Oil and Petroleum Products

Federal investigators in Brazil have uncovered corruption at the highest levels of the government and in the country’s largest corporations.

Renewed U.S. sanctions against Iranian oil exports kick in officially this week as part of the Trump administration’s decision to exit the Iranian nuclear deal. Estimations on how effective the sanctions have been is a relatively messy affair to date. Iran is expected to lose between 1 million to 1.5 million barrels a day in oil sales to Europe, Japan, South Korea, and India, with speculation that some of that oil might wind up instead in China or being repurposed in barter trade with Russia. Today, the U.S. government officially confirmed it was handing out temporary waivers to several of the countries that had previously announced intentions to go to zero purchases from Iran. Snatching defeat from the jaws of victory, the announcement, aimed to keep oil markets from overheating, calls into question the ultimate effectiveness of the Trump Iranian sanctions project overall. Worse still, it has simultaneously lay bare the fact that President Donald Trump, like countless U.S. presidents before him, has to worry about global oil prices in conducting foreign policy, despite an abundance of U.S. domestic energy. Iran has long experience in trying to avoid restrictions on its oil sales including turning off internationally-required tanker transponders to make it harder to track its shipping movements. But available satellite assisted tracking technology has improved since 2012, the last time the U.S. imposed sanctions on Iran. Tracking services are now offering up to the minute updates on Iranian oil exports, helping to illuminate the shadowy world of smuggling. One famous service, Tanker Trackers, even located with precision recent Iranian deliveries to China’s strategic petroleum reserve in Dalian. In years past, Iran has tried to entice major trading partners to evade sanctions compliance by promising sweetheart oil and gas exploration and other lucrative commercial deals. But the more uncertain long range commercial outlook for prolific Middle East reserves weakens Tehran’s bargaining chips. Fewer players, be they government-run firms or private companies, are looking to increase access to oil reserves in a place like Iran these days. After losing billions in investments in geopolitically risky international oil and gas ventures, China’s government has shifted efforts to new, clean energy technologies like renewables, batteries and automated cars. Europe’s big oil companies like Norway’s Equinor, France’s Total, and Royal Dutch Shell are also shifting to renewables and minding their knitting in places with less geopolitical risk. Also losing interest in risky international ventures, many American firms are squarely focused on new North American shale reserves that are now challenging the Middle East for market share. Many European, Japanese, and South Korean refiners initially responded to the Trump administration’s call for zero purchases of Iranian oil by quickly saying they would comply with the new U.S. sanctions, and French firm Total abandoned its natural gas development project in Iran. Ironically, all these pledged sanctions compliance announcements shook oil markets which were already tightening from a deal between the Organization of Petroleum Exporting Countries (OPEC) and Russia to limit supply to boost the price of oil. That prompted U.S. President Donald Trump to start tweeting at Saudi Arabia to intervene with more oil as they had done when then U.S. President Barack Obama had hardened Iranian oil sanctions in 2012 to get Tehran to the negotiating table. Had oil markets been oversupplied at the time the Trump administration was initiating new Iranian sanctions, chances are most countries would have begrudgingly gone along in a manner that would not have disturbed oil prices or added risk to the global economy. But in the context of a crisis-torn Venezuela and surprising reports that Saudi Arabia’s ability to produce more oil was more limited than previously supposed, the administration was faced with harder choices. Before offering its official statement on October 31, 2018, that “sufficient” oil supplies existed to permit a significant reduction in the petroleum purchased from Iran, the administration first jawboned Saudi Arabia to increase its production further, and then, in the aftermath of the Khashoggi scandal and related public U.S.-Saudi strains, the U.S. State Department was forced to hint that waivers would be given to countries having difficulty finding replacement barrels for Iranian purchases. Oil prices began to recede. In all, eight countries officially received such  temporary waivers, including Turkey, India and South Korea late last week. The waffling on sanctions enforcement has definitely helped with oil prices but it means that Iran will have an easier time finding outlets for its oil production, even if it can only take back goods as payment and not cash. Added oil supplies are expected on the market in early 2019 when infrastructure additions will allow higher exports of U.S. crude oil. U.S. diplomats are also working to free up more oil from northern Iraq and the Saudi-Kuwaiti neutral zone in the coming months. That Trump had to berate the