President Enrique Peña Nieto presented a long-awaited energy reform on 12 August that may not be as controversial as feared. There is no doubt that the issue will generate significant political noise, but in the end Mexico appears ready to make changes that even ten years ago were unthinkable. The president's proposal included rewriting portions of the constitution to allow private investment in the oil industry, changes to the national oil company Pemex, and revisions that would allow the company to retain more of its revenues. The government will also seek to open the electricity sector to private participants, though distribution and transmission would remain under state control.
Some pro-market analysts and sector participants were underwhelmed by the proposal. They feared that Peña Nieto's insistence that only profit-sharing agreements would be allowed for upstream production would shut out the two most widely used contractual arrangements in the industry (production sharing agreements and concessions), which would have provided more clarity for oil companies. But those fears may be overblown. Changing the constitution to allow private investment is by itself a major step that should provide investors with legal certainty and the government appears ready to provide attractive enough guarantees to oil companies in the secondary and implementing legislation.
Most of the political attention will be focused on changes to articles 27 and 28 of the constitution, which respectively specify how the extraction and the refining and petrochemical sectors must be structured. The government will only be able to secure the reform's approval if it has support from the center right National Action Party (PAN). The leftist Democratic Revolution Party (PRD) will not openly support any constitutional changes and will probably attempt to mobilize popular resistance to the changes. The PAN's help is needed because constitutional amendments require two-third majorities in both houses of congress as well as approval in half of the state legislatures. But once those changes are secured the government will only need a simple majority to secure approval of secondary and implementing legislation.
The PAN's price for their support, especially after having had their reform efforts stymied by the president's Institutional Revolutionary Party (PRI) during two consecutive PAN administrations, will be more political changes and perhaps more pro-market elements to the oil reform. There is a small risk the PAN would push too hard for concessions, putting the overall process in danger. That is unlikely though given that even the pro-business PAN is aware of how difficult it will be to sell these changes to the general population.
The government is going to face significant opposition from the left, though in the end it may be less than anticipated. Even Cuauhtemoc Cardenas, one the PRD's founders and the son of the president who nationalized Mexico's oil industry in late 1930s included private investment in his alternate proposal to reform Pemex. Moreover, although polls show a majority of Mexicans oppose opening the energy sector, it seems unlikely that they will mobilize against this reform because of other concerns (e.g. violence, desire for better services). And while there are still some factions in the PRI that oppose it, the party seems to have maintained its usual discipline and has supported the president. In the end, the reform is likely to be approved in congress before the end of the year.
Daniel Kerner is director with Eurasia Group's Latin America practice. Maria Jose Hernandez is an associate with the Latin America practice.
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Is Mexico finally on the verge of a historic reform push? Expectations are on the rise, and for good reason. In office just over six months, President Enrique Peña Nieto has taken steps that suggest he is serious about pushing through policy changes meant to, among other things, improve the quality of an education system that produces students who score lower than their counterparts in all other OECD countries in reading, math, and science, and to open the country's lucrative telecommunications sector, which could lower prices for millions of Mexican consumers. The government is also pushing for a state and local fiscal responsibility law intended to prevent governors and local authorities from taking on too much debt. Peña Nieto's financial reform could also help promote public access to credit. According to data from the World Bank, credit as a percentage of GDP remains at about 26 percent (in 2011), much lower than in Latin American peers like Brazil (61 percent) and Chile (71 percent).
But the highest hurdle, energy reform, has not yet been cleared.
In the past decade, Mexico's energy sector has suffered from deteriorating operational, financial, and technological capabilities, sharply lowering production for a vital source of state revenue. Production has fallen from a record 3.4 million barrels per day in 2004 to about 2.5 million today. Faced with rising pensions and health-care bills, the government's high dependency on oil revenues (around 30 percent of total revenues) is becoming increasingly worrisome.
Given the opportunities it might create and its impact on the broader economy, substantive reform of Mexico's energy sector has also captured the attention of foreign investors. In particular, Mexico may have the world's fourth-largest shale deposits, exciting intense investor interest in opportunities for private participation in both offshore and shale plays through profit-sharing agreements (possibly a variant of production-sharing agreements).
Energy reform would also offer Peña Nieto an important political victory, since he will have succeeded where so many of his predecessors have failed. Past attempts have been defeated by a populist commitment to nationalized energy that is written into the Mexican Constitution, limits on investments by state-owned oil company Pemex, the ability of state governments to grab a large share of the industry's resources, Pemex's labyrinthine bureaucracy, assertive labor unions, and politicians who were unwilling to accept the costs and risks that come with change.
The Mexican public has historically opposed the constitutional changes needed for real reform, and it's not clear that this has changed. Recent polling data suggest that 65 percent of Mexicans are aware of the so-called Pact for Mexico, the president's broader reform plan, but there is no public survey on popular attitudes toward the opening of the energy sector to private investment. Yet, this time around, Mexico's president has the demonstrated political will to bring about change, and there are enough lawmakers within his own party and the major opposition party, the National Action Party (PAN), to negotiate a substantive agreement by the end of 2013.
That said, there are a few obstacles Peña Nieto must overcome. The most underappreciated of these is the need to reform Mexico's electoral politics. In early May, the Pact for Mexico survived a challenge from opposition parties when Peña Nieto agreed to allow discussion of electoral reform before September, forcing lawmakers to debate a hotly contested issue just before they take up a crucial energy reform plan that demands goodwill and compromise.
The Mexican Congress is currently in recess, but legislators have announced that they will hold at least two extraordinary sessions in July and August to debate some bills left on the table, helping to clear the legislative calendar. But electoral reform was not included in the schedule; lawmakers are still in the process of designing it and are probably waiting until after local elections on July 7 to finish drafting their proposal.
The fight over electoral reform will sharpen the battle lines among the three major parties just as energy reform will require open negotiation among political rivals. Some opposition factions want a reform that not only increases transparency in the use of campaign funds, but that also includes major changes to the electoral and political systems. Senators from opposition parties -- the PAN and the Democratic Revolutionary Party (PRD) -- want to introduce a second round in presidential elections and reelection of legislators and mayors, as well as introduce coalition government and chief of cabinet, probably as a way of extracting concessions in exchange for support. A large segment of the ruling Institutional Revolutionary Party (PRI) has long opposed these proposals for fear that a second round would enable the PAN and PRD to organize resistance to a PRI candidate and that an end to term limits for lawmakers and mayors would make it more difficult for the party to enforce discipline among its members. In addition, a system that provides more power for parliament could heighten the risk of gridlock at a crucial moment for reform. As a result, the government is unlikely to accept all these demands.
In the end, if the government is as serious as it appears on energy reform, it will have to compromise on electoral reform. Peña Nieto remains committed to keeping things on track, and he will probably cede some ground on the electoral front.
That's why odds of success on energy reform remain good, but the next few months will test the new president's political skills.
Maria Jose Hernandez is an analyst in Eurasia Group's Latin America practice.
ALFREDO ESTRELLA/AFP/Getty Images
As we wrote last August, some governments are watching political developments in Venezuela more closely -- and with more anxiety -- than others. For the past decade, that country's Petrocaribe program has helped 18 Central American and Caribbean leaders avoid the kinds of tough economic choices that sometimes drive angry citizens into the streets -- and helped Hugo Chávez extend his regional influence. Each of these countries has benefited from concessional financing schemes for their imports of Venezuelan crude oil, as well as Venezuelan support for infrastructure projects and social programs. Beneficiaries, especially Cuba, will be watching closely as Venezuelans go to the polls on April 14 to elect Chávez's successor.
