Oil and Petroleum Products

President Muhammadu Buhari is publicly asking the Federal Inland Revenue Service about its failure to meet tax-collecting targets since 2015. The president’s spokesman, Garba Shehu, commented, “it would appear that the country might be heading for a fiscal crisis if urgent steps are not taken to halt the negative trends in target setting and target realization in tax revenue.” Nigerian federal and state entities have borrowed so much money that debt service now consumes more than 70 percent of revenue, according to the finance ministry.  Since the early 1970s, the Nigerian government has been dependent on oil revenue for more the majority of its budget—at present it’s about half—and more than 90 percent of its foreign exchange. Hence, the government is hostage to the world price of oil. Prices have been low throughout Buhari’s presidency, leaving his administration with few options: it can either cut expenditure to fit revenue or borrow to make up for the revenue short-fall. As every government knows, cutting expenditure is difficult. Even reducing the growth of expenditure is hard. State governments also borrow, but when they approach bankruptcy, it is the Federal government that must bail them out. During this current period of relatively low international oil prices and a decline in Nigeria’s oil production, the government has been forced to borrow. During his second term (2003-2007), when oil prices were high, President Olusegun Obasanjo successfully renegotiated Nigeria’s Paris Club debt in 2005. In return for a single payment (possible because of high oil prices), the accumulated debt was largely eliminated. Subsequently, the Nigerian government established a sinking fund. It set a target price per barrel for oil as the basis for government expenditure. When oil was higher than the target, the surplus went into a special fund. When it was lower, the resulting shortfall could be made up by drawing from the special fund. Unfortunately, the fund was largely depleted under murky circumstances during the Yar’Adua and Jonathan administrations, also a period of the great economic downturn starting in 2008.  Successive Nigerian administrations have recognized that the long-term solution is to move away from dependence on oil revenue. That is easier said than done and will require massive amounts of investment. The ongoing security issues that plague the country discourage foreign investment. Perhaps more important, it also discourages Nigerians from investing in their own country and encourages them to export their capital. For Nigeria, oil really has been a curse. Arguably, the country was more developed in 1960 at the time of independence than it is now. Then, it exported food and there was a dynamic manufacturing sector, especially involving textile. Nigeria probably had the best roads, railways, and other infrastructure in West Africa then. But oil and its quick profits sucked up the available capital, and successive military governments pursued bad policies. There are other factors as well: the population is now a multiple of what it was in 1960; too rapid urbanization has introduced economic distortions, and degradation of the environment has accelerated. Taken together, history has not been kind to Nigeria.

