Windfall

by Meghan L. O'Sullivan

  Leveraging the New Strategic Environment

  One of the main takeaways to emerge from this book is that the new energy abundance has dramatically transformed the global strategic environment in a way that is conducive to U.S. interests. Crafting a U.S. strategy that truly maximizes the benefits accruing to the United States as a result of the boom also entails taking full advantage of the new opportunity presented by this strategic landscape. Again, the prospects here are both varied and highly consequential.

  Most importantly, the United States needs to take advantage of the additional breathing space given to it to shore up the liberal international order under which America and its partners—and many of its competitors—have prospered economically and politically. This order has been under attack and the United States has been lethargic as its defender. However, several developments related to the new energy abundance can help the United States in what should be its main foreign policy objective: fending off challenges to the order and reforming it so as to enhance its sustainability.

  For starters, the new energy abundance degrades the power of the most aggressive and influential challenger to that order, Russia. The economic difficulties from low energy prices may, counterintuitively, push Russia to be more petulant in the international arena over the short and medium terms. But the structural changes in energy markets—as much as the price—engendered by the new energy abundance make some of Russia’s traditional tools of coercion less powerful and influential.

  At the same time, the new energy abundance affects what many experts consider to be an ongoing debate within China about whether it should join forces with Russia to construct a new order in the place of that which has existed for decades. Rather than making that option appealing, the energy boom reinforces Chinese confidence in one of the key elements of the liberal international order: the market. Moreover, existing global energy governance bodies provide the United States the chance to show that international institutions can be changed and adapted to accommodate growing Chinese power; doing so is one way to make the point that China need not remake the liberal international order to get the respect and influence commensurate with its changed size and status.

  In addition, the United States needs to take advantage of the new dynamics that have emerged in the Middle East as a result of the new energy abundance. While there is no question that low energy prices place immediate—and in some places like Iraq, existential—strains on countries in the region, the news is not all bad. Particularly in the countries of the Gulf, the new energy abundance has provided policymakers a strong impetus to reform. It has pushed ruling regimes to begin the very delicate—but absolutely essential—process of renegotiating the social contracts they have with their citizens. It is far too early to conclude they will be successful in this renegotiation of reduced benefits for increased freedoms and greater transparency. Even an optimist might be hesitant to bet on such an outcome. But the new energy abundance, in combination with the volatile politics that surfaced in the region during the revolutions in Arab republics, has forced these issues to the fore. What is hopeful is that these countries, and the royal families who rule them, are taking the initiative while they still have sufficient time and the immense wealth to provide some room for maneuver in what will inevitably be a very difficult renegotiation.

  When it comes to the Gulf states, and Saudi Arabia in particular, the United States needs to see the situation for what it is: a struggle against time and culture to reform economies and societies before the only options become revolution or greater repression. The United States, and others in the region and throughout the world, have a huge stake in these reform efforts succeeding. Ultimately, success or failure falls on the shoulders of the people in those countries. The United States cannot micromanage the desired outcome. But it should maximize its efforts to encourage the countries to reach some critical threshold of reform. The United States should not hang back as a disinterested party, perhaps with notions about more democratic regimes coming to power if current royal families fail. In some cases, the reform efforts under way do essentially amount to a renegotiation of the long-standing social contracts between ruling families and the people of their countries. The United States should feel very comfortable in supporting such efforts. Many Arabs, looking at Iraq and other countries striving for democracy in the region, may not press for immediate elections as part of the renegotiation. But they will almost certainly push for less corruption, greater transparency, and more scope for civil society. These measures can all coexist within a monarchy. Eventually, they can also serve as the foundation for even greater political liberalization.

  A third realm in which the energy boom has created new strategic opportunities for the United States relates to greater U.S.-Sino cooperation. These energy-induced openings are of particular value, given the importance of this bilateral relationship and its overall brittleness. For the decade ahead, the relationship between the United States and China will be filled with tensions, as the two powers seek to avoid the so-called Thucydides trap, which suggests that rising and declining powers are almost always bound to clash. While the new energy abundance will not erase many points of friction, it does present the United States and China tangible and meaningful areas of cooperation. The two most obvious opportunities are efforts to tackle climate change and to stabilize the Middle East. Both are challenges of immense proportion, whose outcomes will reverberate throughout the globe. In both arenas—unlike the South China Sea—the United States and China have similar interests, but lack the ability to solve the problems unilaterally. Ideally, these two issues can be a foundation upon which relationships can be built and frameworks created that provide models for bilateral cooperation in other spheres.

