Wednesday, November 22, 2006

Energy Mercantilism on the March

Just over a year ago I wrote about the New Energy Mercantilism, the set of geopolitical phenomena emerging as nations realize that, in the future, there will not be enough energy to go around to sustain projected demand. A market-economy solves this problem by increasing the price of energy until demand inelasticity is overcome and the energy is allocated to where the market says it is most valuable. Mercantilism, rather than trying to distribute shares of the pie more efficiently, aims to lock down as large a share of the pie as possible for your own needs.

A year later, it is clear that mercantilism is on the march.

Joseph Stroupe has written a fascinating article in Asia Times Online about the rise of energy mercantilism. Specifically, he outlines the mechanism by which nations like China, Russian, and India are embracing the mercantilist approach. All three nations are rapidly moving toward an energy market dominated by long-term, bi-lateral supply contracts. This might not sound like a major change, but consider that today energy is supplied to high-liquidity trading bourses where the person willing to pay the most gets the energy. This is significant for two reasons: 1) it ensures that everyone around the world pays roughly the same price for energy (after transport costs are accounted for), and 2) it reduces the ease for deploying the "oil weapon" through an embargo because such action has very dispersed effect--holding 4 million barrels of Iranian oil per day off the free markets increases the price for everyone, forcing your enemies and allies to bear the diminished effects. Long-term, bi-lateral supply contracts (where, for example, Angola commits to supply China with 200,000 barrels per day of crude oil at $60/barrel for the next 10 years) fundamentally alter this dynamic. First, by locking in future energy prices (at quantities far higher than can be achieved on the futures exchanges), everyone will not pay the same price for oil in the future. Second, by exiting the open market through such contracts, the precsion-targeting of future oil embargos increases dramatically. Increasingly, significant portions of China and India's energy supplies are being locked into such long-term, bi-lateral contracts, as are the majority of Russian gas shipments to Western Europe. As a result, much less of the world's energy needs are being met through freely-traded market instruments. It is especially significant when we consider who remains primarily dependent on the free market for their energy supplies: the US, Western Europe, and Japan. As traditional and swing producers (who's production is expected to decline rapidly over the coming years) begin to export less oil to the open exchanges, the price impact on the "West" will be diproportionate. Similarly, the "West's" vulnerability to oil embargos will increase dramatically. Participants in bi-lateral agreements will not be exposed to the same risks to their supplies--they can always resort to the market exchanges to make up for shortfalls (though at higher prices), but the reverse is not true--the "West" cannot quickly resort to bi-lateral agreements to guarantee supplies in times of crisis.

Long-term, bi-lateral agreements also remove energy supplies from dollar-denominated exchanges far more effectively than does opening a non-dollar-denominated exchange. Russian supply contracts to Europe are already non-dollar denominated, even though Russia's ruble-denominated exchange is not yet in full operation. China pays in yuan for oil from Africa--which doesn't harm the petrodollar system for now, as long as that currency remains pegged to the dollar. But the tipping point when domestic Chinese consumption becomes the prime driver of their economy is fast approaching, and at that point the benefits of maintaining the dollar peg will have evaporated.

Peak oil, when it hits world markets with full force in an unknown number of years, will only exacerbate this trend. I'm not so sure about freedom, but energy mercantilism is definitely on the march.

14 comments:

Anonymous said...

I'm probably just stating the obvious, but merchantalism is just a set-up for the follow on military conflicts. We get a preview of the players and thier various alyances. We can guess at thier strategies.

Duck and run for cover.

Dave

adam f said...

Thanks for another great article Jeff.

I'm just stating the obvious also, but demand destruction and 'efficient' distribution of remaining energy to where the market considers it most valuable is not going to be pretty or fair.

By 'efficient' I guess you mean there's less negotiation involved, a relatively simple and transparent mechanism for deciding where the oil goes(?) A couple of points.

1. In terms of efficiency of distribution, the overheads which come from the negotiations and bureaucracy of mercantilism might be judged against the overhead of the grotesquely bloated financial/speculative industries which feed off the market. They members of this class are mostly non-productive members of society who use vast amounts of resources. Considering this our current market system of distribution is terribly inefficient.

2. When the US bankers control the unit of account, savings and trade, lock nations into debt, then insist that poor nations play by the same level trading rules that's a more efficient way to extract their real wealth than military efforts, and it will be an efficient way of seeing that they get little of the remaining oil -- if the dollar hegemony system lasts that long.