This is a guest post by Lucy Best and Michael Collins, research associates for Asia studies at the Council on Foreign Relations. The Innovation Center for Energy and Transportation (iCET), a leading U.S. and China based think tank focusing on Chinese environmental policy, published a report in May 2019 detailing the structure and feasibility of China’s ambitious goal to phase out internal combustion engine vehicles (ICEVs) in favor of new energy vehicles (NEVs) by 2050. The report is part of a larger project launched by the National Resource Defense Council (NRDC) and Energy Foundation China in partnership with the Chinese Ministry of Ecology and Environment and the National Development and Reform Commission (NDRC). The project aims to reduce China’s oil consumption and improve its energy security through the development of renewable energy alternatives. Any Chinese domestic move away from ICEVs would reverberate across global auto and oil markets. China is the world’s largest market for vehicle supply and demand. In 2018, the country’s annual production and sales volume reached thirty million units and total ownership exceeded two hundred million units. China surpassed the United States as the world’s largest crude oil importer in 2017, and was projected to import over seventy percent of its total crude oil in 2018. Automobiles accounted for 42 percent of China’s total oil consumption and over 80 percent of its total refined oil consumption. These factors demonstrate the massive shifts the recommendations in this report would require, both within China and abroad, and the huge implications for automakers and oil exporters. Motivations for ICEV Phase Out The report mentions multiple motivations for China to phase out ICEVs. One factor behind this policy direction is the technological dominance China would achieve should it become a leader in an auto industry increasingly projected to embrace green technology. In recent years, companies such as Tesla and BYD have built their reputations on electric technology, and electric vehicles are expected to spike in production by 2030. As the report itself states, China has the world’s largest car market, and thus can promote changes in the global auto market through its domestic regulations. Chinese President Xi Jinping himself has stated that developing NEV capacity compliments other efforts to improve China’s industrial strength. China currently is not a dominant player in the global auto industry; thus, the country has every incentive to push new technologies and production methods while they have time to build capacity and expertise in these developing markets. In demonstrating a path forward that accounts for anticipated trends in fuel efficiency and energy availability, the iCET report provides and advocates for a roadmap for Chinese predominance in both the domestic and international auto industries. Furthermore, given the number of people in China whose livelihoods depend on automobile access, it is strategic for policymakers and politicians alike to consider the best mechanisms to become more self-sufficient in this industry. Another reason behind the ICEV ban policy is that the anticipated decrease in fossil fuel use from NEVs would improve Chinese energy security. China’s oil demand drastically outpaces its domestic production ability. The country has been a crude oil net-importer since 1996 and has progressed from importing about two million barrels of oil per day in 2004 to over eight million per day in 2017. These trends continued in 2018 despite increasing trade tensions with the United States and Iran, demonstrating the strength of China’s oil reliance. New energy vehicles rely on non-oil resources that are more abundant domestically. Although electricity sources such as coal conflict with public health goals, China has a rich coal supply. Furthermore, Chinese investments in solar power, natural gas, hydropower, and biofuels all can help power increasingly energy efficient and non-combustive vehicle engines in a less environmentally destructive way. Given energy reliance’s adverse effects on Beijing’s pursuit of its own goals, it serves Chinese strategic interests to invest in products that use renewable energy that it can produce independently from geopolitical tides. The final motivation for ICEV phase out is this policy’s public health and environmental benefits. Promoting NEVs is compatible with preexisting Chinese policies, such as the "Blue Sky War" – an initiative that aims to protect the environment and public health. One of the most important elements measured in the air quality index (AQI) is PM2.5, a particulate matter that originates from combustion engine exhaust and carries severe health consequences for prolonged exposure. This is particularly true among young children, the elderly, and otherwise sensitive groups. One 2018 report found that 1.6 million Chinese people die prematurely due to air pollution each year, a trend largely reflected in incidences of cancer and cardio-respiratory diseases. The combustion process also produces ground-level ozone, a compound that inhibits plant growth, leading to massive inefficiencies in China’s agricultural sector. iCET's Proposed Strategy Unlike previous technological leapfrogging in China, transitioning from ICEVs will require a slower approach. Phasing out ICEVs in any country is a tremendous challenge. For China, the task is further complicated by the large disparity in economic development between its underdeveloped Western, Southern, and Northeast regions and the developed Eastern coastal region where major cities like Beijing or Shanghai, municipal governments have already begun to limit ICEV sales and encourage NEV purchases through subsidies or preferential traffic policies. In the past, China has piloted large reforms in a handful of small regions before nation-wide implementation. To account for regional disparities in economic development and the disruption caused by transitioning from ICEVs, the report suggests the Chinese government use a multi-tiered phase-out plan. Under this proposal, cities are divided into four tiers based on economic development and severity of the region’s environmental degradation (See Figure 1). Leading the transition are tier one and two areas including cities like Beijing and Shanghai as well as capital cities like Xi’an in China’s “Blue Sky War” regions which are some of the most polluted in the country. Tier three and four areas include much of the country’s Northeast and Western regions such as Inner Mongolia, Xinjiang, and Tibet which are heavily reliant on coal and economically underdeveloped. The report also divides vehicles into five classes: public passenger vehicles; privately owned passenger vehicles; municipal service vehicles; coaches and intercity light freight vehicles; and medium and heavy freight vehicles (See Figure 2). Passenger vehicles and municipal service vehicles will transition from ICEVs first followed by medium and heavy freight vehicles and coaches. In the next two decades, ICEV use might increase as China’s hinterlands develop. However, the report predicts that ICEV withdrawal will come close to completion by 2050. Implications of ICEV Phase Out The report’s plan carries important implications for global markets concerning both cars and the components necessary to support them. One consideration is that China’s peak oil consumption – and the world’s – will come earlier than anticipated. A study from researchers at Stanford University predicts that peak demand for conventional oil will occur in 2035, whereas less traditional liquid inputs will remain popular until 2070. Either way, both peaks will come earlier if China changes course away from ICEVs and deemphasizes one of its economy’s most petroleum-dependent sectors. Along with this trend, the rare earth metals that comprise components for electric vehicles will increase in value should electric cars become mainstream in China. Elements such as nickel, lithium, lead, and cobalt are essential for the batteries in HEVs, PHEVs, and electric vehicles in general. Whereas economies reliant on oil sales will experience downturn, those with the raw resources for electric vehicle battery components will see a surge in activity. While these economies already are aware of these commodities’ anticipated values, this spike in value will occur sooner than projected should China advance its NEV technology according to iCET’s plan. For example, 49 percent of global lithium production in 2015 occurred in South America, positioning this market it particular to have advantages in a less oil-dependent future. Along these lines, widespread NEV production implies that actors in Chinese industry would become more interested in economies that already have capacity to produce battery components. Therefore, China would become more interested in metal producing countries like Argentina, Chile, and the Democratic Republic of the Congo, while also deemphasizing the importance of oil exporting nations such as Russia, Iran, and Saudi Arabia in its foreign policy. Furthermore, Chinese involvement overseas has the potential to compound the previously listed effects and broaden the plan's applicability outside of China. Initiatives like the BRI allow China to shape not only its own development, but also that of other countries. Although China’s sheer size allows it to shape the global market regardless, its economic reach provides an even more direct mechanism to expand its export market and promote global ICEV phase out should leaders in Beijing be inclined to this report’s suggestions. On a larger scale, the potential for Chinese ICEV phase out in favor of more sustainable alternatives speaks to the global challenge of resource scarcity heading forward. Should the suggestions in this report materialize as policy, China would be providing an example of how to avoid relying on one of the more scarcity prone elements in the global supply chain. Consequentially, if countries like the United States cannot demonstrate that their policies provide more abundant resources and a better way of life, other countries will be inclined to cooperate with China given its system’s ability to deliver. Obstacles to Implementation The study concludes by outlining potential risks and problems China might encounter during the transition from ICEVs to NEVs. These problems can broadly be split into three categories related to policy limitations, resource scarcity, and infrastructure inadequacy. In terms of policy limitations, the study encourages Chinese policy makers to clearly outline a ban schedule on ICEVs by setting up a cross-province and cross-industry committee to understand domestic and international impacts of the ban. Currently, Chinese priorities for transitioning to NEVs remain unclear to both producers and regulators, leading to implementation confusion on the ground. To avoid uncertainty going forward, the report suggests that policy makers should clarify regulatory documents to clearly state goals and expectations. Additionally, the government should implement policies to provide unemployment support for ICEV employees and bankruptcy protection for ICEV companies. The authors go on to outline several concerning resource scarcities that might impact continued development and production of NEVs. The first problem is a scarcity of rare earth metals. Currently, China’s cobalt demand accounts for more than half of the world’s total. Nickel and lithium are also identified as potentially scarce materials. The report advises Chinese leaders to open new rare earth supply chains as well as improve battery recycling utility to prevent supply disruptions. Finally, the report acknowledges several infrastructural problems that hamper the transition from ICEVs to NEVs. China’s electric charging infrastructure is not capable of meeting the demand of daily use of electric and plug-in hybrid vehicles. This deficiency is partly due to an overall lack of charging stations across the country. In areas with charging stations, they are often inconveniently or illogically located. Even if stations were adequately constructed, China’s power grid is currently incapable of supporting the needed energy demand. According to the NRDC, China’s peak energy load will increase by 62 percent in 2020 and 58 percent in 2030. NEV charging during peak load hours will further strain an already struggling grid. The report advises policy makers to incorporate solutions to these infrastructural problems in future NEV transition policies. Other disruptive technologies, especially autonomous vehicles, will profoundly influence any transition plans. While the report briefly touches on such technologies, the authors are uncertain of their effect on ICEV phase out. Regardless, the iCET report offers a comprehensive plan for Chinese policy makers to follow in restructuring the world’s largest auto market.