  Fourth, the new energy abundance has created a fissure in the relationship between China and Russia and, in doing so, provides the United States with the opportunity to ensure that these two countries do not forge a strategic partnership that could be detrimental to U.S. interests. Before the energy boom transformed global markets, China’s burgeoning energy demand and Russia’s vast energy resources seemed finally poised to bring the two countries closer together. Despite their long history of suspicion and mistrust, energy realities were driving Beijing and Moscow to mend fences and build closer ties. The shift from energy scarcity to energy abundance—although not the only factor that matters in explaining this bilateral relationship—has challenged that trend. Now entertaining numerous options for meeting its energy demands, China is no longer dependent on Russia for its future economic prosperity. Yet Russia is more reliant on China than ever before, as a low price environment (as well as sanctions) calls into question Russia’s ability to find new markets. While the two countries are still working closely together, given the disparities, the rapprochement will now occur on China’s terms, rather than as an outgrowth of mutual interdependence. Given these realities, the United States could sit back and delight in the irritants emerging in the relationship. Or it could—and should—be more proactive and use this wrinkle in the deepening of relations between Beijing and Moscow to convince China that its broader interests should take it closer to the West.

  Finally, the United States should continue to support European efforts to inoculate the union against Russian intimidation and aggression through the political use of its energy trade. America should have modest expectations that it will be able to change the negative trajectory of European shale development. Absent a dramatic technological advance that addresses European environmental considerations, Europe as a whole looks unlikely to embrace its own unconventional resources. Nevertheless, the United States can look for ways to support Europe in its efforts to create a new energy union and further integrate the energy sectors of individual member states. A united Europe—in terms of energy as well as other matters—is a stronger ally and is therefore more in the interests of the United States than a divided one. The energy boom—in conjunction with new security realities in the wake of R
ussia’s annexation of Crimea—has helped create what decades of U.S. diplomacy failed to achieve: a Europe more independent from Russia.

  Anticipating New Challenges

  Despite the many ways in which the new energy abundance has strengthened sources of American power and created a new, more friendly strategic landscape for the United States, U.S. policymakers cannot be complacent about the future. As is the case with any big strategic shift, some bad will inevitably come with the good. American leaders would be remiss in not anticipating these negative developments and how the United States can manage or resolve them.

  Some of the negative geopolitical dimensions of the energy boom—from a U.S. perspective—are already on display. The most evident is Russia’s new petulance, which will continue. The new energy realities have created real hardships for the Russian economy, but have not yet spurred political change or economic reform. While energy prices will stabilize, they will very likely remain well short of what Russia needs to generate real growth, particularly in an economy so rife with corruption. In this situation, Putin will continue to shore up his political standing—and protect his inner circle—by delivering psychological benefits to his people in place of economic ones. Such benefits are most easily generated by reasserting Russia as a global power, challenging the United States, and seeking to divide Europe. As a result, U.S. policymakers should be prepared for continued Russian meddling—and need to be realistic about the extent to which there is a real basis for closer U.S.-Russian cooperation.

  Second, policymakers should look at the globe and anticipate the collapse of some states that are heavily reliant on oil and gas revenues. Whereas the countries of the Gulf have taken responsibility for addressing their dire situations, not all countries have either the resources or the leadership to manage this difficult state of affairs. Countries such as Venezuela and Nigeria pose obvious threats, not just to their own people, but to the regions in which they reside given their size and clout.

  Finally, U.S. policymakers might do well to keep another, more long-term possibility on their radar—and that is a Middle East that grows in global importance, rather than diminishes, as the new energy abundance continues to unfold. As discussed earlier in this book, a world that uses less oil for any reason is also a world of cheap oil. But it is also a world where high cost producers are squeezed out of the market and the locus of production settles on countries which can produce the most oil for the lowest price: the countries of the Middle East and the Gulf in particular. In these circumstances, Middle Eastern stability will be ever more important, making today’s efforts to steady that part of the world good investments in tomorrow.

  Policy Prescriptions for All

  Even though much of the increased oil and gas production comes from North America, other countries are also affected by the strategic environment generated by the boom and must therefore think strategically about how to react to it. Some needed policy modifications are as obvious as they are unlikely. Russia’s economy and energy sector practically scream out for reform if they are to become competitive in the new energy landscape. Moreover, Russia will continue to struggle to develop expensive LNG projects as long as its foreign policy endeavors lead the United States, Europe, and other countries to keep sanctions in place. While President Putin may have other, more immediate objectives behind his provocative foreign policy behavior, he is engaged in a vicious cycle in which economic duress requires confrontation abroad, which invites more economic pain at home.