They can expect good news and bad news.
The good news for them is that acting-President Nicolas Maduro, Chávez's hand-picked successor, is highly likely to win. Opposition leader Henrique Capriles Radonski is back for another run after losing to Chávez in October, but following a campaign that is likely to prove nasty, brutish, and short, Maduro will benefit from still-strong popular support for Chavismo, public sympathy for those close to Chávez, and fear that the opposition would reverse the late president's most popular policies. Maduro and his allies will also have the resources and political leverage to boost spending and mobilize supporters.
The bad news is that policy is unlikely to improve under a Maduro administration, and political conditions within the country could deteriorate over time as internal dissent becomes more difficult to manage and worsening economic conditions stoke social unrest. Maduro is likely to maintain Petrocaribe, but in the medium term, domestic fiscal constraints may well force him to reduce foreign aid, since among the spending commitments of state-run oil firm and government piggy bank PDVSA, help for foreign governments is the easiest area to cut. Maduro will have to care more about support at home than friends abroad.
Venezuela is currently giving away about one-third of its oil production at below-market prices, including as part of the Petrocaribe program. At today's prices, the volumes that go to Petrocaribe partners amount to more than $6 billion in lost revenue -- about 2 percent of Venezuela's total GDP.
The new president will probably prioritize aid to Cuba, since the Castro brothers are strategic allies and high-profile friends who likely played a role in vetting him for the presidency. Maintaining strong relations with the Castro regime is also a means for Maduro to protect his revolutionary credentials as he works to establish himself as Chávez's legitimate political heir.
But for other Petrocaribe countries, aid reduction will likely be substantial. The Dominican Republic and Nicaragua would likely face the toughest economic challenges, forcing policymakers to make sharp policy adjustments. Reduction or elimination of Petrocaribe financing would put the DR's Danilo Medina in an especially tight spot. Given the size of its economy and its access to international financial markets, the Dominican Republic is better placed than Cuba or Nicaragua to weather the storm, but Medina is already looking for new sources of state revenue.
Cuts to Petrocaribe would also be bad news for Daniel Ortega's government in Nicaragua. Some estimates have Venezuelan support -- in the form of direct loans to Ortega, energy projects, and oil -- at about $500-600 million a year. That's 7-8 percent of Nicaragua's GDP. Petrocaribe has allowed Ortega to subsidize electricity rates and public transportation, boost public sector wages, spend on infrastructure improvements, and enhance food security. A significant cut to Petrocaribe might even persuade Ortega to make new friends in Washington.
These are a few of the reasons why there will be so much international interest in Venezuela's election -- and in what comes next.
Risa Grais-Targow and Heather Berkman are analysts in Eurasia Group's Latin America practice.
Ronaldo Schemidt/AFP/Getty Images
By Risa Grais-Targow
With Venezuelan President Hugo Chavez gravely ill and the Castro brothers in their twilight years, debate has begun to focus on the future of Chavez's brand of leftist politics in Latin America. There is widespread speculation as to which leader might assume Chavez's role in the region, even though his influence has arguably been on the decline. Among the possibilities bandied about is Ecuador's President Rafael Correa. Correa easily won a third term in the Feb. 17 elections, beating his closest opponent, Guillermo Lasso, by more than 30 percentage points. Correa also expanded his base of support in the National Assembly, where his Alianza Pais looks likely to achieve an absolute majority. Correa, like Bolivia's Evo Morales and Nicaragua's Daniel Ortega, owes much to Chavez, who served as a model for socialist policies, anti-imperialist rhetoric, and doled out hundreds of millions of dollars to his regional allies. While Correa may aspire to use his strong mandate to assume leadership of the Chavez-created Bolivarian Alliance for the Americas, his ability to do so will be limited.
First and foremost, Correa simply lacks the resources. Ecuador is a relatively small country (its GDP is about 20 percent of Venezuela's), and while it is a major oil producer, it does not boast the quantity of oil that can sustain Chavez-like regional "petro-diplomacy" and aid programs. Moreover, in the likely event that Chavez's chosen successor, Vice President Nicolas Maduro, wins a new election, there is no evidence to suggest that he doesn't want to fill Chavez's regional leadership role himself. So far, Maduro's actions suggest that he will represent policy continuity. He is close with the Cuban regime and has imitated Chavez's playbook thus far, including cracking down on the private sector and suggesting that foreign agents were planning an assassination attempt against him.
That doesn't mean that Correa won't try. He boasts much of Chavez's charisma, and has taken every opportunity to vault himself, and Ecuador, onto the international stage, typically at the expense of US policy interests. This has been particularly true since Chavez first became ill in June 2011. Correa boycotted last year's Summit of the Americas in protest of Cuba's absence, and more recently made headlines by granting Julian Assange political asylum. While Venezuela grapples with its internal transition challenges, rather than its regional agenda, Correa could heighten his anti-imperialist rhetoric. Regardless, however, Correa's decisive victory-along with the endurance of Morales in Bolivia, Ortega in Nicaragua, and more center -- left governments in Peru and Brazil -- suggests that the left in Latin America has staying power, with or without Chavez.
Risa Grais-Targow is an associate in Eurasia Group's Latin America practice.
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By Philippe de Pontet and Clare Allenson
Although today's African Union (AU)-U.N. deadline for reconciliation between Sudan and South Sudan has come and gone without a resolution, the Security Council is unlikely to follow through on its threatened targeted sanctions for now (China and Russia are unlikely to endorse them). While an oil deal in the next few weeks remains unlikely, the economic and patronage imperatives in both capitals finally point toward an interim oil deal before the end of the year or in early 2013 -- despite plenty of spoilers on both sides who see compromise as capitulation. Each side has made an initial offer on transit fees, and while more movement is needed, resumption of most of Sudan's 350,000 barrels per day (BPD) will likely occur by the end of the year or, at the latest, in early 2013.
Ever since South Sudan shut down its northern-bound oil production in January, the two nations have been engaged in a battle of economic attrition, punctuated with actual and proxy battles near their disputed border. South Sudan, which depends on oil for more than 95 percent of its revenue base, injected a ray of hope in recent weeks into the long-languishing talks, with an offer of over $8 billion in debt relief and compensation for Khartoum, and pipeline fees of about $8 per barrel of oil. The government of Omar al-Bashir in Khartoum wasted no time in rejecting the offer, insisting that border security is the top priority -- but its revised (albeit still low) offer of roughly $32 per barrel a few days later indicates that the two countries are slowly moving toward a deal. Sweeteners from China and the Gulf states will probably be necessary to get Khartoum to raise its offer further. Despite the initial rejection, the new terms should provide the basis for a reasonable oil deal that could get Sudanese crude flowing again. Though full production will take several months, the largely unexpected addition of more than 200,000 BPD of Sudanese crude would be a small, but not insignificant, supply bump for highly volatile oil markets.