Saudis and then capitulate on Iranian sanctions enforcement is a testament to the limitations of U.S. energy independence. Unlike in OPEC countries, additional U.S. oil export capacity isn’t just magically available on demand by pronouncement by government leaders. The pace of investment in new oil wells, export pipelines, and terminals is in a cacophony of dozens and dozens of independent, uncoordinated commercial oil company decisions that are dictated by markets and capital planning processes. Over the next month or two, rising U.S. oil production, which hit its historical record this month, remains stuck inland, constrained by pipeline bottlenecks. Even when those bottlenecks help keep the price of oil in Texas at a discount to international levels, it doesn’t help the Trump administration, which has to worry about how any shock in the global price of oil would disturb its broader goals that are related to the dollar, trade and global economic growth. That reality became even more apparent when Saudi Arabia hinted it could unsheathe its oil weapon after 44 years of quiescence, if the newly-elected U.S. Congress chooses to enforce the Magnitsky Act in response to the death of Jamal Khashoggi.  Reminding Americans of previous gasoline lines caused by the 1973 Saudi oil embargo, a Saudi commentator noted that the Saudi energy minister’s need to deny the possibility of a replay of 1973 signaled “to those who understand global politics that Saudi Arabia had many cards to play.” The incident laid bare an ugly reality: even with all our newfound oil and gas, America and its allies still need strategic stocks to protect the global economy from any rising petro-power that would try to use oil to blackmail the West into compliance to a political result they don’t want. U.S. production, though responsive to rising prices, is not able to surge rapidly enough to damp down a sudden supply shock. This was certainly noticed in China, which is only half way through building its own stockpile expected to reach 850 million barrels by 2020. China has increased its pace of stock building in the past few weeks, ironically with soon to be sanctioned Iranian oil. It is also a result that has taught a new generation of U.S. leaders about the limits of American oil power.

Ongoing negotiations between FRELIMO and RENAMO, which had resumed in 2016 following some armed conflict, have been suspended; the sticking point between the two movements appears to be the disarmament of RENAMO and the recent elections earlier this month, whose results RENAMO disputes.  Mozambique’s political life continues to be dominated by two political movements: FRELIMO, the ruling party, and RENAMO, the political and erstwhile military opposition. FRELIMO led the struggle for Mozambican independence from Portugal in 1975 and has been in power ever since, while RENAMO has been in opposition. The two movements have different ethnic bases, but the hostility between the two movements also reflected the liberation struggles elsewhere in southern Africa, especially in Rhodesia, now Zimbabwe, and apartheid South Africa. The Soviet Union supported the nominally communist FRELIMO, while Rhodesia and South Africa supported the nominally anti-communist RENAMO. The two movements fought a bloody civil war from 1977 to 1992 characterized by gross human rights violations by both sides. It ended when the Soviet Union collapsed, stopping its support for FRELIMO, and apartheid South Africa became a “non-racial” democracy, stopping its support for RENAMO. Subsequently, FRELIMO prevailed, but RENAMO remained viable and its cadres did not disarm. Nevertheless, post-civil war, the country appeared to be on a positive development trajectory, with economic growth rates as high as 8 percent per year. That ended in 2016 when the country defaulted on its loans because of irregularities in three companies allegedly controlled by the intelligence services. International financial institutions and donors suspended aid. The growth rate fell to little more than 3 percent. It is against this backdrop that elections took place.  Relieving this gloomy picture is the prospect of immense hydrocarbon wealth, primarily from natural gas. Major international companies, including Exxon Mobil (US), Eni (Italy), and SASOL (South Africa) are actively engaged, though actual oil and gas production is some years off.  There is also an Islamist extremist insurgency in northern Mozambique, along the border with Tanzania. There are reports of beheadings and that insurgents have links to al-Shabab. It is also believed that that the militants (or at least some of them) come from neighboring Tanzania. The Mozambican authorities are trying to keep the militants out of the areas of interest to the hydrocarbon companies.  There are reasonable chances that the party negotiations, led by President Filipe Nyusi and RENAMO’s Ossufo Momade, will get back on track, not least because it is in their mutual interest that they do so. Harder to predict is the trajectory of the Muslim insurgency. Is it driven primarily by local causes? Is it linked to al-Shabaab? How skillfully will the government respond? The latter question is particularly important. Elsewhere in Africa brutal and inept government responses—see Nigeria and Cameroon—have made insurgencies worse.