Oil is a global commodity where prices adjust to a supply disruption in one place across all locations, no matter country or location where the problem started. To help people understand what that means, I like to use the analogy of a swimming pool. If one takes a giant bucket of water out of the deep end of a swimming pool, it affects the water level for the entire pool, not just the deep end. The larger the bucket, the more swimmers will notice changes in the water level throughout the entire pool. The upshot of this global nature to oil is that freedom of movement of oil through the Strait of Hormuz is a global problem. Countries might think that maintaining “good” relations with Iran might mean their ships won’t get attacked, but it is not truly relevant. If anyone’s ships are attacked, the oil disruption that could ensue will affect all oil importing countries. The International Energy Agency (IEA) was formed out of an understanding of this notion of the global nature of the oil market. Emergency stock releases need to be coordinated because if one country releases strategic stocks and other countries hoard oil instead, the net supply gain to markets can be cancelled out, hence coordinated stock release policy is advantageous. IEA announced this week that it is prepared to act if oil flows are disrupted from the Middle East. Iran may feel it is getting an upper hand by showing it has been wronged and is a nation to be reckoned with. The problem is Tehran is also showing the world what a problem it could become if it actually had nuclear weapons capability. This week, governments from the U.K. to Germany and to Japan will have to decide how much force to apply to protect oil shipments in their vessels and flag ships. But what if Iran were a nuclear power? The calculus would be quite different. The bargaining process for conflicts where parties have access to missiles with nuclear warheads is altered. Nuclear weapons add additional risk on the party that desires to change the status quo. One can expect the cost is higher for third parties who would want to intervene in regional conflicts. A future nuclear-armed Iranian declaration that only the oil Tehran dictates will be allowed to transit the Strait of Hormuz would present an even more complex situation than today’s geopolitical challenge of sanctions and shipping. The military problem of protecting shipping would become more dangerous and potentially require a military campaign to destroy any active Iranian nuclear warheads before engaging conventional Iranian forces that are blocking free transit of the Strait. The history of nuclear deterrence theory suggests Iran would never use a nuclear weapon, even if it had one because of the extreme consequence of enormous loss from a second strike. But the possibility of internal political instability can in itself alter a bargaining process. One might have imagined Iran would not have taken such a decisive act against British vessels for fear of attack by the North American Treaty Organization alliance. NATO did, after all, intervene in Libya in 2011 under a situation perhaps less clear than blockage of an international waterway.  That leads me to question whether Iran may have overplayed its hand. Now that the strategic risk of a nuclear-Iran is so much more transparent, would Europe still feel it can afford to provide nuclear technical assistance to Iran including equipment under the terms of the 2015 Joint Comprehensive Plan of Action (JCPOA)? China must also see the detriment to itself of a nuclear-armed Iran. It’s easy to facilely link the escalation of tensions with Iran on the Trump administration’s “maximum pressure” campaign, which has disturbed an already tense status quo but now thoughtful analysis needs to be made regarding what the current situation has taught about the war-ready nature of factions within the Iranian government. Some lessons are relevant to future diplomatic solution-building regardless of how we got here. The reality is that conflicts involving Iran throughout the Mideast proceeded – and in some cases escalated- even after the JPCOA took hold. The opportunity that signing the nuclear deal would moderate Iran’s foreign policy regarding regional conflicts and assassination plots in Europe was unrealized, even before the Trump administration reversed the U.S. commitment to the JCPOA. As Europe moves forward in trying to fashion a solution, Iran (and Russia) will need to consider the changing nature of the global oil business. Iran has to concern itself with the future geopolitics of stranded oil assets. Removing itself now from oil and gas commodity markets and direct foreign investment opportunities at this pivotal time in oil’s potentially declining future might have long lasting negative consequences for its energy industry. Moreover, any military exchange that raises oil prices sharply could become the impetus that the West and China needs to accelerate the shift to low carbon energy more decisively. Such a result would reverberate in Moscow whose natural gas giant Gazprom is already struggling against a rise in renewable energy in Europe. China, which has never participated in a large global oil supply cutoff as a giant oil importer (it was self-sufficient in energy in 1973, 1979, and 1990), may also need to educate itself about the consequences of having one fifth of its oil supply have to traverse the Strait of Hormuz. China has more to lose from a poor outcome between the West and Iran than the West does given its lesser dependence on Middle East oil. Tehran may decide that its resistance economy is good enough for regime survival and choose the path of continued confrontation. That would be a tragedy for the entire region and present a serious challenge for the United States. The makeshift response to allow Britain to protect its own shipping calls into question whether the U.S. could abdicate (either on purpose or by accident) its vital superpower naval role which regulates sea lanes and, in effect, facilitates global trade. The consequences of the U.S. withdrawing from such a role is unthinkable for all concerned, even for the Chinese, who may seem to object to U.S. ships in the South China Sea, but, in reality, free ride off of U.S. air and naval power in so many aspects of their economic life. China should be careful what it wishes for. The Trump administration must avoid reconsidering this critical naval role nonchalantly. It is central to the United States’ global authority.  Just the appearance of U.S. hesitation about that role could invite unwanted seafaring military incursions and piracy across the globe. If Iran decides that conflict is better to regime survival than concession, the Trump administration’s lack of a well thought-through, implementable strategy regarding Iran will become an even larger problem. Oil markets will increasingly lose their imperviousness to risk as more speculators bid oil prices up. Regional allies could also become more insecure. All this means that now would be a good time to move away from ideological bents and study up on years of U.S. military gaming exercises regarding the Strait of Hormuz. The U.S. military has years of study and knowledge to fashion and lead an effective international coalition for diplomacy and deterrence in the Strait of Hormuz. It should use it.