I like what you've written elsewhere Jeff about the free market working extremely well if "hidden costs" of pollution, nonrenewable resource use, health etc are worked into the price, but I thought worth bringing up these other issues.

Anonymous said...

Isn't Exxon, Shell, BP, Texaco, etc. already involved in similar arrangements with governments. Couldn't they be seen as Western deals, just like the Chinese deals ? They're all out there wheeling and dealing just like the Chinese.

Jeff Vail said...

The difference lies in the Corporate nature of Exxon, Shell, etc. The corporations will sell their oil to the highest bidder, not guarantee a reasonably-priced supply to a specific country as the Indian and Chinese bilateral contracts aim to do. It is tempting to believe that in a true scarcity situation, the US oil majors would help out the US consumers, but this would be a clear violation of corporate law. Corporations owe a fiduciary duty to their shareholders to maximize returns--if Exxon sold oil to the US even though India was bidding higher, they would be the immediate subject of a derivative lawsuit from shareholders (who, remember, are increasingly globalized themselves) and would have to reverse course. This would not be a problem for China National Offshore Oil Company. Admittedly, Corporate Social Responsibility has evolved considerably since the balance between profit and charity was first analyzed in the A.P. Smith case (see A.P. Smith Mfg. Co. v. Barlow, 98 A.2d 581 (N.J. 1953)), but it certainly hasn't evolved a nationalist tinge--if anything, quite the opposite.

Adam:

I agree that our current market system of distribution is terribly inefficient. It's a lot like democracy--the absolute worst form of government in the world, except for all the others. Of course, I would add "hierarchal" into that famous quote. The vampires of financial speculation add critical liquidity and risk distribution to the marketplace. Still, I agree that it is terribly inefficient--my argument is that any hierarchal form of organization, when it grows beyond a certain size (and it seems to need to keep growing, so they all eventually get there), becomes incredibly inefficient. Which is why I support a highly decentralized, locally self-sufficient model for distribution. Unfortunately, it is not possible to just transition to such a model--I think it needs to be grown up from below to replace hierarchy as the latter becomes ossified and breaks down.

As for dollar hegemony--watching the dollar fall this morning I wonder how long that system will last. It is, of course, premature to say that it's falling apart this week, but...

SEAN said...

Resource wars. Remember ,when push comes to shove, the West will not fall over. Our trump card is?-- food! The gaunlet has already been thrown down, in case you didn't notice. Ethanol is just the tip. Remember the story of King Midas, the original mercantilist. Why do you think the EU has regulated the agricultural import market-food security after the global supply chains broke down in WW2. The new pricing paradigm is barrels/bushels. Global grain supplies are at lowest levels since 1985, and for the first time in history,globally we are now consuming more than producing. Game on. Choose your weapons.

sventastic said...

A couple of things:
First off: Diplomatic alliances.
Russia and China are the primary movers and shakers, setting up bi-lateral, long term contracts with Central Asian and Middle Eastern regimes (nearly all of which are despotic and also supported directly or indirectly by the US government).
These heretofore backwater states will soon rise to energy production preeminence.
My money is on Kazakhstan (and Uzbekistan to a lesser extent) being the big, big winners in about 10 - 15 years with their massive oil and natural gas reserves and Shanghai Cooperation Organization and other alliances that will facilitate providing fossil fuels to Russia, China, and perhaps India.
America is trapped in (basically unilateral) market-driven relationships with wahhabist regimes in Saudi Arabia and the like, which when the go sour, and they most definitely will sooner rather than later. (Remember OPEC embargoes?)
Whereas the Russians and Chinese will have a lot more leverage with (let alone proximity) to the regimes that control the vast reserves in Central Asia.

Long story short: America is screwed; hoist on our own petard of supporting tyrants and (futiley)trying to assert a permanent military posture in the region with our bases (and look how that turned out in Uzbekistan).

sean - you mention food, which, along with water is of utmost importance. Unfortunately, all of our modern agri-business farms are wholly and completely dependent on petroleum products from start to finish. There is absolutely no way to replace the existing infrastructure in time (5-10 years I'd say) before the shit really hits the fan, and then Americans won't have nearly enough food to sustain ourselves in our own country, let alone use wheat as an international bargaining chip.