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. 

Chidi Odinkalu and Ayisha Osori have published a book in Nigeria that says Obasanjo and his associates and supporters essentially stole $500 million to fund the incumbent’s efforts to amend the constitution so that he could run for a third term. The authors are both highly credible human rights lawyers. Among other things, Odinkalu is the former head of the Nigerian Human Rights Council and Osori is the former CEO of the Nigerian Women’s Trust Fund. The title of their book is Too Good to Die: Third Term and the Myth of the Indispensable Man in Africa. It is widely understood that former President Olusegun Obasanjo sought to change the constitution so that he could run a third time for the presidency in 2007, but Obasanjo has always denied that was his intention. In any event, the effort to change the constitution generated widespread opposition, and eventually was defeated in the National Assembly. Obasanjo supported his party’s successful candidate, Umaru Yar’Adua, for the presidency. Since he left office, former present Obasanjo has remained active politically, though his influence has declined. Politics everywhere can be expensive—the U.S. presidential election in 2008, including primaries, cost $2.8 billion. But, according to the book, among the sources of the $500 million illicitly used in Obasanjo’s failed third-term bid was the Excess Crude Account, a sovereign saving account funded by the difference in the world oil price and the price upon which the national budget was based. When the “Third Term Agenda” was at its high point in the mid-2000s, oil prices were high and the account was growing. Odinkalu and Osori also show that during his eight years in the presidency, Obasanjo exercised sole control over the national oil company, the Nigeria National Petroleum Corporation (NNPC). Nigeria’s oil and gas is produced through joint ventures or joint agreements between the NNPC and private oil companies. The Nigerian government receives the lion’s share of the profits, which in turn make up the majority of government foreign exchange. Some of the commentary in the Nigerian media on Odinkalu and Osori’s book makes the point that in some ways, Obasanjo’s administration was a continuation of the way things were done during the generation of military rule when public funds were used for political purposes. The Obasanjo administration, ostensibly a civilian government, was in fact a transitional episode between military and civilian ways of governing, and not just with respect to oil. For example, Obasanjo on occasion ignored Supreme Court decisions that he did not like, as had his military predecessors. His successor, however, obeyed Supreme Court decisions, as have subsequent presidents.  

The reality that many energy companies are getting more serious about investment in low-carbon solutions is getting lost in the political noise of the day.

