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Number 130, October 1997

Energy Security in a Timeof Plenty
by Patrick Clawson

Conclusions- Energy supply trends are good for Western security. Dependence on the volatile Persian    Gulf may increase only slightly, as additional supplies come from stable pro-Western    areas, such as Norway and Latin America. Also, the cost of producing oil is dropping    thanks to the information revolution. 
- In spite of East Asia's rapid growth, world oil demand is unlikely to grow each year by    more than 1.5-2.0 million barrels per day (mbd). East Asian growth is concentrated in    industries that use little energy. Oil demand growth in both China and the former Soviet    Union will be modest as they shut or modernize energy-wasting heavy industries. 
- Market forces increasingly determine what happens in the energy business, except in the    Caspian basin where geopolitical factors will determine whether the region's rich oil and    gas resources will be brought to market. 
- An energy security issue for the coming decade will be adjusting to the next energy    trade pattern, in which East Asia and the Persian Gulf become more tightly tied-each more    reliant on the other. 
- Ample supplies in the world energy market continue to maintain relatively low prices.    Despite an upward blip in 1996, crude oil prices in the mid-1990s have been about the same    as in the mid-1980s, while the average price level for other goods rose about 30 percent    over that decade. 
**Supply Outlook**
From 1986-1996, the world energy supply increased by 2.6 percent peryear, excluding the former Soviet Union (FSU) where production fell sharply. Oil's shareof the world energy supply held constant at about 40 percent; natural gas' share rose to23 percent, while coal's fell to 27 percent, with hydro and nuclear power sources makingup the remaining 10 percent. Most natural gas and coal supplies are consumed in thecountry in which they are produced; oil makes up about 90 percent of the energy tradedbetween countries.

The main factor driving the increasing supply of energy between 1986-96was not price. In fact, prices were not particularly attractive for producers. Instead,two factors came into play:

First, governments adopted more investor-friendly policies. Monopolieswere abolished and protectionist restrictions were eased as governments also lightened theburden of regulation and welcomed foreign investment. The effects of these policiescontinue. For example, thanks to foreign investment, Venezuela is on track to increase itsoil output capacity from 3.5 mbd in 1996 to 6 mbd by 2005. 

Second, the cost of producing oil has been dropping. The informationrevolution is reducing the cost of modeling and sensors. With techniques like 3D or 4Dseismic and directional drilling, a higher proportion of drilled wells are hitting oil,plus more of the oil reserves in a field can be recovered-40 or 50 percent recoveryinstead of 30 percent in the past. As costs drop, more output is coming from lessattractive oil fields. 

These forces have made themselves felt in a wide range of countries,with the exception of Russia, where oil output fell by 3.3 mbd from 1991-96. During thatsame period, 13 non-OPEC countries each increased production by more than 100,000 barrelsper day. Development of deeper offshore fields gave Norway the largest increase at 2.3mbd, compared to the total increase in world oil output of 4.3 mbd. Latin Americancountries, excluding Mexico, were able to increase output 1.4 mbd between 1991-96. Thereis every reason to expect that these trends will continue and that output from outside theMiddle East will continue to increase. Indeed, U.S. oil output in August 1997 was higherthan in August 1996, reversing a long-term decline. Thanks to increasing Gulf of Mexicoproduction, U.S. oil output is likely to increase from the 1996 level of 8.6 mbd for atleast five years.

Because production has become more attractive in areas that werepreviously marginal, Middle Eastern countries have had less of an advantage in the oilproduction business. From 1991-96, oil production by Middle East and North Africancountries rose by 3.0 mbd, but 2.2 mbd of that was recovery from the Iraq-Kuwait war.Outside of those two countries, production rose only modestly from 20.7 mbd in 1991 to21.5 mbd in 1996. Despite the increase in output due to the recovery in Kuwait, the shareof Middle East and North African production in world output rose only 3 percentagepoints-from 32 percent in 1991 to 35 percent in 1996.

Middle Eastern countries face serious domestic economic problems,including rapid population growth and popular expectations that the government willprovide services at levels that can ill be afforded. To fund job creation, balancebudgets, and continue social welfare programs, Middle Eastern governments want to raiseoil production capacity, which they can readily do given their ample reserves. Althoughcurrently producing about 9 mbd, Saudi Arabia has a program underway to raise its capacityfrom 11 mbd to 14 mbd within the decade. The other Gulf Cooperation Council (GCC)states-Kuwait, Bahrain, Qatar, UAE, and Oman-are increasing their capacity from 7 mbd toat least 9 mbd. And Iraq has tremendous production potential were it to abandon itsstubborn opposition to UN resolutions that prevent its full return to world markets.Already, it could produce 3 mbd, and that could rise to 6 mbd within three to five yearsafter sanctions end. On the other hand, Iran's plans to expand its capacity face seriousfinancial constraints, exacerbated by U.S. laws threatening secondary boycotts againstfirms investing in Iranian oil and gas.

