting 1.95 million b/d for 2018. Pemex’s natural gas production has also been declining, and fuel theft has plagued the country’s refining sector. López Obrador has said he will not seek a constitutional change to reverse the 2014 energy reform and will respect the legitimate contracts signed under the reform. There is hope that AMLO can be like President Lenín Moreno of Ecuador and implement reforms from the left with a significant role for the private sector. Will AMLO take this path? We won’t know until he begins to govern, but the Mexican economy and the Mexican people need him to enact reforms that allow Mexico to reap the benefits produced by their energy sector.