Double-Edged Peace Pipes

Chastising Russia over its gas dispute with the Ukraine, Condoleezza Rice recently stated that Russia must "play by the rules." Certainly not economic rules – these would have justified Russia abolishing its hefty subsidy altogether on Ukrainian gas shipments and allowed the $50 Ukrainian price (per 1,000 cubic meters) to rise to the $240 European level. And although Russia and the Ukraine reached a $95 compromise deal that is continuing to rock Ukrainian politics, the incident brought into focus the true source of power and the object of national security for most countries – the supply of energy.

Fifteen years after the fall of the Soviet Union and the caving of its oil export market, Russia has emerged as the world’s foremost energy player, ranking a close second to Saudi Arabia in petroleum exports and first in natural gas, exporting twice as much per year as its nearest rival Canada. Because natural gas is still largely a pipeline phenomenon, Russia’s position as Europe’s primary gas supplier (between 25 and 100 percent) gives it a significant policy club over the region, made even more forceful since Gazprom, the monopoly gas provider, acquired Sibneft – a major Russian oil producer. The dismemberment of Yukos Oil further strengthened the clout of the Kremlin. In about a decade since the ruble’s collapse, Russia has reversed its trade deficit to a $28 billion surplus, thanks to its energy exports.

Oil and gas extraction, like mineral extraction, has followed a predictable path – cheapest first, meaning that the easy pickings are over. Since the ongoing Iraq war has proved outright expropriation to be a costly proposition, the next policy phase of American energy security will be the rush to develop and build pipelines originating in the remaining, mostly landlocked energy centers and route them westward. These centers are primarily at Russia’s doorstep and sit near its ravenous southern neighbor China. They are also where the U.S. fomented a series of "regime changes" with the mild approval of the American public, which, largely unaware of the region’s wealth, viewed these events as "democratic" victories. According to the Cheney energy report of 2001, the Caspian Sea basin (the nexus of this region) holds the greatest untapped oil reserves after the Persian Gulf. Kazakhstan, a country four times the size of Texas that just held “elections,” is the region’s hub, promising to deliver both east and west. Iran, which rims the southern Caspian shore, is under economic sanctions and off limits to U.S. investment.

Transcontinental pipelines raise the complexity and costs of energy extraction and delivery to new levels. The construction process is arduous, and host countries demand transit rents from consortium members. Many of these rent agreements are opaque, often involving "in kind" payments. Ukraine’s gas pipeline system, structured as such (and prone to graft), is cited as a reason for the abysmal level of foreign direct investment (1.72 percent of GDP in 2003) despite the country’s abundant energy and mineral wealth. Pipelines are also prone to sabotage – the recently completed Baku-Tbilisi-Ceyhan oil pipeline (BTC) traverses three risky countries aided by U.S. troop deployment and curves around the Kurdish area of western Turkey, where ethnic war raged for a decade.

The New Matrix

As the geopolitical strategies and alliances of the 1990s dissolve, they are rapidly reconfiguring around a new energy matrix. Shaped by dwindling supplies and burgeoning demand centers, this matrix amplifies the tug of war among producers and end users to establish West vs. East pipelines. The two corridors differ not just in direction but in kind. Eastern-directed pipelines such as one contemplated by Kazakhstan would feed exclusively into China, now the world’s second largest energy consumer. Western pipelines would flow to ports (e.g., the Turkish port Ceyhan, or the Russian port Primorsk) open to world trade. The remaining deals, however, are declining. Iran, for example, second to Russia in gas reserves, has agreed to gas pipeline construction and multi-billion-dollar delivery agreements to both India and China.

Although television news channels tout crude oil as a globally traded commodity, its quoted price per barrel increasingly reflects the residual quantity available at a particular port terminal (for example, the Brent Sea Crude Oil futures contract approximates the price of the region’s oil loaded onto vessel) and not the captive supplies streaming through pipelines into emerging economies. As for the global gas trade, it is still in its infancy and suffers from fragmentation. Shipment by vessel requires cooling and condensing it by a factor of 600 (liquefied natural gas, or LNG), then reheating the product at the receiving end. LNG comprises only a fraction of gas shipments (the primary trade of LNG involves shipment from Indonesia to Japan), and most Western countries, including the U.S., lack re-liquefaction capacity.

Once pipelines for gas or oil are constructed and long-term contracts negotiated, the supplies running through them can be fixed for years. Only strong market signals can divert their flow via the construction of alternative pipelines, given the billions of investment dollars involved and the years needed for completion. Because energy shipment is also prone to disruption – witness Nigeria’s recent declaration of force majeure – Western energy security will increasingly depend on reliable petro-state partners and/or stable countries experiencing a low rate of sabotage. The most recent furor over Tehran’s nuclear ambitions has prompted consideration of rerouting the Saudi Peninsula’s pipelines westward – out of the Persian Gulf and away from the Straits of Hormuz.

The current scramble to secure energy just might be setting the final stage of the Great Game. The growing ties among Russia, China, and Iran – which some deem the new triangle – will increasingly task the West in accessing the remaining energy supplies, despite its grand plan to integrate pariah countries into an investment-friendly international neighborhood. The U.S., in particular, has blundered by conflating military might with real power – the latter measured more and more by quantifiable energy reserves, or in the case of China, monetary reserves available for energy purchase. The U.S. has also stubbed its toe with its sanctions policy on Iran. Sanctions, of dubious value in a unilateral world, are self-defeating in a multilateral one. Mideast/Asian/Russian investment transactions have never been more entwined. By replacing hostilities with peaceful commercial relations, the region has further marginalized the West.

Delusions of Self-Sufficiency

Thirty-five years ago, a war-ravaged U.S. Treasury forced the Nixon administration to halt debt repayment in dollars backed by gold, an event that cascaded into a dollar free fall, the Bretton Woods currency system collapse, rampant inflation, and wage and price controls. When the Arab oil embargo sent the price of crude petroleum from $3.00/bl to $11.00/bl almost overnight, Nixon’s Secretary of State Henry Kissinger proposed a radical new program, "Project Independence," which endeavored to achieve oil self-sufficiency by 1980. Given the dislocation between the U.S. and world energy supplies, it’s been a pipe dream all along. The quest for fossil fuel, however, is genuine and producing seismic political realignments. Pipelines, as they increasingly channel the world’s remaining energy flows, will likely determine the victors and losers in the final Great Game match for decades to come.


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