Prospects for ample supplies for the foreseeable future-given thelikely increases in Middle Eastern capacity and the prospective growing output of the restof the non-FSU world-are good, even if FSU production remains stagnant. In fact, asdiscussed below, FSU production may well rise, given the investments pouring into theCaspian Basin, even if the unfavorable investment climate keeps Russian output fromgrowing.
**Demand Outlook**
While prospects are good for sustained increases in oil output, theoutlook for demand is not as clear. The Energy Information Administration, part of theU.S. Department of Energy, forecasts that oil demand will increase briskly from 1996 to2015, growing from 72 mbd to 103 mbd. Of that 31 mbd increase, 14 mbd will come from EastAsia (a category which excludes Indonesia and India). By contrast, demand in the advancedindustrial nations of Europe and North America will grow only 6 mbd, including modestgrowth for U.S. oil consumption which was 17.4 mbd in 1996. Demand in the rest of theworld-East Europe, Latin America, Africa, the Middle East, and South Asia-will increase by11 mbd.

On the other hand, a host of factors could cause world oil demand togrow less rapidly than this Energy Department forecast. The world economy may not continuethe robust growth rates of the mid-1990s. Global warming concerns could result insignificant restrictions on fuel consumption. There could be a reduction in the massivesubsidies for energy consumption in many OPEC countries. Energy-wasting state-ownedindustries in the FSU and China could be modernized or closed. Natural gas could be usedinstead of oil for much of the new generating capacity in Europe and Asia, especiallysince there is considerable excess gas production capacity in the FSU and several largegas projects elsewhere are in advanced stages of planning. 

In any case, East Asia's growing energy demand can be accommodatedreadily through market mechanisms. Indeed, while East Asia will be an important part ofthe world oil market, it will hardly be an overwhelming presence. Under the EnergyDepartment forecast, East Asia will consume 27 percent of the world's oil in 2015, up from21 percent in 1996. That seems counterintuitive, given that East Asia is growing morerapidly than the rest of the world. The explanation is China-in two ways. First, Chineseenergy consumption is 75 percent coal, which comes from China's ample domestic supplies.Coal is used for railroads (the backbone of Chinese transportation), for heating, and forelectricity generation. Second, industry in China consumes 60 percent of all energy, andmany of the intense energy-consuming industries are inefficient and not growing. China'sgrowth is coming from sectors that use little energy, compared to the industrial behemothsof the Maoist past. Combining these two factors, China's increase in oil consumption until2015 will be almost entirely for road transport; oil consumption for tranportation willprobably increase from .8 to 3.5 mbd.

 

**Security Implications**
The United States has devoted much effort to preserving the security ofthe Persian Gulf-motivated mostly by concern about what instability could do to world oilmarkets and what a rogue could do if he had unfettered access to the entire Gulf's oil.Those will remain serious problems, not only because the Gulf is the world's major oilproducing region (29 percent in 1996) but also because it has 65 percent of the world'sproven oil reserves. Explaining the policy to the U.S. public has been easy, given thesignificant U.S. dependence upon the Gulf for oil imports (roughly 20 percent in 1996). Itwill be interesting to see how U.S. public opinion reacts as the United States uses lessGulf oil. Indeed, the world oil market is splitting into an Atlantic Basin-in which Europeand America import oil from Africa and Latin America-and an Asian market-in which East andSouth Asia import oil from the Persian Gulf.

In the Asian market, the major security issue is whether China iswilling to rely on market forces to supply imports of a vital input like oil. The signsare encouraging. China already relies on imported grain for a significant portion of urbanconsumption, and China's approach to its metal needs (iron and copper) has been to investabroad rather than to search for special political relations. Still, Chinese leaders maythink that political considerations determine oil supplies. Indeed, the oil industry wasdominated by politics, vice markets, for decades until the mid-1980s. And the Chinese mayworry about the U.S. propensity for sanctions on energy producers, seen in the cases ofBurma and Iran as well as the UN sanctions on Iraq. 