In a sign that anxiety about oil security of supply isn’t what it used to be, the Group of Twenty (G20) meeting broke up this week with no big joint statements regarding how to protect the freedom of navigation in the Strait of Hormuz. From the sidelines, U.S. President Donald J. Trump said there was “no rush” and “no time pressure” to ease tensions with Iran. German Chancellor Angela Merkel said she advocated “very strongly” to get into a negotiating process on the Iranian situation. Chinese President Xi Jinping noted that China “always stands on the side of peace and opposes war.” The latter statement was a pretty mild one given that approximately one-fifth of the oil that passes through the Strait of Hormuz is destined for China. China has given no public indication that it plans to protect its own shipping. Roughly 60 percent of crude oil passing through the Strait goes to China, Japan, South Korea, and India. The biggest statement about oil that emerged from the G20 came from Russian President Vladimir Putin who announced at the sidelines that Russia had agreed with Saudi Arabia to extend by six to nine months a deal with the Organization of Petroleum Exporting Countries (OPEC) to restrain oil output to support oil prices. OPEC then announced at its July 2 meeting in Vienna it had agreed to extend the deal for nine months into the first quarter of 2020. In speaking about OPEC’s deliberations, Iran’s oil minister said OPEC was being used as a “tool against Iran” jeopardizing the cartel’s survival. Last year, Iran told other members it was considering quitting OPEC. These various events say a lot about how the geopolitics of oil has changed and the huge implications those changes have for Iran. A decade ago, countries from the Gulf Cooperation Council (GCC) were of the mindset that they would never let Russia become a member of OPEC. At the same time, Iran was also a major rival to the GCC countries in its overall influence on OPEC outcomes, and both Russia and Iran boasted of their relations with each other in bolstering their respective positions in Mideast regional conflicts. But the new reality is that countries like Saudi Arabia now feel that they can basically ignore Iranian sensitivities at OPEC gatherings and have increased incentive to align with Russia on oil, not only because of the pressing need for revenue but also because of the geopolitical benefits of driving a wedge between Russia and Iran. In turn, Iran may have less to offer Russia as Moscow’s relations with the Arab world continue to improve, except perhaps the possible threat Tehran can make trouble for Russia in Syria or along susceptible pipeline routes. U.S. sanctions against Iran have long been in Russia’s interests to prevent Iranian oil and gas arriving in Europe to compete for its market share. But, Russia has a difficult road to navigate in its relations with Iran and Saudi Arabia since it will want to keep itself an important power broker around many of the Mideast’s current conflicts. This keeps U.S.-Russian interactions on the topic of Iran a challenging one.  The results of the G20 and subsequent OPEC meetings highlight the bind Tehran is in. What will be its geopolitical lever if oil and gas, which might have provided in years past, is no longer working? The large market surplus of natural gas is working against Iran. Japan’s state firm Japan Oil, Gas and Metals National Corporation (JOGMEC), for example, just signed on to Russia’s Arctic liquefied natural gas (LNG) expansion, in a sign that many countries that might have bought natural gas from Iran are looking elsewhere. The expected rising supplies of U.S. LNG are another. Chinese firms have also slowed new rounds of investment in Iran’s oil and gas sector and are increasingly investing in China’s own clean tech industry instead. Iran has to concern itself with the fact that as the United States, Russia, and oil producers in the Persian Gulf region expand capacity, its own reserves may become more likely to become obsolete or devalued if oil demand peaks over time. All this raises the question about how a petro-state like Iran reacts to the possible weakening of oil as a strategic tool. Iran will want to show the world that it still has a bargaining chip beyond its own oil resources. Some analysts are suggesting that by boxing it into a corner, the Trump administration might actually incentivize Tehran to lash out to make clear it is too important to ignore in an effort to drive the United States and others to the negotiating table, much the way North Korean missile tests got President Trump’s attention. Most recently, Iran’s response has focused on restarting its nuclear program. Iranian President Hassan Rouhani announced Tehran would return to its previous activities at the Arak nuclear reactor if the remaining signatories to the nuclear deal do not fulfil their promises. Iran might decide to focus on fast tracking its nuclear program to assert itself and gain leverage at a future negotiation. Alternatively, if it gets no geopolitical traction from restarting its nuclear program, Iran could stick with its grey area attacks on energy facilities to make the point it still has hard power to bring to bear. To date, the rules of engagement on cyber warfare against such targets have been harder to establish. A cyber escalation would be a dangerous outcome that would leave the United States with hard decisions about what kind of precedents to set in an active cyber conflict since a large escalation could lead directly to attempted cyberattacks against the U.S. homeland. Oil markets are betting that Iran will not choose to continue to disrupt shipping through the Strait of Hormuz since doing so would clearly escalate into a military confrontation with the United States. A second possibility, which would require much more diplomacy, is that Iran’s oil woes could prompt its leaders to look at the world with colder realism and come directly to the diplomatic route. One reason that approach could be compelling is that perhaps the real lesson for Iran is not that of North Korea, but of Venezuela whose oil industry is now decimated from years of corruption, lack of financing for maintenance, and an exit of foreign investors. As Mideast oil expert Sara Vakhshouri wrote in a report for the Atlantic Council in 2015, “Most of Iran’s oil fields are old and mature, which means they require further investment and treatments like gas reinjection, in order to maintain current production levels. The country’s oil wells are mostly in the second half of their lives, and are facing continued natural depletion of production capacity at the rate of 8-11 percent per year. It is estimated that Iranian oil fields lose between 300,000 to 500,000 b/d of natural reduction every year due to maturity of fields.” With its oil exports further curtailed this year, Iran should worry about not only losing market share today (and for however long it takes to restore its position in the global economy), but also the possibility that output drops could cause it to lose productive capacity more permanently if oil fields are damaged from forced production curtailment or reduced spending on maintenance over time. As Iran can see from its current failure to incentivize relations with Europe, Russia, India, China, and Japan by offering future stakes in its oil sector—a strategy that worked in the past but is apparently no longer effective—time is not on its side when it comes to preserving its future oil and gas sector opportunities.

