Testimony

**"The Geopolitics of Oil**

**And**

**America's International Standing"**

Committee on Energy and Natural Resources

United States Senate

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# Dr. Flynt Leverett[^1]

January 10, 2007

Mr. Chairman, Senator Domenici, members of the Committee, thank you for
the opportunity to speak with you about the global oil balance and its
implications for America's national security and foreign policy.[^2] In
my view, the most profound challenges to America's global leadership
during the next quarter century are *not* posed by the risk of strategic
failure in Iraq, further proliferation of weapons of mass destruction,
or the growth and consolidation of extremist forces in the Islamic
world. Rather, **the most profound challenges to U.S. preeminence during
the next 25 years flow from the strategic and political consequences of
ongoing structural shifts in global energy markets, especially the
global oil market**. Most notably, **cooperation between China and
Russia on energy matters is bolstering Sino-Russian cooperation on
strategic issues, effectively creating a Sino-Russian "axis of oil" as
the principal counterweight to America's global hegemony.**

**Resource Nationalism and Resource Mercantilism**

The basic structural shifts in global energy markets I see boil down to
two important trends:

-   The first is the tightening of margins between global demand for
    crude oil and installed upstream productive capacity. The global oil
    supply has grown steadily in recent years, and there is considerable
    evidence that it will continue to grow for many years to come, given
    suitable oil prices and appropriate levels of investment. But, in
    recent years, global demand for crude oil has been growing faster
    than supply---in no small part because of **burgeoning energy demand
    from emerging economic powerhouses in Asia, particularly China and
    India**. In coming years, demand is likely to continue bumping up
    against installed productive capacity.

-   The second important structural shift in the global oil market is
    **the progressive concentration of the world's oil reserves under
    the control of national governments and national oil companies,
    especially in the Middle East and the former Soviet Union**.

Taken together, these two trends are generating strategic and political
responses on both the supply side and the demand side of the global oil
market. On the supply side, many have noted the rise of **"resource
nationalism"**. Resource nationalism is often defined as national
governments' assertion of ownership rights over oil and gas reserves
against the interests of international energy companies. But there is
another dimension to resource nationalism on which I want to
focus---that is, national governments making decisions about the
production and marketing of the hydrocarbon reserves under their control
not only on the basis of economic factors, but also on the basis of
strategic and political calculations.

There are many examples of how resource nationalism can challenge a wide
range of American interests. These include:

-   Russia's application of energy "levers" to reestablish its hegemonic
    position in the post-Soviet space and bolster its strategic position
    *vis-à-vis* Europe and East Asia;

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-   Venezuela's exploitation of its dominant position as a Western
    hemisphere energy producer and exporter to weaken America's standing
    in parts of Latin America; and

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-   Saudi Arabia using its unique status as the "swing producer" for the
    global oil market to cultivate a deepening strategic relationship
    with China as a "hedge" against precipitous deterioration in the
    Kingdom's traditional strategic partnership with the United
    States.[^3]

On the demand side, we are witnessing an analogous phenomenon, which I
describe as **"resource mercantilism"**---that is, the reliance of
energy importing states on national energy companies to secure access to
overseas oil and gas resources on more privileged bases than simple
supply contracts. Resource mercantilist states provide various kinds of
support to their national oil companies' efforts to acquire hydrocarbon
assets abroad and, like resource nationalist states, often seem to base
their actions in global energy markets on strategic calculations as well
as on commercial and economic considerations.

The outstanding exemplars of resource mercantilism today are, of course,
China and India, both of which perceive increasingly acute
vulnerabilities to their energy security stemming from their growing
reliance on imported hydrocarbons to fill critical portions of their
energy mix. And, there are a growing number of examples of how resource
mercantilism can work against U.S. interests, although not in the way
that many observers initially anticipated. In this regard, while
increased demand from China and other rising Asian economies has had a
very direct effect on global oil prices, there is little evidence that
Chinese and Indian "equity oil" deals are keeping or will keep an
economically or strategically significant part of the world's oil
reserves "locked up" and unavailable to international markets.

-   Currently, oil produced from Chinese and Indian overseas equity
    assets represents less than one percent of the oil produced and
    traded worldwide.

-   If the most optimistic projections of Chinese and Indian oil and gas
    acquisitions abroad prove correct, overseas equity oil production by
    Chinese and Indian national energy companies might represent roughly
    2 percent of total worldwide production in 2020.

However, **statist approaches in the external energy strategies of
rising Asian economies are becoming a serious source of geopolitical
tension**.

-   In East Asia, competition between Beijing and Tokyo over a variety
    of specific energy deals, a bilateral dispute about sovereignty over
    possible natural gas reserves in the East China Sea, and jockeying
    over the ultimate destination of a projected Russian oil pipeline to
    Asia have all contributed to the deterioration of Sino-Japanese
    relations in recent years.