There has been much interest in Asia about what increasing oil importsfrom the Gulf will mean for protection of the sea lanes of communication (SLOCs) acrossthe Indian Ocean and up the South and East China Seas. It is hard to see how China couldin the coming decade or two play a significant role regarding those SLOCs. China and theUnited States share a common interest in freedom of navigation in those SLOCs, and theUnited States will protect those SLOCs. Were relations between the United States and Chinato deteriorate, China could not deny those SLOCs to the United States, while the UnitedStates could deny them to China. Energy security may be used as one argument among many bythose in Beijing who want a blue sea navy. 
**Caspian Oil**
While the role of market forces in the oil and gas industry isincreasing, one area where geopolitics remains primary is the Caspian basin. Rich oil andgas reserves lie under and around the Caspian Sea, mostly oil in Kazakstan and Azerbaijanand gas in Turkmenistan. The proven reserves are about on the same order of magnitude asaround the North Sea: 16 billion barrels of oil and 8.3 billion cubic meters of gas,according to the United States government. The same source estimates that possiblereserves are much greater: 163 billion barrels of oil and 17.6 billion cubic meters ofgas, which would make them equal to 16 percent of 1996 global proven reserves of oil and12 percent of gas. U.S. firms are investing billions of dollars, primarily in the Azerioffshore and Kazakh Tenghiz fields. 

The problem is how to get the oil and gas to market from the landlockedCaspian countries. Commercial rationale alone would seek outlets to the south, via Iran orAfghanistan. Three oil pipelines are already under construction or renovation: a 1.2 mbdoil pipeline from Kazakhstan via Russia to the Black Sea and two 0.1-0.2 mbd pipelinesfrom Azerbaijan to the Black Sea, one via Russia and one via Georgia. Also underconstruction are two short gas pipelines to hook up the Iranian gas network with itsneighbors: Turkmenistan in the east, and Turkey in the west. While the Kazakh pipelinewill carry most of that country's projected oil capacity, additional major pipelines willbe needed, especially for Azeri oil and Turkmen gas. Many routes are under discussion,with framework agreements signed for several routes. All of the projected routes haveproblems, which will make the choices difficult:
- Existing pipelines go through Russia. Adding more capacity to those pipelines raises    fears of excessive dependence on Russia. Plus economics dictate that Caspian oil going    through Russia would probably go to Black Sea ports, from where it would be carried by    ship. That could create problems in the increasingly crowded Bosporus Straits. 
- Transport via Iran faces political problems, i.e., U.S. reluctance-if not opposition-and    Azerbaijani suspicions of Iranian irredentism. Plus the Iranians are offering poor terms    and have a bad reputation from their price gouging in the 1970s on the gas pipeline to the    USSR. 
- Turkey is lobbying vigorously for pipelines across its territory to the Mediterranean.    But the political geography is complicated: a pipeline to any of the producing countries    would have to cross at least one transit country before getting to Turkey, plus the best    pipeline routes inside Turkey cross unstable Kurdish areas. 
- Other pipeline routes are equally difficult politically (to India via Afghanistan and    Pakistan) or challenging economically (to China from Kazakhstan). 
**Recommendations
- Maintain the U.S. commitment as the ultimate guarantor of security in the Persian Gulf,    while beginning a dialogue with Europe about a fairer sharing of security responsibilties.  
- Defuse a potentially dangerous rivalry in the Caspian basin by: (1) clarifying that the    United States welcomes Russian investment in the region; and (2) laying out a road map for    Iran of what  quids  it must deliver before the United States will offer the  quo     of dropping objections to investment in pipelines via Iran.  
- Encourage a dialogue with China about energy security in which the United States can:    (1) make clear that it will protect SLOCs for all shipping, and (2) encourage China to    concentrate on market mechanisms to guarantee its energy needs. 
- Welcome Chinese investments in foreign energy projects, such as announced intentions to    invest more than a billion dollars in Kazakhstan. While the Chinese role may reduce    opportunities for U.S. firms, that is a price worth paying for avoiding politically    motivated Chinese ties with rogue oil producing regimes like those in Iran and Iraq.

Patrick Clawson is the author most recently of U.S. Sanctions on Iran(Emirates Centre for Strategic Studies and Research, 1997). He is indebted to Peter Daviesof British Petroleum, whose BP Statistical Review of World Energy 1997 is the source fordata cited here, unless otherwise noted. Dr. Clawson can be reached at (202) 685-2217,e-mail [email protected], or facsimile (202) 685-3866.

The Strategic Forum provides summaries of work by members and guests of the Institutefor National Strategic Studies and the National Defense University faculty. These includereports of original research, synopses of seminars and conferences,the results ofunclassified war games, and digests of remarks by distinguished speakers.

Editor in Chief - Hans Binnendijk

Editor - Jonathan W. Pierce
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