I woke up this morning thinking I would write a blog explaining just how challenging it would be for Iran to close the Strait of Hormuz for a prolonged period of time. This is not to say that there could not be a battle in the waterway: Iran has lots of conventional weapons, including mines, submarines, a large fleet of speed boats (think the USS Cole bombing), torpedoes, and missile batteries. But I thought to myself, why would Iran want to give the U.S. military the rationale to target Tehran’s largest military assets and destroy them? Then I saw a news report that a short range Katyusha missile hit a site very close to ExxonMobil’s operations center in southern Iraq, near the Zubair oil field, where Italian oil firm ENI is helping restore production capacity. Royal Dutch Shell also has personnel in the area. That brought me back to my father-in-law’s favorite expression “Too clever by a half.” For those of you who don’t know that term, the internet defines it as meaning “annoyingly proud of one’s intelligence or skill and in danger of overreaching oneself.” I don’t think that definition, though accurate, does the phrase justice. The formal definition doesn’t fully convey the high level of arrogance and stupidity involved when someone makes an incredibly large mistake because they think they are outsmarting someone when in reality they are about to create a huge disaster for themselves. Now you could be wondering: Am I talking about Iran or the United States? Let’s talk about both. Iran is so used to working through proxies with no consequences on its ruling elite or its physical motherland that it believes that it can offer these endless, faceless “sabotage” operations with impunity.  On the flip side, the United States is used to stationing an aircraft carrier somewhere and believing that it is a solution to small-scale attacks (e.g. weaker party doesn’t want an actual military engagement so they back down). This, however, fails to recognize that force projection in the age of asymmetric warfare may not be the most effective deterrent. It begs the question of “proportional” response. Iran is hoping for that messy debate. That is why it appears that Iran could be selecting discrete high-value targets with methods that are hard to fingerprint.  That brings me back to Iran’s original threat, when the United States announced it was withdrawing from the Joint Comprehensive Plan of Action (JCPA) nuclear deal and reimposing sanctions on Iranian oil exports. Iranian President Hassan Rouhani said “If one day they [America] want to prevent the export of Iran’s oil, then no oil will be exported from the Persian Gulf.” And that brings me to my favorite parenting advice for raising a two-year old. Don’t threaten something if you don’t intend to carry it through. As the United States considers the uncomfortable decision on how to convey diplomatically or, in the worst case, militarily that continued attacks on oil installations across the Persian Gulf will not be tolerated, it needs to acknowledge that Iran has many ways to harass oil exports to the international market. As I wrote previously, referring to all these efforts as “sabotage” underplays their significance. The inventory of oil attack events to date is starting to be extensive. It includes attacks on shipping via missiles from Yemen, attacks via missiles in Iraq, attacks on oil and petrochemical feedstock shipping with limpet mines, attacks on regional oil facilities using drones, notably in Saudi Arabia, several major cyber incursions against the Saudi oil and petrochemical industry, and sabotage activities that led to explosions on oil pipelines across the region, notably in Bahrain. Then there is the possibility that the contamination of oil coming from Russia to Europe was more malicious than it appeared. I have written a book with economist Mahmoud El-Gamal on the close linkages between the seminal business cycle, the oil price cycle, and Middle East geopolitical violence. We updated that work in a journal article that highlights how the more lasting impact of war-related damage to oil facilities is endemic to lasting oil price volatility. The problem for both the United States and Iran is that the global rules of engagement for asymmetrical attacks on energy facilities are extremely unclear. If the United States hits Iran with traditional fire power against Iranian military targets to deter further conventional attacks on oil exports, will that address the cyber domain or not? Does cyber have to address cyber? The patterns of engagement are unclear and that is dangerous for all concerned. That lack of clarity raises the stakes of a miscalculation, especially on the Iranian side. The anonymous declaration this week in the New York Times that the United States military is stepping up its digital incursions to Russia’s electric power grid highlights the challenge of deterrence. Iranian cyber incursions into U.S. infrastructure date back many years. There is a tendency among geopolitical commentators to dismiss the usefulness of diplomacy in stale conflicts. One often hears talk that there is little possibility for a reset of the Iran nuclear deal, hence no point to dialogue between the United States and Iran either directly or through intermediaries. This is clearly incorrect. The problem with that logic is that diplomacy is often needed so countries do not misunderstand the progression of events that could result from a string of ambiguous situations. In the case of asymmetric attacks on energy, diplomacy is sorely needed to define those ambiguities and bring transparency to what constitutes a clear and present danger.   