The premium appears to be creeping back into international oil prices as markets wait to see who will be policing the sea lanes in the aftermath of a Saudi announcement that it would temporarily halt oil shipments via the Bab el-Mandeb Strait. The Saudi announcement came after two of its oil-laden tankers were attacked by Yemeni Houthi militias. Shipments in the Bab el-Mandeb Strait, which connects the Red Sea and Suez Canal with the Persian Gulf and Indian Ocean via the Gulf of Aden, is a major sea route for oil shipments of close to five million barrels a day (b/d) of crude oil and petroleum products in both directions, including 2.8 million b/d flowing from the Mideast to Europe. Refined products from Saudi Arabia’s Yanbu refinery on the Red Sea are frequently exported south through the Bab el-Mandeb Strait to Asia. The Strait can be bypassed for northern traffic by sending ships on a longer, more expensive route around the southern tip of Africa.  Yemeni rebel attacks on shipping in the Bab el-Mandeb Strait are not a new occurrence but take on new importance in light of the U.S. withdrawal from the Iran nuclear deal (JCPOA) and subsequent planned reimposition of sanctions against Iranian oil sales. Iran has threatened that the United States would be mistaken if it thinks Iran would be the “only” country unable to export its oil. Iran explicitly mentioned its ability to close the Strait of Hormuz through which over eighteen to nineteen million b/d of Mideast crude oil transits. The United States has the capability to reopen any blockage of the Strait by military means and provided minesweepers and military shipping escorts to reflagged Kuwaiti oil tankers in the 1980s during the eight year Iraq-Iran war.  Saudi news outlets have run headlines in recent days that the United States was “weighing” its military options to keep the sea lanes open. The headlines, also published in Israeli newspapers, are referring to a statement made by U.S. Defense Secretary James Mattis who told Pentagon reporters on July 27 in discussing Iran’s threats to a different waterway chokepoint, the Strait of Hormuz, “They’ve (Iran) done that in years past; they saw the international community put dozens of nations’ naval forces in for exercises to clear the strait…Clearly this (closure) would be an attack on international shipping and could have an international response to reopen the shipping lanes…because the world’s economy depends on those energy supplies flowing out of there.” Mattis called upon Iran to abide by international rules.  Analysts say the U.S. withdrawal from the JCPOA has strengthened unity and coherence of the various factions within the Iranian government, moving Iranian President Hassan Rouhani to the right. Thinking about succession down the road for aging Supreme leader Ayatollah Ali Khamenei is influencing how the current line-up of political and religious leaders inside Iran are responding to the country’s current problems, Iran watchers say.  Still, in private briefings, Iranian officials are throwing around the term “strategic patience” as a guide to current thinking and noting that Iran has weathered sanctions for decades and will take no drastic measures against the United States or its regional allies. The argument goes that Tehran can afford to wait out the Trump administration, which will face a new election in 2020, and that Iran’s priority in the interim should be to avoid direct military clashes with the United States—which it believes U.S. allies Saudi Arabia and Israel would like to provoke. That raises the question regarding how much control Tehran has over its many armed proxies in Iraq, Yemen, Syria, and Lebanon. The relative independence of such proxies increases the risk of unintended or inadvertent clashes across a range of flash points, complicating U.S. responses.  In the intervening years since the Iraq-Iran war, several Arab oil exporters have built oil pipeline bypass routes so that a portion of their crude oil exports could avoid the Strait of Hormuz. Saudi Arabia’s Petroline, which can carry five million b/d of Saudi crude oil from eastern fields to an export facility on the Red Sea, is being expanded to carry seven million b/d by year end. Use of drag reduction agents can augment flows by as much as 65 percent. Abu Dhabi also has a 1.5 million b/d crude oil pipeline from Habshan to Fujairah that bypasses the Strait. Oman is building an oil storage hub at Duqm, and several Gulf Arab producers keep floating oil storage in tankers off the coast of Fujairah. Industry estimates are that Saudi Arabia also has over seventy million barrels in operational and strategic storage in Asia and Europe, among other locations.  Saudi leaders have been hoping that a military victory at Yemen’s port of Hodeidah might pave the way for intervention by the United Nations, progress on diplomatic negotiations, and by extension, a reduction in the risk to shipping in the Red Sea. So far, this goal has not been reached; hence, headlines in official news outlets about the U.S. role in the sea lanes.  