The embattled Bashir administration cannot afford to appear weak, and declined a meeting with South Sudan President Salva Kiir ahead of the U.N. deadline this week. But it literally cannot afford the drastic austerity that looms on account of lost oil revenues, which explains Khartoum's acceptance to attend an AU summit with Kiir in the near future. The envisioned Sudanese cutbacks make Greek austerity look like a walk in the park -- not to mention the additional pain of high inflation, a sharp depreciation of the Sudanese pound, and an incipient anti-regime protest movement. The Kiir administration faces an equally negative outlook, with inflation well above 70 percent and a 56 percent-unfunded budget despite a nearly 40 percent cut in spending. Dwindling donor patience will serve to push Juba's hand toward a deal. Even more significant is Juba's belated realization that a southern-based pipeline, if it emerges at all, is years away and therefore not a panacea for its pressing needs.
A binding deal on oil revenue sharing will not be possible or sustainable if the Sudans remain in a shooting war on both sides of the border. Both of the military-dominated governments would plough a huge percentage of oil revenues into security, risking an even greater escalation, making both sides understandably wary of an oil deal without security guarantees-particularly Khartoum, which faces multiple insurgencies just a year after its painful loss of the south.
Talks have broken down several times over the location of a demilitarized zone, which would represent the first step to ending hostilities. During her visit to Juba this week, Secretary of State Hillary Clinton will pressure the Kiir administration to follow through on security guarantees in order to move negotiations forward. Juba's implicit bargain now appears to be to demobilize its affiliated militias in Southern Kordofan and elsewhere, in exchange for an independence referendum in Abyei, which would likely see the district join South Sudan. Khartoum will no doubt exact a higher price, through higher transit fees. Hammering out such a deal will be tough, but the reality of a mutually destructive stalemate, together with both Juba and Khartoum's revised oil offers, should offer scope for a deal-albeit a shaky one-sooner than most would expect.
Philippe de Pontet is the director of Eurasia Group's Africa practice. Clare Allenson is an associate in the firm's Africa practice.
ASHRAF SHAZLY/AFP/Getty Images
By Nicholas Consonery and Willis Sparks
For China's top leaders, this is not a good time for confrontations with the neighbors. The country's once-a-decade leadership transition is expected to unfold this fall, and neither outgoing nor incoming officials want uncertainty or ugly international headlines to interfere with the official choreography.
Thus the worry that Asian governments like the Philippines and Vietnam, emboldened by a commitment from Washington to maintain a robust strategic presence in the region, are pushing more aggressively to assert territorial claims in the South China Sea. More worrisome still, China's leaders face patriotic pressures from within for a forceful response.
China and its neighbors could be working together on joint oil and gas exploration in these disputed waters. Proven and undiscovered oil reserves in the South China Sea are estimated to be as high as 213 billion barrels, according to a 2008 report from the U.S. Energy Information Administration. If accurate, that's larger than the proven oil reserves of all but Saudi Arabia and Venezuela. But territorial disputes continue to block efforts to prove these estimates, and the potential for open hostilities in the area is growing, threatening to disrupt trade flows and stoking regional tensions.
The most recent conflict is the impasse
between the Philippines and China over the Scarborough
Shoal, a small island 100 miles off the coast of the Philippines
claimed by both countries. In April, Philippine naval vessels discovered
Chinese fishing boats in a lagoon of the Scarborough Shoal, provoking a three-month
standoff in which Beijing used trade barriers to pressure Manila, which called
on Washington for help. Though the standoff seemed to have been resolved in
June, there are still Chinese fishing boats in the shoal.
Manila is pressing the issue both to stoke national pride at home, to justify greater defense spending, and to draw the U.S. deeper into territorial disputes. Vietnam has similar motivations, though Hanoi appears to have less appetite for tension than Manila at the moment. Neither Chinese neighbor wants to punch toe-to-toe with Beijing, and cooler heads are always likely to prevail. But confrontations at sea can spin beyond the control of state officials back on shore.
There is a similar problem in Beijing. When Chinese officials discuss how best to manage territorial claims in the South China Sea, there are lots of negotiators seated around the table. Local leaders, maritime police, customs and border officials, as well as representatives of national oil companies and the Chinese Navy each have their interests to assert. Any of these actors can play to increasingly hawkish public opinion to operate outside the limits set down by senior leaders.
That's why, though the leadership would like to put a lid on territorial tensions, China has been making so much South China Sea news in recent weeks. Two weeks ago, the state-owned China National Offshore Oil Company (CNOOC) opened nine blocks for exploration in waters also claimed by Vietnam. Not long after, a spokesperson for China's Defense Ministry announced that the navy was conducting combat-ready patrols in the area.
In months to come, China's top leaders will do their best to strike a delicate balance-to appease belligerent voices at home and within the government while reassuring outsiders that China is not becoming more aggressive. But each time one of the neighbors makes another provocative move, Beijing's balance becomes a bit harder to maintain.
Nicholas Consonery is an analyst in Eurasia Group's Asia practice. Willis Sparks is an analyst in the firm's Global Macro practice.
HOANG DINH NAM/AFP/Getty Images
By Willis Sparks
Western officials (and more than a few Western celebrities) have criticized China in recent years for its protection of Sudan's government. They've charged Omar al-Bashir's regime in Khartoum with support for ethnically motivated militia attacks on civilians in the country's Darfur region -- and China's government with complicity. Bashir, the world's only fugitive head of state, was indicted by the International Criminal Court in 2008 for Darfur-related crimes against humanity. Beijing uses its veto power to block international efforts to supply UN peacekeepers for Darfur, critics say, to protect its oil interests in the country.
It's ironic then that China's energy needs are now helping forestall a broader (and perhaps bloodier) confrontation in Sudan.
Last July, Sudan became two countries. The mostly Muslim North and mainly Christian South finalized a relatively amicable break-up as South Sudan became an internationally recognized independent state. But like most divorces, this one did not produce a clean break, because the two countries share custody of the country's oil wealth.
Before the separation, Sudan produced about 500,000 barrels of crude oil per day. South Sudan now sits atop 75 percent of that total, but the pipelines that transport the oil and the ports that move it to market lie in the North. Since July, the northern government in Khartoum has faced a series of political and economic crises, and its foreign reserves have dwindled to dangerously low levels. Bashir's government needs some way to draw more cash from the oil it has lost.
Not surprisingly, North and South have yet to agree on how to share oil revenue, and each side has used its leverage to pressure the other. An opening of negotiations offered little promise of progress: Khartoum demanded a transit fee of $36 per barrel. The southern government in Juba offered less than a dollar.
On Nov. 8, President Salva Kiir of South Sudan dramatically upped the stakes in the dispute by ordering the expulsion from the south of Sudapet, the North's national oil company and a financial lifeline for its government. Khartoum countered with an announcement that oil exports from South Sudan would be suspended.
China quickly jumped in.
This oil is especially important to the China National Petroleum Corporation (CNPC), which has equity production in Sudan of about 200,000 bpd, 15 percent of its total overseas output. Despite its growing involvement in oil exploration and production abroad, CNPC is still a newcomer to this game, with fewer options than its international peers.
And CNPC is important for China's government, because the company is a guarantor of China's energy security. Most of the crude that CNPC draws from Sudan is not shipped home to China but is sold on international markets. Yet Beijing has emphasized the importance of holding oil assets overseas, providing fuel that can be directed to China if events threaten a sharp drop in supply.
