I started earlier this week a series about what it means to "control" oil. I have put up two diaries already (see links below) about what it means in general to "control" oil and how prices are set. This new diary looks at the question of security of supply for an importing country like the US:
- Military force
- Boycotts and their dynamics
- Client States
Don't hesitate to bring up questions if there are topics that you'd like to see covered.
Previously:
The global fight for the control of oil
The global fight for the control of oil (II) - oil prices
Security and reliability of the supply of such a vital commodity as oil are obviously very important goals. But, oil markets are extremely liquid and, unless you are in a serious crisis situation (war, boycott), you will ALWAYS be able to purchase oil in the market at the current price. Conversely, it is also extremely unusual for any player in the market (especially the suppliers) to lock themselves in exclusive arrangements with a single (or a restricted number of) party. Long term supply and purchase contracts do exist, but they usually include some flexibility and, pretty much always, a reference to market prices. In some cases, you will see oil provided by one country to another at below-market conditions (see for instance Chavez's Venezuela providing supplies to Cuba), but this is a way to provide aid in kind and it has no impact on the overall market - and the recipient cannot be said to have "control" of that supply in any sense.
Military power
In times of crisis, security of supply becomes a completely different question. Crisis means that the world oil market effectively breaks down and that it becomes impossible to find the requisite oil at any price.
In the case of war, what will matter is physical control of the production assets and of the supply lines for sufficient volumes for your country and possibly your allies. Fields must be secured, pipelines must be secured, oil terminals and sea lanes must be secured, etc... The history of the past century, and especially the two World Wars, show that this is an essential part of any major war, and it requires the investment of very large military assets. (See "The Prize", by Daniel Yergin, for instance, for a detailed description of the role of oil throughout the 20th century wars). In such a context, pure military might, and military control of the relevant areas, is most relevant.
This means, obviously, that in times of piece, the availability of such military might is a deterrent against any potential foe who would have its own oil supplies secured, or that would attempt to capture the oil assets as a preemptive aggression. If you rely on exports, it is therefore inevitable that you will require the ability to project significant military forces to avoid war or a crisis (or have allies that have such capacity...).
Thus (among other reasons) the global reach of the US Navy, to protect shipping lanes and to project immediate air and sea power in sensitive areas; thus the French forces pre-positioned throughout oil-producing countries in Western Africa; thus the military alliances and treaties with oil producing countries.
The mere possibility of war thus justifies a significant level of military spending and diplomatic efforts, to prevent any vulnerability during any eventual war.
(This also means that a part of military spending should be incorporated in the cost of imported oil. This is the simplest justification for an oil tax in any oil-importing country, and it is also a strong argument to avoid selling arms to other oil importers or oil producing countries, unless you have good reason to trust them. We'll get to that).
Boycotts
A boycott can only be organized by an entity that controls a large enough portion of overall production to create a real overall shortage. The oil market being very liquid, this means that the production cut must be bigger than any reduction in short term demand that can be tolerated by the importers, or compensated for by a simple price increase (even if large); thus leading to actual shortages. The "natural" suspect for a boycott in the oil market is OPEC; indeed, they gained prominence when they engineered a boycott in 1973 following the war with Israel. They control a significant portion of oil production (around 50% back then, closer to 40% today) but they control an even bigger portion of known reserves, which makes their likely market power in the future even bigger.
A boycott requires strong discipline by the cartel members against free-riders (if anyone reduces its production, the price increases and the temptation for others to fill the void also increases). It also requires that the boycotters be able to do without the corresponding revenues while the boycott lasts, and that they also be able to withstand the diplomatic consequences of their position viz. the importing countries that face the boycott.
Following the 1973 experience, Western countries have taken a number of steps to reduce the impact of a new OPEC boycott. The most important one has been to create strategic reserves allowing each country to go at least 3 months without any exports. This ensures that any boycott has to be sustained for a considerable period of time, thus leaving room for diplomacy or other measures without having to face the immediate pressure that shortages generate.
The other step taken by many countries was to try and reduce their oil consumption by developing alternatives or substitutes. Energy savings were encouraged; nuclear or coal-fired plants were built to replace fuel power plants. Obviously, such measures take more time to implement and cannot do much in the short term against a boycott. However, in the long run they are quite effective, and Europe's oil consumption is still lower today than it was 30 years ago. (In the US, the 1979 level was reached again in 1998 only). By reducing overall demand, they tilt the market balance back in favour of the buyers and thus limit the immediate impact of a new boycott. Higher oil prices caused by the boycott also encouraged the development of more expensive oil fields that were not under the control of the boycotting countries (such as the North Sea, the Gulf of Mexico or the Gulf of Guinea in Africa), thus also influencing in the buyers' favor the oil market balance.