President Donald Trump has actively tweeted about oil prices in recent weeks including a tweet that specifically mentioned how the United States protects regional countries. More recently, Presidential tweets have included warnings to Iran not to “threaten the United States.” The United States plays a critical role defending the global sea lanes and ensuring the free flow of oil around the world. Yemeni attacks on Saudi shipping make it harder for oil prices to recede, and saber rattling between Iran and the United States is on the rise as the November oil sanctions deadline approaches. This geopolitical backdrop is currently keeping oil markets on edge, despite increases in supply.  As U.S. midterm elections approach, high oil prices might not be the only factor that enters voters’ minds as they prepare to vote. The American public is weary of costly military engagement across the Middle East and could wonder why the United States is so unable to extricate itself from its role defending Middle East oil shipments, especially in light of rising U.S. domestic oil and gas production. Less than 10 percent of U.S. oil imports came from Saudi Arabia in 2017, with an additional 600,000 b/d originating from Iraq. But, Saudi Arabia remains a major oil supplier globally and most of the world’s spare oil production/export capacity sits in Saudi Arabia, Kuwait, and the United Arab Emirates. That means any disruption of oil supplies in the Persian Gulf would be a major threat to the global economy and would hurt U.S. trading partners, thereby damaging the U.S. economy as well even if the United States could more easily replace its limited Saudi and Iraqi oil imports. Hence, U.S. oil and gas production and exports have not reduced the U.S. need to police the free flow of oil from the Middle East. Oil commodity prices are also set globally which means like a swimming pool, where taking out water in one end of the pool affects the water level across the entire structure, an oil price rise due to the loss of supply in one part of the world is reflected in U.S. price levels as well all other locations across the globe. Rising oil prices still put U.S. consumers and important industries like the automotive sector under pressure, even if they are less negative for the overall U.S. economy. Ironically, the more successful the United States is in convincing the major economies to shun Iranian crude oil purchases, the more it could need to talk to the very same countries about sharing the financial or military burden of defending the sea lanes for oil flows from the Middle East. Without taking such action, it will be hard to convince Iran or its proxies that it is counterproductive to escalate threats to international shipping. Although the United States has appeared to shun international cooperation of late, continuing to maintain a very broad the coalition of European and Asian countries in sea lane navigation matters could discourage risky brinksmanship activities by all parties that could benefit from a direct confrontation between the United States and Iran.      

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.

As energy ministers from major oil producing countries gather in Vienna this week to discuss the stability of global oil markets, the variables that will dictate outcomes have rapidly shifted. Pre-meeting narratives that previously focused on the appropriate level of external private investment—either too much, in the case of U.S. shale producers, or too little, in the case of private sector international oil companies—look woefully inadequate to explain current oil market conditions. Instead, how to deal with the accelerating political and institutional breakdown of several national oil companies across multiple continents now stands out as a pressing structural challenge for the Organization of Petroleum Exporting Countries (OPEC) and U.S. policymakers alike. I highlighted this problem vis a vis Venezuela last March. Stated intentions to replace lost barrels from Venezuela and potentially Iran has brought acrimony back into the OPEC fray. U.S. plans to sanction Iran’s oil exports are the most recent publicly visible geopolitical irritant, but the history has shown that eliminating the endogenous geopolitical swings in the oil cycle takes more intervention and planning capability than even the most well intended partnerships can master, much less nation states whose relations have been punctuated by direct military threats or proxy wars. Talk of a sustained Saudi-Russian alliance that would be effective in eliminating the factors that could cause gyrations in oil prices seem overstated. All of OPEC’s fourteen members have flagship national oil companies (NOCs), that is, state-controlled entities that oversee their nation’s energy industry. Other important oil producing countries such as Brazil, Mexico, and Russia also have NOCs that dominate their oil and gas sectors. Many of these national firms are facing structural budgetary, corruption, or other internal political challenges, including attacks on facilities by local rebel groups, criminal gangs, terrorists, cyber hackers, and/or armed combatants in ongoing military conflicts.   