The country's thirst for energy -- and management of the political vulnerabilities it creates -- remain a top priority for Beijing. Sudan represents less than 5 percent of China's crude oil imports, but add an extended export shutdown in Sudan to the current range of worries and headaches across oil-producing North Africa and the Middle East, and you could have significant upward pressure on global oil prices at a time when the Chinese leadership is already worried over price inflation and the risk of unexpected foreign economic shocks.
This is an especially anxious time for Beijing's economic policymakers. Volatility in Europe and the slow recovery in the United States -- China's largest trading partners -- fuel fears of a sharper-than-expected slowdown inside China. It's also a delicate moment for the country's politics as a leadership transition begins in earnest in 2012. That's why China moved quickly to pressure the North to renounce its threatened blockade.
To save face, Khartoum announced it would allow the oil to pass but would seize about a quarter of the profits as compensation. Low-level violence will continue, and we can expect to see more of the increasingly common attacks on oil fields along the two countries' poorly demarcated border. There will be more turmoil in restive oil-producing regions in the North. But thanks to aggressive Chinese mediation, the oil continues to flow, and Chinese diplomats are now trying to broker a long-term deal on transit fees.
Don't expect China to dive more deeply into conflict resolution in other countries. On foreign policy, China's leadership is risk-averse even in the most confident of times, and the looming transition to a new president, premier, and party elite over the next two years will make officials even more cautious. Only when political and commercial interests clearly coincide, as they do in Sudan, will Beijing move quickly to intervene in the politics of other countries.
In this case, however, Chinese intervention helped avoid a dangerous foreign conflict -- at least so far -- even if Western critics are cynical about its motives.
Willis Sparks in an analyst in Eurasia Group's Global Macro practice.
ASHRAF SHAZLY/AFP/Getty Images
By Risa Grais-Targow
Cuba. Oil. Two words that tend to get U.S. politicians hot under the collar, though usually not in the same sentence. That could change as the 2012 campaign season heats up in the U.S. and as Cuba's plans for offshore oil exploration materialize. The Chinese-built, Italian-owned Scarabeo 9 rig is scheduled to enter Cuban waters in August or September, and a consortium of international oil companies is set to begin drilling soon after. The struggling island nation, which currently depends on generous oil deals from its friend and neighbor Venezuela, has high hopes that its potential offshore resources might rev up its sagging economy. (Cuba claims that it has 20 billion barrels of "probable" oil in the continental shelf just off Havana, while the U.S. Geological Survey thinks that number is closer to 5 billion barrels.) But as the rig makes its steady way from Singapore, officials in Washington are getting anxious. Many lawmakers doubt that Cuba has the regulatory capacity or expertise to drill safely, particularly without the U.S.-manufactured equipment that the more than 50-year-old embargo has kept out of Cuban hands. And with BP's spill in the Gulf of Mexico still fresh in the U.S. public's mind, politicians are flagging the possibility of a Macondo-like spill 50 miles off the Florida coast.
The specter of such a disaster has already prompted several legislative efforts to punish foreign firms that drill in Cuba -- or at least those who chose not to comply with U.S. safety standards. Since January, Congressional hardliners from Florida have introduced three bills proposing to deny contracts to such firms or visas to their employees. The bills are designed to appeal to anti-Castro constituencies in the run-up to the elections, but widespread haggling over the issue is set to increase as Cuba's drilling plans progress, and the issue could become a talking point for presidential candidates in battleground states. For its part, Cuba will keep scrambling to convince the international community that it will uphold international safety standards. But those PR efforts will do little to cool the heated debate brewing on the Hill.
That said, none of the bills is likely to move anytime soon, given another powerful constituency: oil. Pro-drilling legislators in the House will be wary of punishing foreign oil companies (some of which have U.S. operations). The issue will also be overshadowed by pre-election priorities such as job creation. In the absence of Congressional action, the administration will likely take an ad-hoc approach. It might twist companies' arms behind closed doors, as it recently tried to do with Spain's Repsol, to get them to abandon their plans altogether. Or, if that doesn't work, it might simply push for guaranteed safety compliance. Measures that involve engaging directly with Cuban officials are unlikely, leaving room for less controversial alternatives such as allowing companies that specialize in emergency response to contract with Cuba and creating some kind of exception to the embargo that allows Cuba to use certain U.S.-manufactured equipment to prevent or minimize spills.
Risa Grais-Targow is a member of Eurasia Group's Latin America practice.
ADALBERTO ROQUE/AFP/Getty Images
By Risa Grais-Targow
By all rational measures, Cuba is effectively irrelevant to the United States. The island is small, its economy is about the size of New Hampshire's, and since the collapse of the USSR it poses no strategic threat. Yet the Castros have a habit of popping up in the headlines. In part, that is because of the inevitable fascination with a small country that has been a foreign policy irritant for the United States since 1959 and, more recently, its outsized role in Florida politics. But change is coming to Cuba, slowly but surely, and with change comes the possibility of unexpected volatility.
Cuba is gearing up for the first Cuban Communist Party (CCP) congress in 14 years, to be held April 16-19. Much of the event will be focused on formalizing Raul Castro's small steps toward economic liberalization (e.g., trimming the state's workforce and allowing more room for entrepreneurs) outlined in a November 2010 wish-list of 300 reforms. Another, perhaps more important, development will be the identification of the next generation of leaders, including the appointment of a new second-in-command for the CCP (the second most powerful position in Cuba). The long delay since the previous CCP congress suggests that there has been much internal wrangling over that issue.
The Castros are clearly on the way out (Fidel is 84 and Raul is 79), and the CCP has promised that the congress will usher in a new generation of leaders. Just how new and young they will be remains to be seen. On March 25, Raul Castro announced that the 50-year-old Economy and Planning Minister Marino Murillo, who has been the architect of much of the economic reform agenda, would now oversee its implementation as a sort of economic czar, signaling Raul's devotion to the reform process. The CCP may, however, simply shuffle senior party members into new positions rather than appoint younger reformers.
Such developments could also be important for the U.S. and perhaps trade with Cuba. Unless Congress decides to revisit the issue, the Helms-Burton Act of 1996 stipulates that the Cuban embargo cannot be lifted while the Castro regime is still in power. A shift in the leadership could also open the way to dealing with other potential concerns. For example, Cuba is actively exploring for oil in the Gulf of Mexico, raising U.S. concerns about how it would handle disasters similar to the 2010 Macondo well blowout.
But the CCP faces deeper challenges than this round of leadership refreshment. Most young Cubans are disenchanted with the regime. They have spent most of their lives in post-Soviet Cuba dealing with grinding economic hardship. Finding true believers among that generation is likely a difficult task and the regime's ability to implement meaningful reforms will affect the stability of Cuban politics further down the line.
Risa Grais-Targow is an analyst in Eurasia Group's Latin America practice.
ADALBERTO ROQUE/AFP/Getty Images
By David Bender
Remember when Iraq was all about the oil?
Bush administration officials predicted that a post-war spike in Iraq's oil production would pay for both the conflict and ease the country's transition to democracy. Anti-war protesters countered that the war itself was little more than an oil grab. Now that the American combat mission is officially over, where is all that oil, and how will it change Iraq and the world?
It seemed for years that violent chaos inside Iraq made a big increase in oil production entirely unrealistic; but now there are growing signs that oil project work could begin on several fields in the south over the next six months. If these projects move ahead, over the next decade, Iraq could begin to contribute enough production to significantly influence the global oil market, providing enough supply to undermine assumptions that energy demand from emerging Asia and increasing production costs will squeeze energy markets and add serious upward pressure on prices in the mid 2010s.
