Petro-Nationalism: The Futile Search for Oil Security.

• Author: Griffin, James M.

"The world oil market, like the world ocean, is one great pool." --M.A. Adelman I. INTRODUCTION

Petro-nationalism is alive and well, manifesting itself both by oil consuming as well as oil producing countries. (1) Unfortunately, for oil security the implications of Adelman's "great pool" or bathtub analogy (2) are still not well-understood. Since the 1970s, we have been accustomed to seeing the major oil producing countries pursue petro-nationalist policies. The Arab oil embargo of 1973 signaled the willingness of oil producing nations to use oil as an instrument to achieve international political objectives. As recent events reveal, petro-nationalism is not the sole province of oil producing states. With China joining the U.S. and the E.U. as voracious oil importers, this paper focuses on a new form of petro-nationalism--by oil consuming countries. For China, petro-nationalism has involved circumventing market institutions in a variety of ways to enhance its own oil security. It has meant forging strategic bilateral agreements with oil producing states, like Iran, to lock-up oil supplies in exchange for political alliances. As described by Alves (2013), state owned Chinese banks have been active lenders in infrastructure-for-oil in Angola, Ghana, and South Sudan with China receiving a guaranteed long term oil supply. Yet another manifestation is China's dispatching its state-owned oil companies abroad in search of oil supplies that they can, in turn, control. Furthermore, China's unwillingness to allow its domestic oil prices to fluctuate with world prices signals that it would be unwilling to allow prices to rise in the event of a supply disruption and thereby share in worldwide conservation. Implicit in such actions is the belief that markets fail (or might fail in the future) to provide energy security--the assured access to fuel at a reasonable cost. (3)

Even U.S. policy has not been immune from petro-nationalist tendencies. In 2005, when the Chinese National Offshore Oil Company (CNOC) attempted to purchase Unocal, a relatively small American oil company, a firestorm of Congressional denunciations erupted and Unocal's fate was decided as a matter of vital national security. (4) Then in 2007, the U.S. embarked on an ambitious program to expand biofuel production under the Energy Independence and Security Act. Even more recently, fracking has led to an excess supply of light sweet crudes particularly suited for European and Asian refineries. Nevertheless, U.S. policy makers have been reticent to relax oil and natural gas export controls enacted in the 1970's even though they violate WTO rules. With prospects that the U.S. and Canada combined may become "oil independent," raises the question of how the U.S. might respond in the event of a severe oil disruption.

This paper takes the contrarian viewpoint that petro-nationalist oil security policies are likely to be ineffectual, very costly, and politically destabilizing internationally. Because of the bathtub, oil security is a public goods problem with a worldwide scope (Kapstein (1990)). Thus cooperative solutions are essential. Particularly troublesome are consuming country actions, such as bilateral supply agreements and efforts to achieve oil autarky, which aim specifically at achieving a political or economic advantage vis-a-vis other oil consuming nations. These misguided actions are likely to trigger politically destabilizing oil resource competition among major oil consuming nations.

Section II provides a description of the two key premises underlying the petro-nationalist mindset. Specifically, the two key premises are: (1) the long run supply of oil is fixed immutably with no close substitutes; and (2) oil markets either are or would become regionally fragmented into a series of regional wash basins. Given these two premises, bilateral oil deals and oil autarky are seen as logical policies. However, as shown in Section III, these premises rest on fallacious assumptions. The bathtub analogy turns the policy prescriptions on their heads. Section IV examines the implications of the bathtub analogy in a simple stylized model with two oil producing countries and two oil consuming countries to reveal the consequences of the two petro-nationalist policies. Section V outlines workable policy actions that would genuinely enhance security without heightening international tensions. Section VI explores the ability of Realist International Relations Theory to explain the popularity of petro-nationalism. Section VII summarizes the key findings.