-   Even more significantly, **China's statist approach to external
    energy initiatives has become a source of geopolitical tension
    between China and the United States. In particular, China's search
    for oil is making it a new competitor to the United States for
    influence, especially in the Middle East, Central Asia, and
    Africa**. This, in turn, is creating new foreign policy as well as
    commercial options for energy exporting states at odds with U.S.
    foreign policy goals, including Iran, Sudan, and Syria.[^4]

**The New Axis of Oil**

As separate phenomena, resource nationalism and resource mercantilism
are posing increasingly serious challenges to U.S. interests around the
world. But **the challenge to America's global leadership becomes far
more profound when these phenomena intersect, as they do in what I have
called a "new axis of oil" that is acting as a counterweight to American
hegemony on a widening range of issues**. The heart of this undeclared
but increasingly assertive axis is a growing geopolitical partnership
between Russia (a major energy producer) and China (the paradigmatic
rising consumer) against what both perceive as excessive U.S.
unilateralism in world affairs. Sino-Russian collaboration provides the
essential frame for a loose and shifting coalition of energy exporting
and energy importing states that acts in specific ways to challenge U.S.
leadership in world affairs.

**The impact of the new axis of oil on American interests has already
been felt in the largely successful Sino-Russian effort to minimize U.S.
influence in Central Asia**. Sino-Russian cooperation has been critical
to the rise of the Shanghai Cooperation Organization, the world's
largest regional security organization (in terms of the populations and
territory of participating states) and the only regional security
organization in the world in which the United States does not
participate. Working through the Shanghai Cooperation Organization,
Moscow and Beijing have collaborated over the past three years to cap
and then roll back the post-9/11 extension of American influence into
Central Asia.

**The new axis of oil is also reflected in Sino-Russian cooperation to
frustrate a significant segment of U.S. policy objectives regarding the
Iranian nuclear issue**. Both Russia and China have complicated policy
agendas toward the Islamic Republic. To be sure, neither Moscow nor
Beijing sees Iranian acquisition of a nuclear weapons capability as a
Iran as a desirable turn of events. But both are prepared to tolerate a
higher-level of Iranian nuclear development than the present U.S.
administration. Moreover, each has other interests that it wants to
pursue with Iran.

-   For Russia, these interests include exporting civil nuclear
    technology and conventional military equipment. For China, they
    include cultivating Iran as an energy supplier.

-   And, both Moscow and Beijing have interests in collaborating with
    Tehran in Central Asia to manage Sunni extremist threats there and
    minimize U.S. influence. To these ends, Russia and China have now
    included the Islamic Republic in the Shanghai Cooperation
    Organization as an observer.

In this context, neither Russia nor China will support multilateral
sanctions against Iran that would put these various interests at risk.
As a result, there is no prospect of getting the United Nations Security
Council to impose sanctions on the Islamic Republic that would be
stringent enough to leverage changes in Iranian behavior on the nuclear
issue.

Even more significantly, **Russia and China see the controversy over
Iran's nuclear activities as an important issue on which to "draw lines"
against what both Moscow and Beijing consider excessive U.S.
unilateralism in international affairs**. In this regard, Russian and
Chinese leaders considered the Iraq war a dangerous precedent and are
determined not to see that precedent repeated in Iran. In the end, the
United States or others may use military force unilaterally to try to
delay Iran's nuclear development, but Moscow and Beijing will use their
status as permanent members of the Security Council to ensure that there
is no plausible international legitimation for such unilateral action.

**The Race for Iran**

The geopolitical and geoeconomic stakes at play in Iran go well beyond
the nuclear controversy. **There is now a broader strategic competition
underway between the United States, on the one hand, and Russia and
China, on the other, concerning Iran's economic and political role in
the Middle East and global energy markets in coming decades**. The
outcome of this competition hinges in considerable measure on which
countries will assume leading roles in helping Iran develop its enormous
hydrocarbon resources.

Iran's resource base is truly impressive. If one converts Iran's
reserves of natural gas---the second-largest in the world, after
Russia's---into barrels of oil equivalent and adds them to Iran's proven
reserves of conventional oil---the second-largest in the world, after
Saudi Arabia's---Iran's hydrocarbon resources are effectively equal to
those of Saudi Arabia and significantly greater than those of
Russia.[^5] Moreover, Iran's low rates of production of crude oil and
natural gas, relative to its reserves base, suggest that the Islamic
Republic is perhaps the only major energy-producing state with the
resource potential to increase production of both oil and gas by orders
of magnitude over the next decade or so.