Iraq is now producing about 2.4 million barrels per day. The 12 contracts signed with some of the world's largest oil companies fuel hopes that Iraq can increase production nearly fivefold by 2020. That target is unrealistic, but even the likelier tripling of production levels will have important implications for the global economy and raise interesting questions about regional political dynamics. For the moment, Saudi Arabia is the only producer with enough spare capacity to single-handedly move prices. How will the Saudis respond if Iraq can produce enough oil to usurp some of that market power? How will Iran react if a surge in Iraqi production drives down oil prices, depriving Tehran of badly needed revenue? Globally, will Iraqi oil power Chinese and Indian growth? Will it kill the electric car? Iraqi oil production increases will have widespread effects-if they happen.
But Iraq will be a politically volatile and potentially unstable place to do business for the foreseeable future, and a spike in the country's oil production is anything but a sure thing. Nearly six months after parliamentary elections, U.S. combat troops leave behind a country without a government. Vote winner Iyad Allawi, incumbent Prime Minister Nouri al Maliki, an array of Shia sectarian leaders (including firebrand cleric Muqtada al Sadr), and the Kurds remain locked in a seemingly endless battle of diplomatic nerves, holding fruitless rounds of negotiations, forming and breaking alliances, and making declarations of principle with little bearing on political realities.
ALI YUSSEF/AFP/Getty Images
By Erasto Almeida and Willis Sparks
As a constant gush of crude oil into the Gulf of Mexico illustrates the dangers of deepwater production, policymakers around the world must make tough choices on how and when to open other deepwater projects. You'd expect that America's ongoing nightmare might generate serious debate in Brazil, where policymakers and petroleum engineers are moving forward with plans to develop one of the world's largest oil discoveries in a generation. Political factors ensure that that's not so.
Brazil's plans are plenty ambitious. British Petroleum's Deepwater Horizon project drilled at ocean depths of 4,920 feet. Brazil's reserves, discovered in 2006, are located beneath a layer of salt more than 7,200 feet down. Petrobras, Brazil's national oil company, will assume ultimate responsibility for bringing the oil safely to the surface if current legislation makes its way through the country's congress.
The technical challenges are considerable. Petrobras will have to reinforce pipes to withstand enormous deep-water pressure. Special alloys must be used to limit the corrosive effects of high levels of carbon dioxide. The unstable ocean floor above the salt will make rigs difficult to anchor. No oil company in the world has ever faced such complex challenges. Yet, Brazil is advancing full speed ahead, and its plans have broad public and political support. Why?
First, there's an element of national pride involved. Brazilian officials remind doubters that Petrobras is the world's leading producer of deep-sea oil reserves. The state-owned company produces more than two million barrels per day, more than three quarters of which is drawn from deepwater wells. Nearly one fifth of the total comes from depths equal to BP's Deepwater Horizon rig. Officials add that, as with the financial crisis, America's current problem flows from a catastrophic failure to regulate. Brazil will adopt tougher safety standards. The country's National Petroleum Agency, responsible for oversight of rig and well safety, is already preparing a detailed study of the state of equipment -- and of contingency plans should disaster strike. Whether the subject is big banks or big oil, Brazilian officials insist there is little risk in their country of American-style regulatory complacency. That said, they're also likely to limit the cost of new regulatory burdens to ensure that plans move forward without unnecessary delays.
Second, Brazil's legislative debate over oil reform has centered in recent months on how the huge expected deepwater profits will be divided among federal, state, and local governments. That gives political powerbrokers at every level a substantial share of the spoils -- and a reason to support the project.
In addition, the current government sees state-owned Petrobras as a useful tool of economic policy. During the slowdown in Brazil that followed the U.S. financial crisis, Petrobras helped protect local jobs by expanding local investment and buying larger percentages of its equipment from Brazilian suppliers. Petrobras can be even more useful if it meets its public target of doubling production over ten years, and most of the added output will come from the deepwater pre-salt reserves. President Luiz Inacio Lula da Silva has called the deepwater discovery a "second independence for Brazil." In part, that's because it can reduce the country's dependence for growth on economic conditions elsewhere. That's a powerful political incentive for a fast-developing country.
Ironically, the spill in the Gulf could actually accelerate Brazil's plans. If oil-stained U.S. beaches lead to a longer-than-expected U.S. deepwater drilling moratorium, additional supplies of capital and equipment could become available. Some of those supplies will likely make their way south.
Only a major spill that finds its way onto Brazil's beaches could slow the momentum toward developing the pre-salt reserves. That's not impossible. The most promising deposits are located offshore between Rio de Janeiro and Sao Paulo, Brazil's most densely populated cities by far.
But even a large spill might not make a difference. The largest wells are 150 to 250 miles offshore. More to the point, Brazilian officials say that ocean currents would carry leaking oil further out to sea -- not onto Brazil's beaches.
Are they right? We won't know for sure unless and until it happens. But we do know that, for better or for worse, Brazil is about to drill deeper than ever before.
Erasto Almeida is a Latin America analyst at Eurasia Group. Willis Sparks is an analyst in the firm's Global Macro practice.
MUSTAFA OZER/AFP/Getty Images
The 11 people arrested and accused of spying for Russia have titillated the tabloids and reminded Cold War veterans of the good old days. But they won't do much damage to U.S.-Russian relations. In fact, the two governments are getting along much better at the moment. There are three major reasons for this, and all of them have to do with the view from the Kremlin.
recently ailing economy is now feeling much better. The financial crisis
inflicted more damage on Russia
than on most other emerging markets, in part because of a steep drop in oil
prices. When Obama first proposed a "reset" in U.S.-Russian relations, Moscow was hemorrhaging
reserves, and Kremlin officials hadn't arrived at any clear idea on what to do
about it. Prime Minister Vladimir Putin was traveling the country assuring local workers
that complacent oligarchs, not state officials, were to blame for the
volatility, and that their government would ensure that all would again be
well. President Dmitry Medvedev and his more western-oriented advisors were
beginning to look like convenient scapegoats should the public become restive
and Putin run out of businessmen to punish.
Things have changed. The economy has picked up thanks to some skillful economic management and a rise in oil prices out of the danger zone.
is feeling much better about its neighborhood. The Orange Revolution is now a
distant memory. In 2004, a presidential election in Ukraine lifted the Putin-endorsed
Viktor Yanukovych over Viktor Yushchenko. But Ukrainian nationalists and
several Western governments charged fraud, and the race was re-run. Yushchenko
won the do-over, fueling suspicion and hostility in Moscow. But his leadership earned little
public confidence during his five-year tenure, and Ukraine's latest election elevated
Yanukovych, who has now taken his country's bid to join NATO off the table for the foreseeable future.
Alex Wong/Getty Images
By Greg Priddy
It might seem premature to address how the world oil market and other regional powers will accommodate rising Iraq oil production capacity -- considering that the outcome of Iraq's recent election remains unresolved, and the process of putting together a governing coalition has barely begun. But some of the broad dilemmas that more Iraqi oil will create are structural in nature, and not terribly dependent on the new government's makeup. One thing's for sure: Both Saudi Arabia and Iran will face major challenges to their interests if this scenario plays out.
