Energy Security Through the Eyes of the World Energy Outlook

I had the pleasure of attending Dr. Fatih Birol’s presentation at the Canadian launch of the 2012 World Energy Outlook, the International Energy Agency’s annual analysis of the state of the global energy market. I had planned to write earlier, but the crucial factors for energy security remain quite timely.

The message of the IEA is loud and clear: the energy sector is shifting rapidly, and traditional expectations are being rapidly overtaken by events. Energy is a constant fixture in security policy, and in the next few years, the energy sector will transform in such a way that many of our existing assumptions will prove obsolete.

Rising United States

Every major economy in the world is set to increase its reliance on imports, except the United States. The rise of unconventional oil and gas technologies has been a dramatic success story for the United States. By 2017, the IEA predicts that the United States will overtake Russia as a producer of natural gas, and dethrone Saudi Arabia as the world’s largest oil producer. This will not only have major implications for the American economy, but will change how the United States looks at the regions on which it has traditionally depended for oil.

The Middle East Pivot

Middle Eastern exports of fossil fuels are in the process of a dramatic shift away from traditional markets in Europe and North America and toward India and China. OECD countries will decline to one third share of world energy use by 2035 as compared with two thirds in 1975, while China and India take the lion’s share of the difference. 90% of Middle Eastern fossil fuel exports will soon go to Asia. At the same time, American imports from the Middle East will drop to an all-time minimum as the United States develops unconventional oil sources with new extraction technologies.

Rising Iraq

Iraq has huge oil resources that were unexplored under the old regime. It has been inviting foreign investment in the energy sector, and enjoys comparative advantages that should help it to do rather well. Production costs per barrel of oil are much lower than in other countries (15 times cheaper than Russia, 13 times cheaper than the Canadian oilsands) due to a lack of geological obstacles.

Because China is the largest expanding market, it is expected that most of Iraq’s oil will go to China. Chinese investment in the country has risen accordingly, and 30% of expanding oilfields in Iraq are owned directly or indirectly by Chinese companies. One cannot help but think of the old charge that the United States went to war in Iraq to get oil. It seems that China will be the main beneficiary.

When China Coughs, the World Shakes

When China closed a series of coal mines due to unsafe working conditions last year, China’s share of imported coal rose by 2.7%. It was an unnoticeable difference domestically, but for a six-month period, global average coal prices jumped to $120 from $90. This was a taste of things to come. As China grows, it will become the lynchpin of the global energy market, and its policies and decisions will have global repercussions.

The good news is that China has invested heavily in renewable energy, so much so that it will account for almost a third of its added power generation capacity by 2035. In that time, China will have added the equivalent of the entire US and Japanese power grids to its capacity. Given such enormous expansion, any measure taken by China to reduce its call on limited resources is good news for the world. Better still, its massive investment in renewable and efficient technologies will yield global benefits as the price of these technologies drops and development costs are absorbed.

The bad news is that China is destined to depend heavily on imported fossil fuels, a situation in which neither China nor anyone else feels secure for reasons that are all too familiar to security analysts. The Chinese economy depends on oil coming through the Indian Ocean and the Malacca Strait, a strategic supply line which China is keen to protect. It also makes China all the more hungry for closer fossil fuel resources, bad news for the region as disputes over oil chains with offshore drilling potential heat up.

China currently imports about 15% of its natural gas and about 50% of its oil. By 2035, it will import more than 80% of its oil with a corresponding increase in gas. Some of this will come from overland pipelines, but much will still have to transit the Indian Ocean, and China has already begun to expand its involvement in oil-producing countries throughout the Middle East and Africa.

The Big Picture is in the Details

At the moment, world oil prices are at an all-time high, going by annual average rather than daily prices. This high, however, is not consistent. Developed economies are introducing carbon taxes, making oil more expensive to the consumer, while developing countries pour in fossil fuel subsidies. In this tug of war, carbon taxes lose, imposing a $10 cost per ton of CO2, as compared with a $110 per ton incentive from subsidies.

The IEA’s message, however, is that efficiency measures pay for themselves by reducing costs and increasing energy security. The United States’ expected shift toward energy self-sufficiency is possible not only because of new extraction technologies, but because it has been underwritten by new efficiency standards, which are reducing domestic consumption.

Natural gas prices remain indexed to oil, which in turn raises household heating and power costs as well as input costs for industry, degrading the competitiveness of the most-affected regions. This indexing may not last much longer, however, as many new countries become exporters of natural gas using unconventional extraction technologies and the market becomes more competitive.

The outlook is worst for Europe. Europe’s economic state may have much to do with energy prices, and particularly with natural gas prices, which are vastly higher than in North America or China. Still, the IEA predicts that household utility prices will continue to rise in Europe even as they fall in China and elsewhere.

Renewable energy sources will account for half of new global capacity by 2035, but the central questions are where this growth will take place and how efficient we can make our continued use of fossil fuels. 1.3 billion people in countries with high and rising populations have no access to electricity, notably in Sub-Saharan Africa and India. The pollution generated by rising economies, notably China, is already an international issue, and with the continued expansion of automobile ownership and road transportation, things will certainly get worse before they get better.