Iran, however, cannot realize this potential without significant
infusions of investment capital and transfers of technology from abroad.
Since the mid-1990s, **U.S. policy has sought to constrain the
development of Iran's hydrocarbon resources by barring U.S. energy
companies from doing business there and threatening European companies
undertaking projects in Iran with secondary sanctions. These policies,
combined with a problematic investment climate in the Islamic Republic,
have limited investment flows and transfers of technology into Iran's
oil and gas sectors**. Recently, Iran's Oil Minister publicly
acknowledged this.

Some have suggested that insufficient investment in new productive
capacity, along with the combined effects of the depletion of already
developed oil and gas fields and the growth in its domestic energy
demand has put the Islamic Republic's oil and gas exports into a
precipitous decline. But, **it would be a mistake to assume that, absent
rapprochement with the United States, these trends will continue
unchecked and put the Islamic Republic in an increasingly precarious
economic and strategic position**.

Over the last several months, Iranian officials and energy executives
have told me that **Iran is developing an alternative strategy for
increasing its production and exports of crude oil and natural gas, a
strategy that does not rely on substantially improved relations with the
United States or the West generally**. This strategy has three principal
elements.

-   First, Tehran continues to explore the possibility of energy deals
    with European energy companies that are willing to do business in
    the Islamic Republic. While some significant European energy
    companies are reducing their involvement in Iran, there are still
    prominent Europe-based international energy companies with upstream
    investments there that are pursuing additional deals.

-   Second, Iran is developing ties to state-owned energy companies in
    other Islamic countries (i.e., Petronas in Malaysia) and, more
    importantly, to national energy companies in China and India.
    Chinese companies, in particular, are making commitments to invest
    substantial amounts of capital in Iran's oil and gas sectors.

-   Third, Iran is exploring possibilities for cooperation with Russia
    to develop its energy production and export capabilities. In
    particular, Tehran is now willing to "coordinate" the marketing of
    Iranian gas exports with Moscow to ensure that Iran's emergence as a
    gas exporter does not work against Russia's economic or strategic
    interests. In return, Moscow has agreed to provide financial and
    technical support to help Iran boost its natural gas production.[^6]
    In this context, at the most recent summit meeting of the Shanghai
    Cooperation Organization, Russian President Vladimir Putin and
    Iranian President Mahmoud Ahmedinejad announced that their two
    countries would explore possibilities for cooperating to provide
    energy exports to Asia.

Privately, Iranian officials and energy executives acknowledge that this
approach is not the optimal way to develop their country's hydrocarbon
resources. But, as a senior Iranian diplomat put it to me recently, Iran
"cannot wait on the West forever."

**The significance of Russian and Chinese cooperation to develop Iran's
hydrocarbon resources goes far beyond its impact on the rate at which
the Islamic Republic's oil and gas exports increase or decline or on the
extent of Tehran's regional and international isolation. Such
cooperation has the potential to help Moscow consolidate a position as
the leading player in supplying energy resources to major markets in
Asia as well as Europe, with considerable attendant strategic benefits.
It also has the potential to consolidate a Sino-Russian axis of oil as
the principal counterweight to U.S. hegemony in regional and
international affairs**.

**Strategic Challenges and Policy Responses**

There are other arenas in which structural shifts in the global oil
market and strategic and political responses to those shifts pose
serious challenges to America's leadership in international affairs. For
example, **how major energy exporting states---primarily in the Middle
East and Russia---handle their enormous and growing current account
surpluses is now as important to the management of global economic
imbalances and the future of the dollar as the world's leading reserve
currency as the decisions of China and other major Asian economies**.
Here, too, there is considerable potential for a variant of the axis of
oil to develop considerable strategic leverage over the United States.

Of course, the foregoing analysis poses the critical question: "What is
to be done?" The intellectually and politically facile answer to this
question is to advocate "energy independence" for the United States.
Unfortunately, this is not a serious response to the strategic
challenges facing our country. Simply put, **there is no economically
plausible scenario for a strategically meaningful reduction in the
dependence of the United States and its allies on imported hydrocarbons
during the next quarter century**. Reducing our dependence on
domestically produced and imported hydrocarbons has many attractions as
a policy goal, but we should have no illusions about how rapidly this
can be achieved or how soon it can provide meaningful relief to the
strategic challenges I have described.

This means, above all, that **we must begin to take energy security
seriously as a foreign policy issue and prioritize energy security as a
national security objective relative to other foreign policy goals**.
For example, how important is an abortive drive for Ukraine's accession
to NATO to American interests compared to securing Russian cooperation
with the United States and its allies on energy supplies, as well as
cooperation on the Iranian nuclear issue and other pressing problems?
Reasonable and honorable people can come up with different answers to
this question and others like it, but to avoid addressing the questions
is to avoid the responsibilities of political leadership.