The Saudi-Iraq axis is simpler than the Iran-Iraq one. If Iraq's production capacity rises to even half of the clearly unrealistic 12 million bpd by 2020, which was a goal cited by Oil Minister Hussein al Shahristani, it will likely serve to maintain some of the current overhang of spare capacity for longer than would have otherwise been the case. This would prevent a retightening of the world oil market that may have put upward pressure on prices. Saudi policy will have to confront how to deal with this situation -- both in terms of whether to delay investment in their own capacity, and how to accommodate what has the potential to be a much stronger second-place producer within OPEC. At some point, Saudi Arabia may approach the new Iraqi government for a discussion about how to renegotiate the system of OPEC quotas in order to accommodate Iraq's increasing oil production with both countries' interests in mind. But depending on how the bilateral relationship evolves, achieving this sort of cooperation may be problematic. Iraq has already added written provisions into its service contracts with foreign oil companies dealing with government-mandated output cuts. This demonstrates that the Iraqi side is beginning to grapple with the idea that it may at some point be adding capacity to an oversupplied market and need to exercise restraint.
The implications of increasing Iraqi oil are even more complicated when it comes to Iran. US secondary sanctions under the Iran Sanctions Act (ISA) have been reasonably successful at hindering development of additional Iranian oil and gas production capacity. While they haven't stopped activity altogether, they've kept it at a level where the volume of oil available for export is likely to continue its gradual slide over the next decade as production declines and domestic demand continues to grow. In this scenario, an eventual retightening of the world oil market with attendant higher prices would clearly be in Iran's national interest, helping it to maintain revenues even while volumes fall a bit during the next several years. The increase in Iraqi capacity, however, could prevent this from happening -- taking a toll on Iran's government finances, and potentially creating tension between the two Gulf neighbors. Given the substantial amount of Iranian influence within Iraq, and the still-latent disputes about the border and control over the Shatt al Arab waterway, this market-driven tension could potentially spill over into the geopolitical realm.
All of this, of course, is dependent on whether Iraq's internal stability permits large-scale oil development to move at a rapid pace, which remains a big "if" at this point. Still, it's not just a matter for the oil market. This situation has the potential to substantially redraw the map of state finances and national power in the Gulf.
Greg Priddy is an analyst in the Global Energy and Natural Resources practice at Eurasia Group.
ESSAM AL-SUDANI/AFP/Getty Images
By Daniel Kerner and Willis Sparks
Remember when Britain and Argentina went to war over a handful of hard-scrabble islands with little to recommend them but two thousand windblown people and a few million penguins? In 1833, Britain seized and begun occupying what it called the Falklands, a set of islands just 350 miles off Argentina's coast and about 8,000 miles from London. Argentines, who refer to them as Islas Malvinas, have demanded their return ever since.
In April 1982, General Leopoldo Galtieri's military government announced that Argentina had finally claimed ownership of the islands. Prime Minister Margaret Thatcher insisted that they still belonged to Britain. To rally the Argentine people to a military junta blamed for large-scale human right abuses and a floundering domestic economy-and convinced that Thatcher would let the islands go rather than fight for them, Galtieri ordered an amphibious invasion. The British navy arrived and quickly forced an Argentine surrender.
The war lasted 74 days and killed 255 British and 649 Argentine troops -- along with three local residents. The Argentine government was soon forced from power, and Thatcher rode a surge of patriotic pride to a landslide re-election the following year.
Though Argentina withdrew, it has never surrendered its legal claim on the islands; ownership is enshrined in the country's constitution. The Falklands have experienced an economic boom in recent years, thanks to the revenue generated by increased exports of squid. But for most people outside Argentina and Britain, the war represents little more than a curious footnote of naval history.
Until last weekend.
On Sunday, a British-based oil company, Desire Petroleum, began drilling for oil in the northern basin of the islands. The news has provoked sharply rising tensions between a lame duck government in Britain, where the 1982 war remains a point of pride, and a struggling government in Argentina, where hard feelings over the conflict remain alive and well. Both governments face critical elections -- Britain later this year and Argentina in 2011.
Faced with few real options, the Argentine government tried to pre-empt the British exploration with a decree on February 16 that all ships moving to and from the islands that use Argentine ports or pass through Argentine waters must have a permit. Cristina Fernandez de Kirchner's government is now tightening the diplomatic screws on Britain, mainly by working to win broad support for its position from across Latin America. Other British oil companies are expected to explore the area soon.
Exploration will continue for the next few months. Local officials in the Falklands government claim there could be as many as 60 billion barrels in reserves beneath the basin, but some experts are skeptical. It's not yet clear that oil deposits near the islands contain enough accessible oil to make further investment worthwhile. Tensions will likely subside in coming weeks, and no one envisions a sequel to a war that killed nearly 1000 people. The Argentine government has said publicly that armed conflict is not an option, and the Argentina public is highly unlikely to support one.
But what if local officials are right about size of the oil reserves? What if there is much more oil there than some experts think? If two governments fighting for their political lives at home will go to war over islands famous only for their penguins, what might they do to secure billions of barrels of oil?
Daniel Kerner is a Latin America analyst at Eurasia Group, and Willis Sparks is an analyst in the firm's Global Macro practice.
JUAN MABROMATA/AFP/Getty Images
By Ian Bremmer and David Gordon
After years of being wildly bullish on Brazil, we're in for a bump. The country stands to gain from a strong rebound in growth over the course of 2010, but Brazil's newfound economic abundance will lead to a drop in the quality of economic policymaking -- both on macroeconomic policy and, to a much greater extent, through leaning more heavily on state-owned enterprises. As a result, 2010 will be marked by growing investor concern on both macro and sectoral policy as the October presidential election draws near.
Brazil's challenge of abundance looms greatest in the oil sector. The government wants more control over resources, and has very little desire to allow the international community to profit unduly (or, in some cases, even duly) from the exploitation of the country's vast new oil frontier. With Lula's political capital running high, he should be able to approve legislation creating a new exploration and production framework which relies heavily on state-owned Petrobras. What's happening in the oil sector, while more extreme, should be seen as part of broader trend whereby state enterprises grow in relevance and industrial policy becomes more inward focused. That's a negative for Brazilian markets. A rosy economic outlook is also likely to impact the discipline of macroeconomic policymaking. The Lula administration isn't about to abandon a macroeconomic framework which has proved wildly successful, but lowered fiscal vulnerabilities will tempt the administration to keep fiscal policy expansive for longer than markets would like. That will put additional pressure on the central bank precisely when the membership of its board may be in flux...as Central Bank President Henrique Meirelles considers a run for elected office.
Markets will thus become jittery as the elections draw near, particularly given that some of the concerns will be overblown when investors awaken to these risks more explicitly. Lula's hand-picked candidate Dilma Rousseff enters 2010 favored to win the election, and she will undoubtedly deepen the government's turn toward a bigger state. Sectoral policy won't be evenly problematic -- in the telecom sector, these drivers exist, but are weaker; while in transport infrastructure, the political push actually goes the other way (more foreign investment needed given the scope of projects needing completion before the World Cup in 2014 and the Olympics in 2016). If opposition candidate Jose Serra wins, the sectoral up-side will be larger given the lack of a bias toward state-owned enterprises, and fiscal policy will be tighter. But markets will surely be concerned over his long standing criticisms of both exchange and monetary policy.