Indeed, it can be argued that the West's energy policies were too successful: oil prices have been going down steadily in real terms (and even in absolute terms), and by 1999 they were close to their lowest levels ever (in real terms). This has led to people stopping to worry about energy and consuming it once again with abandon (the SUV craze in the US being the most obvious phenomenon. Europe has been protected to a certain extent by the fact that gas prices have never gone down thanks to steadily increasing tax levels, but its gas prices are still close to 30-year lows in real terms).
Of course, a boycott is a highly aggressive act and any boycotter can expect a vigorous reaction from the countries that suffer from such an act. The US being both the largest importer and the main military power around the world, they can be expected to be in the lead of any counter-offensive, which is likely to include diplomatic pressure, trade or financial sanctions (oil being traded in dollars, all the oil exporters' funds and financial assets are for a large part effectively managed in NY) and military action.
In the short term, it is not clear today who would "win" a tug-of-war brought by an OPEC boycott - it would depend on the political objective of such a boycott, and on whose side time would be (disruption caused by oil penury more or less compensated by reserves management on one side; disruption caused by lack of revenues, of imports and threat of an attack on the other). If the objective of the boycott is to increase prices and capture revenues, a short show of force might be sufficient and would not necessarily degenerate into a major crisis; if there is a political issue at stake, it is much harder to predict. Having engaged the guilty countries, created links, mutual interests and co-dependencies appears to be the surest way to have some way to reach to these countries.
In any case, it appears that the capabilities of each side in the worst outcome (war) will have an impact on what happens in the short term, as rational players (and leaders of countries are usually assumed to be so) will not engage in games of brinkmanship they cannot expect to win. Therefore the military might of the USA can be expected to be the ultimate arbiter of a long crisis and can be argued to give them ultimate control over oil resources - at a cost which should be made explicit to its taxpayers. In a shorter crisis, other factors will play, such as domestic politics (and tolerance for shortages or higher prices), diplomatic leverage. Here, it can be argued that the US have weakened their position by having both a population with very limited tolerance for any kind of restriction or price increase on gas, and less goodwill in the world than in the past.
Altogether, security of supply for any importing country does not depend on short or medium term relationships with any given oil producer for access to its oil, but rather in its ability to deal with a crisis, by being ready to live with reduced supplies at home for a long enough period, and to react to any crisis by having leverage on the guilty party. Military might, strong trade or political ties can work. Policies to reduce oil consumption reduce the "target profile". Cost-benefit analysis here likely shows that energy savings are cheaper than aircraft carriers.
Client States
So, does it make sense to have "client states" or to protect corrupt regimes in oil producing countries? Friendly regimes are less likely to be involved in a boycott; they are also more likely to be on your side (and/or to request your help/protection) in a case of conflict ; if they depend on you for weapons or other important imports, they will also be unlikely to seek conflict. On the other hand, if the relationship favors only a regime which is cut off from its population, the danger is that you will be seen as an enemy by that population, and should that regime fall, it might suddenly become a lot more hostile. Iran and Venezuela are examples of corrupt regimes supported by the US which switched to being quite hostile (and regularly make noise about disrupting oil supplies, although in practice they rarely do).
It must be noted however that hostile countries are quite often reliable trade partners, even for strategic commodities such as oil. Both Iran and Venezuela continued to export oil after the regime change, but they have been quite active - and quite effective - in trying to get prices up. The Soviet Union (and then Russia) was a reliable exporter of natural gas for many years since the 70s and that trade relationship was never a source of tension between the West and Russia although it was one between the US and Europe...
Venezuela is widely seen as being part of the US sphere of influence, so its hostility is mostly irrelevant: if there is no major crisis, it will export its oil ; it there is a major crisis, the US has the ability, if necessary by force, to do whatever it needs to ensure that oil will keep on being exported. Domestic turmoil is another issue, as it can disrupt production to the detriment of all, importer and exporter alike. A sane policy towards any oil producing country should be to at least avoid to exacerbate domestic tensions and any rift between a regime and its population.
Iran is at the heart of a very unstable region, with many players, so friendly or hostile, it is not clear in a situation of war if its oil production could continue (military fighting, sabotage, etc...) and if produced, where it would be sent to - and if it would get there (and this is true of all Gulf states oil production). So again, the quality of the specific relationship before the crisis has actually limited impact on either "normal" or "crisis mode" availability of its oil.