Beyond this general proposition, I would suggest two other concrete
policy responses to the strategic challenges growing out of trends in
the global oil balance. First, **it is critical for the United States to
pursue a "grand bargain" with the Islamic Republic of Iran**---that is,
a diplomatic process aimed at resolving all of the outstanding bilateral
differences between the United States and Iran as a package. My
criticism of proposals for issue-specific or step-by-step engagement
with Iran, such as those presented in the Iraq Study Group report, is
not that these proposals go too far but, rather, that they do not go far
enough. By continuing to reject a grand bargain with Tehran, the Bush
administration has not only foreclosed any real chance that Iran will
accept meaningful long-term restraints on its nuclear activities; it has
also put the United States in a losing position in the longer-term
geopolitical and geoeconomic struggle over Iran.[^7]

Second, **it is important to induce the leading resource mercantilist
states, China and India, away from statist approaches in their external
energy strategies, so as to reduce the chances that they will bolster
their strategic commitments to an axis of oil as an international
counterweight to the United States**. In this regard, it is critically
important to bring China and India into the International Energy Agency,
the OECD's established "club" for major energy importing states.
Similarly, it is important to encourage the internationalization of
Chinese and Indian national energy companies. There is considerable
evidence, especially in the Chinese case, that these companies are
becoming more market-oriented and profit-focused in their strategies and
operations, and are increasingly willing to challenge their national
governments over external energy initiatives that d not make commercial
sense. In many ways, these companies are the most promising channels for
promoting more market-based approaches to external energy policy in
China and India.

[^1]: ^^ *Flynt Leverett is Senior Fellow and Director of the
    Geopolitics of Energy Initiative at the New America Foundation. He
    is also a visiting professor of political science at the
    Massachusetts Institute of Technology and a principal of Strategic
    Energy and Global Analysis, LLC. Previously, he served in government
    as senior director for Middle East affairs at the National Security
    Council, on the Secretary of State's Policy Planning Staff, and as
    senior analyst at the Central Intelligence Agency.*

[^2]: For more detailed presentations of the ideas offered in this
    testimony, see Flynt Leverett and Jeffrey Bader, "Managing
    China-U.S. Energy Competition in the Middle East", *The Washington
    Quarterly* (December 2005); Flynt Leverett and Pierre Noel, "The New
    Axis of Oil", *The National Interest* (Summer 2006); and Flynt
    Leverett, "The Race for Iran", *The New York Times*, June 20, 2006.

[^3]: On this point, see also Flynt Leverett, "Reengaging Riyadh", in
    Flynt Leverett, ed., *The Road Ahead: Middle East Policy in the Bush
    Administration's Second Term* (Washington, DC: The Brookings
    Institution Press, 2005).

[^4]: Statist strategies for accessing hydrocarbon resources around the
    world---with their associated inclination toward corruption,
    provision of "soft" loans, and offers of investment and aid in
    unrelated projects and sectors---also challenge the rules-based
    international order for trade and investment in energy that the
    United States has long championed and, in some cases, weaken the
    leverage that Western governments and international financial
    institutions can use to promote better governance and transparency
    in oil-producing countries.

[^5]: In its December 19, 2005 issues, the *Oil and Gas Journal* lists
    Iran's proven reserves of crude oil as roughly 133 billion barrels.
    The same source lists Canada as holding the world's second-largest
    oil reserves, roughly 179 billion barrels, putting Iran in third
    place. However, the reserves estimate for Canada includes 175
    billion barrels of reserves in oil sands; this justifies the
    statement that Iran holds the world's second-largest reserves of
    conventional oil. When one converts natural gas reserves into
    barrels of oil equivalent (boe), Saudi Arabia has 302.5 boe in
    combined reserves of oil and natural gas and Iran has 301.7. By way
    of comparison, Russia's aggregate hydrocarbon reserves---the world's
    third-largest---are 198.3 boe. I am grateful to Bijan Khajehpour of
    Atieh Bahar Consulting for sharing the results of his calculations.

[^6]: According to both Iranian diplomats and current and former Russian
    officials, a high-level working group has been set up to oversee
    bilateral energy cooperation. On the Iranian side, the working group
    is headed by the Deputy Oil Minister; on the Russian side, it is
    headed by the chief of Gazprom's international activities.

[^7]: I have written elsewhere on the content and feasibility of a
    U.S.-Iranian grand bargain; see Flynt Leverett, *Dealing With
    Tehran: Assessing U.S. Diplomatic Options Toward Tehran* (New York:
    The Century Foundation, 2006).