The narrow and congested Mideast waterway has become a site of escalating U.S.-Iran tensions. Conflict in the wake of tanker attacks there could jolt global oil supplies.

In 2015, Muhammadu Buhari defeated incumbent President Goodluck Jonathan. Buhari ran on two major issues: improving the deteriorating security situation associated with the Islamist insurrection Boko Haram and cleaning up government corruption. In 2019, President Buhari was re-elected, again on an anti-corruption ticket.  Jonathan and his former oil minister, Diezani Alison-Madueke, have long been thought “on the street” to be implicated in the theft of oil revenue. While their associates have had assets seized and are under investigation by British and U.S. authorities, up to now, neither has been charged. But in a court case in London involving international oil companies and the oil block designated OPL 245—thought to be one of the largest untapped reserves in Africa—lawyers for the Nigerian government accused Jonathan and Alison-Madueke with plotting to “receive bribes and make a secret profit.” According to the court filing, “the receipt of those bribes and the participation in the scheme of said officials was in breach of their fiduciary duties and Nigerian criminal law.” The oil block has been at the center of controversy since 1998, when, it is claimed, the oil minister at the time, Dan Etete, essentially awarded it to himself. It has since pulled Royal Dutch Shell and Eni into its orbit, both of which are the subject of an Italian investigation.  All parties are refusing to comment or are denying any wrongdoing. Nevertheless, it is hard to believe that Nigerian government lawyers would charge Jonathan and Alison-Madueke with receiving bribes without clearance of some sort from the Buhari presidency. Now re-elected, President Buhari may be emboldened to move against the “big fish” of corruption.

The United States keeps signaling that it has hard power. Most recently, the United States made known that it was deploying additional ships, the USS Abraham Lincoln and USS Arlington, to the Middle East. The USS Abraham Lincoln is now said to be in the Red Sea. This deployment follows a similar U.S. movement in the South China Sea. There appears to be a lot of hard power on display these days since China and Russia have also been moving military assets around the globe in a similarly transparent, public manner. You would think that all this bravado of big military hardware would be minimizing risky actions by small players. But, ironically, all this symbolism isn’t achieving much where oil security is concerned. That’s because state and non-state actors alike have learned that “sabotage” is hard to react to. But just because these acts of sabotage to date have seemed minor, it doesn’t mean that they are not geopolitically significant. Taken en masse, they are a symptom of an increasingly unstable setting at a time when spare oil production capacity in and outside OPEC is quite limited. The point is that as tensions rise among large and mid-size global powers, the list of recent and unusual oil sabotage acts is growing, and they could eventually add up to a major problem for oil markets. First, there was the mysterious contamination of Russia crude shipments to Belarus. That “sabotage,” now reportedly under investigation by Russia’s Federal Security Service (FSB), will reduce the availability of the physical storage tanks for some refineries along the Druzhba pipeline since removing the tainted oil by slowly diluting it in small amounts into clean oil will take months. The explanation of corruption should give little comfort. If the Kremlin cannot control its local corruption problems, or if it so wanted to teach a lesson to Belarus that it was willing to disrupt the reputation of its own oil exports, or if some technical production and collection problem was hard to solve, it’s not good news for European oil consumers. The Russian problem was followed by this week’s “sabotage” in the Persian Gulf which seemed to traders similarly penny-ante. First, a handful of ships near the port of Fujairah appeared to be bashed in with a sharp object like a limpet mine or ramming by another vessel or weapon on Sunday. Oil traders joked on twitter that the attack was not aimed to be serious since it is hard to move oil prices on a Sunday. Still, the location of the attack was significant because the United Arab Emirates has been investing to capitalize on the port’s location outside the Strait of Hormuz to expand crude oil storage facilities. Fujairah is also the location Arab countries held floating storage of over 70 million barrels of crude oil back in the mid-2010s as a precaution against oil disruptions following Russia’s invasion of Ukraine and Iranian statements threatening to close the Strait of Hormuz. The head of Iran’s Parliament’s national security committee tweeted that that “explosions” of Fujairah showed that the security of the south of the Persian Gulf is “like glass.”  Initial rumors that Saudi oil tankers were on fire or that the Fujairah port was on fire turned out to be fake news. A day later on Monday, Saudi Arabia confirmed that a drone attack had damaged two pumping stations on its East-West pipeline that carries oil from large eastern Saudi oil fields to the kingdom’s west coast where it can be exported to circumvent the Strait of Hormuz. Saudi Arabia also has export-oriented refineries on its west coast that typically serve Europe and utilize crude oil shipments from the East-West pipeline. Saudi Aramco had recently announced plans to expand the East-West pipeline and keeps chemical drag reduction agents on hand at the pipeline that mean the pipeline could handle up to 6.5 million barrels per day (b/d) of exports of crude oil via the Red Sea in an emergency, thereby bypassing the Strait of Hormuz. Last year, over 2 million b/d of oil were sent along the pipeline as part of normal logistical operations. To date, the oil market has reacted with a relative yawn to all these various sabotage reports. But the breakdown in norms across the globe – whether those norms are the free and clear operations of sea lanes, respected guarantees of oil quality, or most importantly, the safety and security of citizens, workers and vital energy infrastructure inside national borders-- is bad news for an internationally traded commodity like oil. A typical trader response is that the U.S. trade war with China takes precedence over these small sabotage events, given that trade conflict’s long run potential to harm global economic growth. However, analysts say China may be willing to add to its stimulus plans at least for now and so far, few are predicting a U.S. recession any time soon. By contrast, oil analysts from Wall Street firms such as Cornerstone Macro and Citi caution that the number of recent geopolitical events with implications for oil markets are running unusually high. The idea that U.S. production exists as a safety net seems equally spurious, even under the best of circumstances. U.S. output growth in any given month faces real limitations. Optimistic predictions for the Permian Basin that it could someday reach 8 million b/d might be possible, but for now, U.S. crude oil production is less than 15 percent of total global supply. Trump administration officials hint that Washington is prepared to use the U.S. Strategic Petroleum Reserve (SPR) and Washington-watchers figure the White House might ultimately be slow to turn any screws intended to stop China from buying Iranian oil. But as internal pressures on a wide variety of petro-regimes from around the world mounts, it might become harder and harder to stave off an upward march for oil prices this summer as small scale “sabotage” takes its toll on oil facilities in multiple locations at the same time internal conflicts continue to loom in major producing countries like Venezuela and Libya. The White House shouldn’t take great comfort in the fact that oil traders are relaxed. They (and their algorithms) could be simply wrong.