The situation is a little like post-Mandela South Africa
(though from a more attractive economic trajectory), where people and
markets expected continuity until Thabo Mbeki disappointed. Leaders like
Mandela and Lula are impossible acts to follow. Post-Lula, Brazil will not have the capable policymaking of
the past several years and Brazil
will be in for a bumpier transition as a new administration seeks to put its
stamp on managing the country's newfound economic wealth. Still, the long-term
outlook for the country remains strong. By 2011, Brazil should be set for a bounce.
Next up: India-Pakistan
Ian Bremmer is president of Eurasia Group, and David Gordon is the firm's head of research.
Sean Gallup/Getty Images
By Ian Bremmer
Brazil's emergence as an investor-friendly, free market democracy has been one of the world's most encouraging stories of the past several years. As Venezuela's Hugo Chavez perfects his Castro impersonation, Ecuador and Bolivia follow Chavez's example, and Argentina's economy flounders, Brazil's President Luiz Inacio Lula da Silva has maintained responsible macroeconomic policies -- while redistributing wealth to narrow the still-considerable gap between the country's rich and poor. But as he begins his final year in office, a huge off-shore oil find has emboldened his government to deepen state control of the energy sector, clouding the investment picture.
Lula now looks likely to win a legislative battle over the future of Brazil's
oil sector. State-owned oil company Petrobras will then hold exclusive rights
to operate all new exploration and production in off-shore fields that are
believed to contain one of the world's largest deposits of crude oil discovered
in recent years. Brazil's government will then control all activity in the
new fields, making the big decisions on project operation and management. Over
time, Petrobras will become a much larger but less profitable and less efficiently
No surprise then that multinational oil companies resolutely oppose this plan. Despite the tremendous potential in the offshore fields, many of them may simply opt not to work with Petrobras under the terms the Brazilian government has proposed. That's why there's a real risk that Brazil will have to turn to Chinese and other state-owned energy companies for the resources they'll need to bring this oil to market. That will be bad news for those who import oil because, though Petrobras has the technical expertise for the job, the company is already approaching overstretch on development of existing projects. The fact that Petrobras can do the job doesn't mean it should. Partnership with oil multinationals with much more experience managing projects to recover maximum quantities of deep sea oil deposits would bring more oil to consumers -- and do it more quickly and efficiently.
Brazil's opposition isn't happy with Lula's plan either, but his popularity (near 80 percent) has kept the opposition quiet. Even Sao Paolo Governor Jose Serra, the candidate most likely to defeat Lula's preferred successor (Chief of Staff Dilma Rousseff) next October is keeping most of his reservations to himself. Lawmakers who would normally oppose a government-managed plan are eager to remain in Lula's good graces as elections approach.
Multinational oil companies are moving cautiously, as well. They've aired their criticisms through Brazil's Petroleum Industry Association, but have avoided direct involvement in Brazil's election dynamic.
Without determined opposition, the legislation will probably pass. If Serra wins next fall's presidential election, he will probably try to reverse the legislation. But that would be a long process. If Dilma wins, international oil companies can only hope for an eventual victory in court on the reform plan's constitutionality. Either way, Brazil's energy sector will be much less investor friendly for the next several years.
Ian Bremmer is president of Eurasia Group.
ANTONIO SCORZA/AFP/Getty Images
By Greg Priddy
Saudi Arabia faces a complex set of challenges in its role as leading member of OPEC amid ongoing economic and financial market volatility. After achieving an unprecedented level of compliance with OPEC production cuts from other members earlier this year, the kingdom now confronts a problem: compliance is beginning to fray, even as a weakening of the U.S. dollar and a surge in global equities markets push the oil market surging ahead.
If the breakout above $75 per barrel for West Texas Intermediate (WTI) crude oil is sustained and the momentum continues, it's entirely possible that Saudi Arabia will intervene to try to tamp down prices. If that happens, it wouldn't be as part of any understanding with the United States -- a relationship now under serious strain -- but from pure self-interest. With the global economic recovery still fragile, a rapid momentum-driven escalation in oil prices could weigh on consumer confidence and economic growth. That could produce a drop in oil prices. Saudi Oil Minister Ali al Naimi has spoken in recent months of a "goldilocks" range for crude oil at around $75 per barrel, and hinted at action to blunt any sustained push past $80 per barrel.
The Saudis also need to manage price increases to maintain pressure on Iran. Iran's nuclear progress has Gulf Arab governments on edge -- and the Saudis, in particular, would like to avoid taking any action that provides Iran's government with extra revenue. The Saudi government can balance its budget with WTI crude oil in the vicinity of the high $50s. That means they are now replenishing reserves at a rapid pace after running a deficit for the first half of this year. Despite spending cuts, Iran is still under financial pressure, and the Saudis would like to keep it that way.
Managing output levels and prices will be difficult, given that global inventories of crude oil and petroleum products remain well above their normal ranges. Any move by the Saudis to tamp down a surge in prices would likely involve a modest amount of increased exports -- say 500,000 bpd -- and could be pulled back once it has its intended effect of breaking the market's momentum. To bring inventories down, however, the leading Gulf Arab members of OPEC (Saudi Arabia, Abu Dhabi, Qatar, and Kuwait) will need to keep their own output well below pre-September 2008 levels through at least the end of 2010. Right now, compliance outside the Gulf Arab members has receded, particularly in Iran and Angola. Nigeria remains at its target, but that's a result of the continuing violence in the Niger Delta, not a policy decision to keep its promises.
Greg Priddy is a Global Energy & Natural Resources analyst at Eurasia Group.
JOE KLAMAR/AFP/Getty Images
What will oil wealth do for (or to) these countries? It's hard to say, but maybe Ghana, Uganda, and Sierra Leone can break the resource curse--at least they have clear models not to follow across the continent.
Eurasia Group analyst Willis Sparks
The Iraqi government draws 95 percent of its revenue from oil production. Every plan its political leaders can imagine will depend on reliable access to oil profits, and every political faction knows that the country can't achieve lasting political stability until a durable agreement is reached on who owns the estimated 115 billion barrels of reserves and who holds the right to sell them. As tens of thousands of US troops withdraw from the country over the first eight months of 2010, competition for control of that oil will intensify.
After years of haggling, Iraq's political leaders have yet to reach agreement on a hydrocarbon law that determines how oil profits will be divided among the country's competing factions -- a plan that is necessary to revive an energy sector that has suffered from years of under-investment -- and a steep drop in oil prices from $147 per barrel last July to less than $65 today.
Plans to attract badly needed investment and technical expertise from international oil companies face serious political obstacles. Many Iraqis continue to believe that the United States invaded Iraq to grab control of its oil. As Iraq fell under foreign military occupation, its would-be political leaders discovered that pledges to protect Iraqi oil for Iraqis boosted their personal popularity. Support for opening the country's oil sector to Western companies won't win many votes in upcoming parliamentary elections, now scheduled for January.
Political competition for control of the country's oil will sharply intensify next year. The post-Saddam constitution stipulates that Iraq's natural resources belong to the Iraqi people. But different political factions read this idea in different ways. The document also provides that "the federal government, with the producing governorates and regional governments, shall undertake the management of oil and gas extracted from present fields." Some interpret this clause to mean that the central government in Baghdad has the right to manage Iraq's oil. Provincial leaders argue that this stipulation gives local governments the right to exploit resources located on their territory, especially in newly discovered fields.