2. THE TWO KEY PREMISES UNDERLYING THE PETRO-NATIONALIST MINDSET FOR OIL CONSUMING COUNTRIES

   1. Overview

      The petro-nationalist mindset rests on two premises. The first premise is that there exists a fixed, immutable supply of oil that will someday be exhausted with no reasonably priced substitute available. Based on this premise, oil consuming nations should either: (a) seek to lock up long-term reserves of oil through bilateral agreements with oil producing countries; or (b) use their state owned oil companies in an attempt to discover and control reserves either domestic or foreign. The second premise is that oil markets either are, or will become, regionally fragmented--a belief perpetuated by experiences from World War II. Both of these premises are either false, or might exist only in unusual circumstances.

   2. The Fixed, Immutable Supply Premise

      A common misconception is to equate the physical fact that the earth contains a fixed quantity of oil trapped in the earth's crust with the economic conclusion that the amount of future oil production is also immutably fixed. Accordingly, once such supplies are depleted, there will be no close oil substitutes available at reasonable costs. Obviously, if this were true, a petro-nationalist strategy of locking-up oil reserves would have great strategic as well as economic value. For example, any state with access to low cost oil and an economy with a predominantly industrial base will likely experience more rapid economic growth. In turn, this growth would enable it to achieve great power status and surpass other states without access to low cost oil. In this sense, access to oil supplies has both a short-term (via supply disruptions avoided) and a long-term security dimension (via avoidance of losing a unique input). In the event of a short-run supply disruption, access to cheap supplies would enable the state's economy to avoid the typical recession that most industrialized economies experienced during the 1973-74, 1979-80, and 2007-2008 oil price shocks. Looking long-term, when other industrialized countries have exhausted available oil supplies and are forced to buy much higher cost oil substitutes, access to low cost oil would enable such a state to have a strategic power advantage vis-a-vis others.

      Empirical support for the fixed immutable supply hypothesis dates back to M. King Hubbert (1956), who argued that oil production in a region follows a bell-shaped curve that peaks and then declines immutably. By fitting such a curve to historical production rates, some researchers thought that the point of peak production could be predicted ex ante. Implicit in this approach is the notion that geology is the sole determinant of ultimately recoverable reserves so that nothing could be done to extend or delay the point of peak oil. Support for the Hubbert curve analysis stems from his highly accurate prediction that oil production in the United States' lower 48-eight states would peak around 1970. (5) Less attention is given to the facts that his prediction that U.S. natural gas production in 2000 was 65% too low, or that his forecast of world oil production in 2000 was low by 50%. (6) Modern day disciples of Hubbert include Simmons (2005), Campbell (2005), and Campbell and Laherrere (1998). The latter offer an extensive menu of estimates of ultimate recoverable reserves by country. These estimates tend to be pessimistic, predicting that peak production is imminent and that subsequent production will decline rapidly thereafter.

   3. The Regional Wash Basins Premise

      The other key premise of the petro-nationalist mindset is the idea that oil markets either are or would disintegrate into regional wash basins. With regional wash basins, we would observe structurally fragmented trading patterns that allow prices to differ substantially across countries or regions. To be sure, this premise of regionally fragmented oil markets is grounded in history. During World War II, world oil markets were bifurcated into two areas--Axis and Allied controlled--with the latter having access to bountiful supplies from the U.S. and Latin America. One can think of a fence dividing the two areas. The prices of petroleum were very different on both sides of the fence. In 1944, U.S. oil prices were $1.21 per barrel or $12.87 per barrel in inflation adjusted 2013 dollars. Germany, on the other hand, was forced to produce much higher cost gasoline from coal in one of the early commercial applications of the Bergius hydrogenation process. (7) After losing access to U.S. oil imports, Japan had to rely on increasingly unreliable oil supplies from the East Indies. In sum, crude oil supplies were vastly different on both sides. Daniel Yergin argues in The Prize that the abundance of Allied petroleum supplies was a major reason the Allies won the war. (8) He cites Lord Curzon's famous remark that "the Allies floated to victory on a sea of oil."

      Since World War II, oil supply disruptions have occurred with considerable frequency. As Gholz and Press (2010) point out, subsequent oil disruptions have occurred for the following three reasons: (1) natural disasters, like hurricanes Katrina and Rita; (2) internal instability within a major exporting industry, such as the Iranian Revolution of 1978-79 or the oil field strikes in Venezuela in 2002-2003; or (3) the military conquest of one oil producing country...