With significant risks now looming over global energy markets, the United States should be careful in evaluating any future oil sanctions, Amy Myers Jaffe writes in the following Q & A which first appeared on CFR.org.  Oil prices ticked up a few percentage points after the announcement. Do you expect prices to remain higher, or is there enough supply in the market to cover a drop in Iranian exports? U.S. sanctions had already curbed Iran’s oil production substantially earlier this year. The Trump administration’s tough stand on waivers could remove an additional five hundred thousand barrels per day or more from the market in the coming weeks. This would come on top of production cuts planned by the Organization of the Petroleum Exporting Countries (OPEC) and ongoing production and export problems in Libya and Venezuela. Oil prices will continue to be sensitive to any supply disruptions, despite expectations of rising U.S. oil production and possible production increases from Saudi Arabia. Should prices begin to rise precipitously, the Trump administration could make sales from the United States’ strategic petroleum reserve. How has the United States’ growing role as a major crude oil exporter changed its attitudes when it comes to sanctions?  There is no question that rising U.S. oil production has emboldened U.S. policy regarding oil sanctions. U.S. crude oil exports reached record levels, above 2.5 million barrels per day, in recent weeks and are expected to rise further this year. However, the administration should take care not to impose too many complex sanctions in the oil market at once because surprise events such as hurricanes, accidents at major oil fields, or geopolitical strife can create sudden disruptions in oil supplies and leave markets more vulnerable to price spikes. U.S. crude oil production is still less than 12 percent of the total global crude oil supply. It can only go so far in hedging against the multiple risks now looming in the market. Iran has threatened to stop the flow of oil from other big suppliers via the Strait of Hormuz. Could it do that? How exposed is the U.S. economy to oil disruptions in the Middle East? The Strait of Hormuz is more than twenty miles wide. It would be extremely difficult for Iran to close it completely for an extended period of time. There is the question of whether Iran could use asymmetric warfare tactics, such as swarming speedboats and missile attacks, but the possibility of a decisive international military response led by the United States makes such an endeavor extremely risky for Iran and its military. Iran would likely use more clandestine approaches, such as cyberattacks on neighboring state oil facilities. Saudi Arabia and the United Arab Emirates have alternative pipeline routes that can bypass the Strait of Hormuz. In the case of Saudi Arabia, upward of 6.5 million barrels per day in exports could bypass the Persian Gulf. The U.S. economy is less exposed now to oil price shocks than in past decades due to the lower oil intensity of the U.S. economy. Still, high gasoline prices can derail consumer spending, especially on durable goods such as cars. At the same time, an oil price shock in the developing world could cut into countries’ appetites for U.S. goods and services. China is the largest purchaser of Iranian crude. How do you expect it to respond to the Trump administration’s decision? China said that Iran’s discounted oil was too cheap to pass up, and it has been increasing its purchases of Iranian crude in 2019, reaching over seven hundred thousand barrels per day this month. In the past, China attempted to circumvent these sanctions by purchasing Iranian crude on a barter basis or by promising to pay Tehran once sanctions are lifted. In the end, the United States and China have many bilateral issues of greater salience, so both sides will be reluctant to fight over Iran policy. What will this additional pressure on Iran achieve? Iran has little incentive at this point to negotiate with the Trump administration so close to the U.S. presidential election cycle. Iran has a policy it calls strategic patience, which is simply waiting to see if a new administration might reinstate the Iran nuclear agreement or take a less aggressive posture. The International Atomic Energy Agency maintains that Iran has continued to comply with nuclear inspections set up by the deal, which is still being honored by European signatories.

Since Russia’s 2014 invasion of Ukraine, Western powers have hit Moscow with economic sanctions, hoping to put a stop to President Vladimir Putin’s aggression. Have they worked?

On April 25, the managing director of the Nigerian National Petroleum Corporation (NNPC), Maikanti Baru, said that Aliko Dangote's new Lagos oil refinery is central to the government meeting its ambitious plan to triple Nigeria's refining capacity to 1.5 million barrels per day (bpd). When complete, the new refinery is estimated to be able to refine 650,000 bpd, which alone would more than double the current capacity.  Africa’s largest oil producer has long been forced to import refined petroleum products because of a lack of refining capacity. These imports are a significant drain on the country’s foreign reserves. At present, there are four sate-owned refineries, but they rarely meet their combined 445,000 bpd capacity because of neglect, mismanagement, and periodic attacks on the oil industry by militants.  Dangote is a highly successful businessman with broad political connections. Forbes named him Africa’s richest person in 2019 with an estimated net worth of $12.2 billion. He is, apparently, investing massively in his new Lagos oil refinery and its associated real estate development. Given his track record, chances are good that his new refinery, will, indeed, be able to meet the 650,000 bpd target. The Buhari administration has also revived the goal of doubling Nigeria’s oil production to 4 million barrels a day. That goal, formulated during the administration of Olusegun Obasanjo (1999–2007) has been stalled by a variety of factors, including investor uncertainty, security issues, and the vagaries of the international oil market. With Dangote’s involvement, increasing refining capacity may be easier to achieve than doubling oil production, even if the goal of 1.5 million barrels a day is a stretch.