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China in the South Sea Islands: Pride Goeth (first published 7/23/12)

This article was written just before the recent announcement by China of its intention to garrison the Paracel Islands, and should be read accordingly.

When island standoffs come once every few weeks, and the grounding of Chinese frigates on disputed shoals is the expected order of the day, the question “Why the heck does anyone care?” moves to the forefront of the minds of most reasonable observers. What the Spratleys or the Paracels actually represent to China’s foreign policy from an internal perspective is a question comparatively ignored. Of course, answers of a sort to both questions are quick to hand. Resources, national prestige. But what does that really mean?

Energy

Is the CCP so worried about the vulnerability of their energy supplies, not to mention future shortfalls as development continues, that they are consciously risking the very considerable goodwill they had amassed in the past decade of Chiang Mai currency swaps, the China-ASEAN Free Trade Agreement and a carefully-strategized soft-power offensive on the geostrategic necessity of finding abundant, proximate oil and gas resources? There is reason to believe that China is deeply concerned about the vulnerability of its African oil supply to disruption en route through the Indian Ocean and the Malacca Straits. Further, the CCP has known for over a decade that it will have to dampen consumption levels and invest in sustainable technologies or risk outstripping the conceivable energy (and other) supplies available to them. However, it is quite likely that they have a few years left to go before that wall is in sight.

Prestige and Territory

East Asia is home to quite a number of ongoing territorial disputes, both maritime and continental, and China is involved in quite a few of them, yet life has somehow gone on without any hint of resolution. It could be that what China might have seen as pre-emptive actions in the region- notably Vietnam’s threat last year to grant oil concessions in the Spratleys- required a countervailing assertiveness for home consumption, and that the issue has snowballed. If this were the case, we could expect China to look for an opportunity to cool the issue down.

What Happened to the ‘Peaceful Rise’?

Why didn’t the recent ASEAN meeting show any sign of this? China wants all of these issues to be negotiated on a strictly bilateral basis. China has historically been quite careful about the limitations it might incur through multilateral commitments, and ASEAN can be said to bear much of the credit for acculturating China to the many multilateral organisations it has joined in the last decade. In the end, however, the strain of caution remains, and China may well see multilateral negotiation as a dangerous gamble particularly here, where they would have to be seen to play by ASEAN rules in the best case, and in the worst case the United States might try to muscle in, as it already has. Unfortunately, many ASEAN countries seem to have been driven beyond the point where the status quo is considered acceptable. The issue is live, and China may not be able to defuse it.

That is one interpretation. Another is that the CCP has yet again done too good a job substituting nationalism for Maoism. This has got it into trouble before. Widespread protests erupted within China in 2005 over Japan’s bid for a Security Council seat, and were immediately suppressed by an embarrassed Communist Party. It could be that popular opinion has swung through China Emergent all the way to China Triumphant. The tone of Chinese military rhetoric and building programs certainly suggests something of the kind. If so, then the secret fear of many China observers could come to pass: that a situation might develop in which the Chinese Communist Party feels that it cannot defy nationalist sentiment in the name of reason and will abandon its long policy of conflict containment in order to survive politically.

By far the worst case scenario is that the Party leadership, having decided that it cannot or will not clean up the internal corruption, political and labour scandals which have led to a constant, exponential annual increase in public protest since the 1990s, actually views these events as a useful distraction. This is the worst case, not because the Party is stirring up conflict as a distraction a la General Galtieri in the Falklands, but because if it has truly thrown in the towel and given into another generation of corruption under the Party “princelings” (and the structure of the new leadership suggests that possibility) then China surely is headed for a different kind of wall, a political wall in addition to a resource wall. It will surely take other countries with it.

The Tone of the Region is up to China

In any case, whatever the scenario we entertain, the significance of the island disputes is not in the disputes themselves- but that does not mean they are not significant. Every scenario points to the same choice. If China doesn’t find the will and the means to cool things off (and no one but China can), China may find itself crashing right through all its rhetoric of “peaceful rise” and all of its hard-won trust in the region. China can be either the nationalist bully, or the conciliatory regional power- but the choice is in play.

Afterword

When this article was first written, it concluded with the words “Hang on to your hats.” Little did it appear how apt that advice might be. The decision to garrison the Paracels comes after the installation of a municipal government for the islands’ sparse population, and announcements regarding the development of tourism and natural resources. By themselves, any of these could be seen as diplomatic manoeuvres, and the garrisoning of the islands, which were captured from South Vietnam in 1974, is not an entirely surprising extension of China’s military presence in the group. Taken together, however, all of these things indicate a disturbing assurance on the part of China that it can make a disputed island group its own simply by behaving as though it were. China either does not expect anyone to muster the force or the will to effectively contest such a policy, or wishes for such an incident in order to demonstrate the futility of any resistance to its territorial boxes.

Regardless of the military fact that China can indisputably win any conflict up to a regional war with any or all Southeast Asian countries, in either case, it is making a serious mistake. Even if everyone backs down, the results would undoubtedly polarise the region, and even if no one wanted to risk open conflict, this would be a definitive end to the friendly face of China’s rise, and the beginning of a path that might ultimately lead to a confrontation involving the United States, something that could not fail to be disastrous for everyone involved.