  For other countries, the steps that would best suit their economies and their pursuit of prosperity are more easily adopted. In Africa and Latin America, resource-wealthy countries should follow the example of Mexico and adapt their investment frameworks to the new reality in which potential foreign investors have a multitude of places to invest—and less capital to make those investments. The days that Steve Coll wrote about in his 2012 book on ExxonMobil, Private Empire, are already gone; the phrase “the end of easy oil” is no longer bantered about. Even when prices rise further, investors will have a greater number of options for where to plow their dollars, including the United States. African and Latin American countries should therefore not assume that international companies are hungry to develop their resources regardless of the terms offered and the risks that must be incurred. They will need to offer more competitive terms and more ironclad assurances that those terms will not change. And they will also need to increase transparency within their own systems and—perhaps most important—manage their politics and the inevitable pressures of resources nationalism.

  The countries of the Middle East face a different set of challenges. Some might move toward inviting in foreign investment to help develop more difficult-to-access oil and gas. For the Gulf countries in particular, this would be a significant departure from past practice, and over the longer term they have more pressing priorities. First, as discussed, they face the urgent and complicated task of renegotiating their social contracts—a task that many have already begun. Second, as some leaders have started to appreciate, they must navigate a world in which their most precious resources—oil and gas—become less valuable over time. Eventually, technology and politics will bend the demand curve for oil downward. Preparing a resource-dependent country for this reality, in the Middle East or elsewhere, requires a multi-tiered strategy. Even in countries where the resistance to the idea of peak oil demand (as opposed to peak oil supply) is still strong, leaders should go through the exercise of asking themselves how their short-, medium-, and long-term national strategies for development would differ if they assumed declining demand in the out years. Doing this will, at the very least, sensitize them and their systems to other possible trajectories—and encourage them to take a hard look at the strategies they have currently in place. Ideally, such plans would be resilient in the face of a variety of scenarios for the future, including one of declining demand for oil.

  The “risk” that China runs is of a very different variety. As with the United States, China may not take full advantage of the many opportunities the energy boom presents it. To begin with, the new energy abundance is just one reason why China should reevaluate the approaches it has taken toward the development of resources beyond its own borders. While China will continue to have cause to invest in and purchase oil and gas from abroad, there is less need for it to adhere to the model it executed in previous decades in which Chinese entities overpaid for equity investments and, in propping up often nefarious regimes, incurred the condemnation of the international community. The new energy realities give China the space to reevaluate and adjust this going-out strategy in a way that removes many of its downsides, but still allows China to reap the benefits of its upsides.

  Even more importantly, the new oil and gas realities provide China huge opportunities at home to tackle the politically and physically toxic environmental issues facing the country. As discussed, even the most sanguine projections for China’s future still have the country heavily dependent on coal. Natural gas, which is cleaner—generating approximately half of coal’s carbon emissions—could allow China to clean up its environment without sacrificing the economic growth that is so important to the legitimacy of Communist Party rule. Today, China does not appear to be on track to fully exploit the advantages of natural gas. This is the case as China, despite some efforts, has been unable to create adequate demand for natural gas because—even after pricing reforms—it remains nearly three times as expensive as coal when used to generate electricity. Policy can influence the relative attractiveness of fuel sources, but it is obviously important to do this without jeopardizing economic growth too greatly. Here again the energy abundance offers new possibilities to China. When the price of natural gas was north of $15 per mmbtu in Asia (as it was in 2012), making natural gas competitive with coal would have required radical policy interventions—such as placing an unrealistically high price on carbon. But with the price of natural gas sliced dramatically by the energy boom, policy nudges
such as liberalizing end-user prices, encouraging competition in natural gas production and distribution, and allocating more resources to investment in natural gas infrastructure are more practical, more affordable, and politically feasible.

  Asia as a whole should also translate this era of energy abundance into more lasting gains. While each country will have individual priorities, the region collectively should use this period of abundance to undertake institutional and market changes that will serve it well in any energy environment. Already, efforts are afoot—in Singapore, Japan, and China—to develop regional natural gas hubs where the purchase and sale of natural gas can be more fluid and more closely tied to the forces of supply and demand, continuing the move away from oil-indexed contracts.

  How Could This Book Be Wrong?

  When he was chairman of the National Intelligence Council, Joe Nye (now my colleague at Harvard’s Kennedy School) always ended meetings by asking: “How could we be wrong?” The future anticipated in this book is not inevitable. The new energy abundance could be, for example, shorter lived or less consequential than this book expects. Here are five possible developments that either independently or collectively could deliver a very different energy future from that presented in these pages.