As a result of these ongoing NOC difficulties, supplies from several OPEC countries, Venezuela, Libya, Iraq, Iran, Nigeria, and Angola have been volatile in recent years. In particular, the collapse of Venezuela’s oil industry and a slide in deep water oil production from Angola have been more instrumental to the market success of OPEC’s agreement with Russia and other non-OPEC oil producers than the producer group’s “planned” cuts in reducing excess inventories by almost 200 million barrels since early 2017 and pushing Brent oil prices up from about $55 to $75 a barrel. Cornerstone Macro noted in a recent report that oil stocks in industrialized countries experienced a counter seasonal decline of three million barrels in April, as compared to the more customary twenty million buildup on the heels of reduced global supplies and more robust than expected U.S. and global economic growth. While Saudi Arabia, Kuwait, the United Arab Emirates, and Russia did make promised output reductions to help tighten oil supply over the course of 2017, unintended production declines continue to be more material. Not only did oil output declines from Venezuela, Algeria, Angola, Ecuador, and Gabon amount to losses of close to one million barrels a day since early 2017, according to Citibank, markets have come to expect accidental supply disruptions from conflict prone oil regions in Libya and Nigeria. That reality prompted one prominent energy columnist to conclude that OPEC has become “an increasingly unreliable supplier of an essential commodity.” Whatever the outcome of the OPEC-non-OPEC Vienna group’s deliberations this week, it could turn out to be only a temporary fix to this more structural NOC problem than generally understood. Right now, OPEC spare productive capacity is highly limited. Saudi Arabia and Russia together would probably have difficulty adding much more than 1.5 million barrels a day to markets through the end of the year. Ongoing problems in Libya and Venezuela, combined with renewed sanctions on Iran, could possibly take more than that off the market. And what if a new supply problem emerges? Saudi Arabia and Russia are discussing longer run cooperation. What would that look like in a world where uncertainty plagues many national oil companies around the world, including, perhaps, their own firms? Does budget-constrained Saudi Arabia agree to divert billions in tandem with Russian firms to expand additional oil fields’ productive capacity down the road to capture future market share that could be available as NOCs in other countries continue to fail? If Saudi and Russia make capacity expansion pushes, what becomes of OPEC as a coherent organization? Will the Vienna group need to shrink in number? Conversely, if Saudi Arabia and Russia choose to make only a quick stop-gap measure just to keep markets from overheating in the next few months and don’t invest in new capacity, will they sacrifice future revenues to private oil and gas investors who can bring on capacity more quickly if NOC capacity continues to falter? The 2014-2015 price collapse has proven that a year or two of low prices won’t be sufficient to knock out growth in U.S. tight oil. That means restarting a price war in the short run isn’t an ideal option for OPEC, especially if those flooding the market do not appear to be able to survive the prolonged revenue drop that would make a price war option an effective threat. And my guess is that low oil prices also aren’t likely to be sufficient to knock out capital investment by the major international oil companies (IOCs). Those companies have started to pivot their strategies to direct their capital spending to activities that will be more productive than those pursued over the last decade when booking new large reserves was the priority. Rather, companies are focused on spending programs that can bring higher production more quickly, such as directing capital spending to shorter cycle field extensions and satellite field developments that can bring first oil into the market rapidly within one to three years (as opposed to mega-projects that took near a decade to develop). Companies are also developing new techniques to reduce the cycle time and costs on challenging green field projects.  Moreover, innovation in the private oil and gas sector is increasingly de-risking the landscape for future oil and gas investment for private investors. As technology improves, companies are going to be able to squeeze more barrels out of all kinds of existing known in place source rock, not just oil and gas from shale formations. The most recent example is the Austin Chalk where U.S. companies are rushing to test new drilling techniques to positive results.   There’s an additional rub. Saudi and Russian efforts could have trouble influencing intermediate oil demand trends. Even if the Vienna group takes production increase decisions this week that staves off any economically crippling oil price shock that could have sent oil demand into a tailspin, caution signs are already emerging that oil prices even at $70 a barrel are creating some economic headwinds. Markets are already nervous about trade wars. Reports are emerging that high fuel prices are hindering economies within the Euro zone and elsewhere. Rising fuel prices are visibly creating economic and political problems in India and other developing economies. And the United States needs strong demand growth elsewhere to manage its own economic issues. In the case of an unexpected global economic slowdown, OPEC supply disruptions could take a back seat again to “lower for longer” story lines about failing oil demand (potentially in the midst of rising U.S. production in 2019), which could make any discussion of a more permanent, workable Saudi-Russia oil alliance even harder to envision.