Time to learn which roots and berries are edible, folks.

galacticsurfer said...

Mercantilism is the precursor for protectionism or withdraw from the GATT/USD based global UN system. It is like before WWI with a lot of alliances and interests under the surface after decades of growth and change. The Chinese and Russians mercantilistic long term contracts are neocolonialist in nature. This is similar to the German and Japanese relationship to the west before WWII. Chinese, Russians, Indians need new colonies for raw materials and markets. The west does not want its system with a lock on resources and markets through their own rule book(UN/GATT/USD reserve currency) to be disturbed, although they can break the rules when they please(Iraq invasion). The end of this will be war. USA is too far away from Eurasia to control it although this is the only way to retain global hegemony. Obviously China, Russia and India and the Arabs can work together aginst the USA and Western Europe or the "West" can try to divide and conquer them. Slowly this old tactic is not working anymore. Colonialism is being thrown off of Asia. After "the American Problem" has been solved Asia will dominate the world and if there is disagreement over who has the last say then China, Russia and India could fight it out but this could be a story for another day, maybe antoher century.

Anonymous said...

Just a couple of thoughts on all this:

The US still produces about 5 million barrels per day. Effectively, the production of Canada and Mexico can be added to this total. did someone say NAFTA?

If push comes to shove add Venezuala.

This all adds up to a lot of oil. Enough to grow a lot of food and support a fairly large military.

Petroleum infrastructure makes a pretty easy target. The US can knock out a lot of rival supply infrastructure pretty easily. It will retain this capability for the forseeable future.

To me, the US comsumer culture is toast, in the very near term. It will be easy to blame this on terroists and thereby justify all types of strikes on varios targets, e.g., Sudan's oil infrastructure, etc.

Eh, I could go on. But you get the idea, I think.

Bottom line, a real shit storm seems to be in the making.

Dave

sventastic said...

I would say that the attempts at regional hegemony and/or parity attempted by Czarist Russia and Imperial Britain during the Great Game (1800-WW2) is a bit different from the strategies and tactics employed by contemporary Russia, China, and the US in Central Asia (which I predict will be the new epicenter of the oil crisis in the near future).
I think a major lesson that is being learned by the oppressed people of Central Asia is that it is much more favorable (and profitable) to play multiple super-powers off of each other politically and economically rather than depending (or being dominated by) only one.
As can be observed by the radical cooling of relations between Russia and the US compared to the detente they enjoyed at the turn of the century, international relations will be increasingly strained as the effects of Peak Oil (and global warming) irreversibly shift the current paradigm.
Breaking points abound, and it is only a (short) matter of time until more dark angels of human aggression are loosed in this region and globally.

Georealist said...

The bilateral (as opposed to market) trading of oil might be characterized as a number of things..oil imperialism comes to mind..but it certainly isn't mercantilism. Mercantilism, in all its forms, was and is based on exporting, as opposed to importing, and with setting up favored sons in house to peddle ones products.
In any case, these arrangements end up largely in one of two ways...someone decides they aren't getting enough..or they are paying more than enough... and there is a nasty dispute (war). Or they simply can't deliver the goods...like pretending they have the long term technology for pulling oil/gas out of the ground when they don't have anything close to it...Does Russia..Iran or fill in the blank come to mind???
In fact..our current market system is very efficient.
Just ask some German whose freezing in a couple of hyears because Russia is mad again whether a bourse is better than a load of BS.

Davem said...

If we truly had free-market conditions in the US, the US would be on the gold standard (a free market in money -- of all things--).

Our government would not prohibit us from self-sufficiency in oil (or anything else); our government would not prohibit us from bi-lateral contracting; our government would not be out trying to establish a world empire. Instead, it would be protecting our legitimate interests.

Big government is dragging us downward -- rapidly!

Billy g said...

Faced with the reality that peak oil, violence in the World's oil rich areas (Especially the Persian Gulf)or both can significantly reduce supplies of conventinal oil injecting chaos into the world economy and its social and political systems, negotiation of a UN treaty establising fomulae to distribute conventional oil in times of liquid fuel shortages is at least two decades over due.

Failing to take international action that addresses oil shorages and sets quota's and distribution criteria that will mitigate the crisis and inject a fair method of sharing the pain, invites World War Three, the most popular war in history as Americans sacrifice their sons and daughters to save their SUVs.

Bill

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