This is the dispute that generates constant tensions between Baghdad and the Kurdistan Regional Government (KRG). Kurdish leaders, ever ready to assert the KRG's political and economic autonomy and much less resistant to doing business with Western companies, claim the right to formulate their own energy strategy and to award contracts to international oil firms. Baghdad insists these contracts are invalid and has "blacklisted" companies that invest in the Kurdish region. This multilevel game of chicken stokes political instability and fuels mutual suspicion.
And though the two sides managed to agree on an improvised revenue-sharing scheme that gives the KRG 17 percent of the profits from the oil exploited on its territory, the lack of an established energy law limits the inflows of investment that Iraq's rusting energy sector badly needs if it's going to maintain current levels of production -- let alone expand output.
The Iraqi government has now received its wake-up call. On June 30, Baghdad launched an international bid round to offer service contracts for field development. Iraqi officials calculated that access to some of the country's vast reserves would persuade reluctant firms to ignore the considerable political and security risks and jump into Iraq's oil sector. They gambled that the bid round would make for good television, broadcasting it across the country. They were wrong. Oil Minister Hussein al Shahristani now faces an uncertain political future.
As Iraq moves toward the next parliamentary elections scheduled for January 2010, oil will remain at the heart of every political debate. And as US troops begin to leave the country in large numbers, the Iraqi government will need steady flows of oil revenue to finance reconstruction of the country, further development of Iraq's army and police forces, and the social spending needed to provide Iraqis with basic services. Until Iraq's various political factions forge the political compromises necessary for equitable sharing of oil profits, and until large-scale outside investment in oil infrastructure expands production and export capacity, there will be plenty to fight over and no guarantee that Iraq can be rebuilt.
MARWAN IBRAHIM/AFP/Getty Images
By Eurasia Group analysts Robert Johnston and Willis Sparks
Until the middle of last year, a sharp rise in oil prices figured among the most important developing stories in global politics. Many analysts expected high economic growth to continue for the foreseeable future -- particularly in leading emerging markets such as China, India, Russia, and Brazil -- enriching and empowering the governments of countries with oil to sell, and generating anxiety among consumers about longer-term access to supply. In July 2008, oil sold at $147 per barrel.
Fast-forward six months. On Jan. 7, oil closed at $42.63. The steep price drop flows in no small part, of course, from the global financial turmoil now dominating the headlines -- a meltdown that weighs on economic growth and sharply reduces demand for oil and other key commodities. Oil market players are now more worried about the resilience of demand than security of supply.
In the new industrial and geopolitical environment, speculation has intensified over which countries and energy players are best positioned to weather the downturn -- and which ones are more likely to suffer. In other words, who will be the winners and losers? Here are a few answers you might not expect.
Winner: Saudi Arabia
How can Saudi Arabia, a leading oil producer, possibly be considered a winner from a sharp drop in oil prices? The Saudis enjoy windfall profits as much as others do, but it's important to remember when assessing winners and losers that these are relative terms. When a trend hurts one player less than it hurts his competitors, he can credibly call himself a winner. Saudi leaders have budgeted much more conservatively than regional rival Iran, which is burdened with aging oil infrastructure and the need for high oil revenue to finance diesel imports. Lower prices harm Iran's economy much more than Saudi Arabia's, creating turmoil in Iran ahead of presidential elections in June.
We all know that fast-emerging China has worked up an unquenchable thirst for crude oil. But India actually imports a larger percentage of its oil than China does. To protect its political popularity, the Congress Party-led Indian government subsidizes expensive petroleum products to keep costs low for consumers. That's even more important for 2009, an election year in India. When prices are high, the Indian government must compromise India's fiscal health to safeguard its own political capital. Earlier this year, the Congress Party found itself forced to risk a political fight with powerful diesel end-user groups (farmers and bus drivers, in particular) by raising regulated retail diesel prices by 10 percent following a rise in global spot prices. Lower oil prices have now relieved some of that pressure.
India's national oil companies also benefit from lower prices. They now face less risk of getting priced out of competitive international upstream acquisitions (as they did in Kazakhstan and Angola) as lower oil prices force many of their rivals to become more selective in where, how, and how much they invest.
Winner: International Oil Companies (IOCs)
Like the Saudis, the IOCs (supermajors) are unlikely winners from low oil prices. Certainly, they're likely to take significant losses in their downstream businesses as demand for refined products falls sharply. But for the most part, IOCs can sustain these losses thanks to a disciplined approach to capital spending. Investments like the high-cost Canadian oil sands projects provide an exception, but IOCs have few upstream projects now underway that require oil prices of more than $40 per barrel to generate reasonable returns.
IOCs will also likely benefit from greater access to reserves as lower prices force many governments that now need a lot more foreign investment to back away from policies that favor domestic firms or seek greater rents from IOCs.
Finally, the big oil companies will likely face less scrutiny in Washington as retail gasoline prices and corporate profits fall. President-elect Barack Obama's advisors have already signaled that they have no plans to follow through on campaign pledges to tax windfall profits. Lower prices will also slow momentum toward greater spending on efforts to advance alternative fuels. Climate change policies that would impose new burdens on consumers of oil will falter, at least for the near term.
Russia remains the largest global oil producer, but its oil sector prospects have deteriorated dramatically as prices have fallen. Policy misjudgments and geological challenges have exacerbated Moscow's problems. After increasing production capacity from 6 million to more than 9 million barrels per day between 1999 and 2004, Russia's capacity growth has since slowed sharply and its production outlook is now bleak. According to most forecasts, production will contract in 2009. Output at older fields in western Siberia is declining rapidly, and resource nationalism has undermined investment in newer fields. In greenfield areas like eastern Siberia and the Arctic shelf, the need for substantial infrastructure investment will add to the cost of development. All these problems undermine Russia's ability to compete for the shrinking supply of global investment capital.
Loser: Frontier Markets
Frontier markets, smaller developing states with emerging economies, have not traditionally been the target of oil industry development efforts. Many of them are geographically remote and lack stable political and regulatory structures for foreign investment. In the atmosphere of "pre-peak oil" worries, reserves in places such as Uganda, the Republic of the Congo, Mozambique, Suriname, Papua New Guinea, and Kirgizstan attracted commercial interest that was driven by so-called junior (or minnow) exploration companies that specialize in identifying attractive geological plays that they hope eventually to pass on to larger companies. But lower oil prices have sharply limited the capital available to these smaller companies as markets cut allocations to the prospects that look most risky. This is a risk not only for these small-cap companies, but also for the economic development of countries that might benefit from their investments.
Loser: New Energy Technologies
Projects to develop new energy technologies are struggling as markets recalibrate expectations for oil prices and, by extension, consumer and government demand for alternative technologies and fuels. This is true for biofuels, coal-to-liquids, oil shale, and many types of oil sands technologies. Development of these fuels has already been dogged by environmental controversy, but with oil prices easing, the energy-security-based arguments for government support of these fuels will look much less politically compelling. Markets for venture-capital-driven clean fuels based on fuel cells and hydrogen are also contracting. Governments will continue to subsidize clean fuels, but with less urgency as retail gasoline prices fall, significantly diminishing public demand for new energy technology.
The Call, from Ian Bremmer, uses cutting-edge political science to predict the political future -- and how it will shape the global economy.