With significant risks now looming over global energy markets, the United States should be careful not to go too far with oil sanctions.  

Iran appears increasingly boxed in by intensifying U.S. sanctions, the latest of which will effectively cut it off from its main oil customers.

Sadly, they also help keep the country’s repressive regime in power.

It’s a geopolitical jungle out there in the oil world right now and only the fittest will survive. The new oil Darwinism is replacing the older thesis that all producers can succeed over time because the current lack of adequate capital investment is going to create an oil supply gap in the future that will once again boost oil prices (the so-called supply hole thesis). There are still some active looming supply crunch proponents who are talking down the potential of U.S. unconventional oil and gas, but recent announcements by ExxonMobil and Chevron about robust plans for U.S. onshore drilling appear to dispel the notion that a debt-ridden U.S. industry is on the verge of potential failure. Projected Permian oil production for the two American oil majors alone is 1.9 million barrels a day by 2024, on top of already robust output from U.S. independent oil companies. Citi estimates that U.S. oil production increases could fill most of the expected increase in oil demand for the next five years. That could leave OPEC in a bind, Citi suggests, since the producer group could lose up to three million b/d of market share to U.S. producers if it chooses to cut production to defend $65 oil prices, according to Citi estimates. The unexpected success of U.S. shale has - for the time being - been ameliorated by the dramatic demise of output from within OPEC’s ranks. A variety of ongoing problems from civil unrest to sector mismanagement have created supply disruptions from Nigeria, Libya, Algeria, Venezuela, and Iran, the latter two impacted additionally most recently by U.S. sanctions policy. The situation prompted one Middle East oil leader to note privately that OPEC’s stronger members will take market share from smaller, more troubled OPEC members whose sectors are continuing to stumble. In the past, OPEC’s largest producers Saudi Arabia, the United Arab Emirates, and Kuwait have stepped in to replace fellow OPEC member oil exports disrupted by sanctions or war. The process has often created acrimony inside the producer group, especially when new production sharing agreements are required when and if a disrupted producer’s oil output is restored. This time around is no different. Iran, whose oil exports have recently been curtailed by U.S. sanctions, threatened to quit the organization at OPEC’s end of year meeting last December in Vienna amid accusations that Saudi Arabia and Russia were taking advantage of its conflict with the United States. A last minute compromise, orchestrated by Russian energy minister Alexander Novak, salvaged the tense situation by promoting a compromise, which exempted Iran from the wider OPEC-Russian production cut agreement. In the longer run, cohesion might become more difficult for the current OPEC grouping as divisions arise between members whose industries are deteriorating and need sharply higher prices to offset declines and those who can cope with new competitive forces and still be able to expand. For the time being, OPEC’s larger members are trying to preserve the organization while at the same time, embarking on strategies to cope with future challenges. Abu Dhabi’s national oil company (ADNOC) is partnering with Western firms to apply new technologies to boost capacity to five million b/d by 2030 and is looking for refining assets abroad. Saudi Aramco is pursuing a sophisticated strategy that includes diversification into natural gas, petrochemicals and trading as well as making sure to keep its production costs low to extract as much revenue as possible from legacy assets. But beyond diversification strategies, officials from OPEC’s big guns - Saudi Arabia, Kuwait, UAE and Iraq - have such low cost production that they are assuming that they can be the last ones standing. But while it might be tempting among Middle East producers to forge a policy to wait for U.S. shale to peak and sputter out in the coming years, it is early days on drilling technology innovation with new ideas on how to tap improved data, automation, lasers and CO2 injection to improve recovery rates not only in the United States, but around the globe. All that technology might mean that pure geology (e.g. ultimate size of reserves) might not matter as much as stable access to capital as a new winning characteristic of the future Darwinian challenge in oil. Thus, in the new Darwinian oil world, we can expect to see continued announcements about how low the largest players can go on costs. ExxonMobil threw down the gauntlet recently by stating its next Texas Permian oil increment will come at price tag of $15 a barrel, substantially below break evens for some of the smaller U.S. companies operating in the Texas shale. It’s also well below the kind of oil prices needed for OPEC’s member fiscal budgets which require oil prices to range from at least $45 to as high as $80 a barrel, depending on the country. As a new report published by Council on Foreign Relations on the Tech Enabled Energy Future notes, the convergence of automation, artificial intelligence, advanced manufacturing and big data analytics is poised to remake the transportation, electricity, and manufacturing sectors in ways that could eliminate oil use just at the same moment when those same technologies could make it easier and cheaper to extract oil and gas. As digital energy technologies take hold, large oil producers will have to consider whether their reserves could depreciate in value over time if they delay oil production and development in an effort to hold up prices in the present and garner short-term revenues. This reality is adding to the challenges many oil producer governments already face from mounting budgetary stress, prompting widespread calls for energy sector reforms in a host of oil states around the world. In the new digital energy world, fittest is being redefined and access to the largest reserve base will no longer be the overwhelming metric for success. The winners and losers could prove surprising.