Just over a year ago I wrote about the New Energy Mercantilism, the set of geopolitical phenomena emerging as nations realize that, in the future, there will not be enough energy to go around to sustain projected demand. A market-economy solves this problem by increasing the price of energy until demand inelasticity is overcome and the energy is allocated to where the market says it is most valuable. Mercantilism, rather than trying to distribute shares of the pie more efficiently, aims to lock down as large a share of the pie as possible for your own needs.
A year later, it is clear that mercantilism is on the march.
Joseph Stroupe has written a fascinating article in Asia Times Online about the rise of energy mercantilism. Specifically, he outlines the mechanism by which nations like China, Russian, and India are embracing the mercantilist approach. All three nations are rapidly moving toward an energy market dominated by long-term, bi-lateral supply contracts. This might not sound like a major change, but consider that today energy is supplied to high-liquidity trading bourses where the person willing to pay the most gets the energy. This is significant for two reasons: 1) it ensures that everyone around the world pays roughly the same price for energy (after transport costs are accounted for), and 2) it reduces the ease for deploying the “oil weapon” through an embargo because such action has very dispersed effect–holding 4 million barrels of Iranian oil per day off the free markets increases the price for everyone, forcing your enemies and allies to bear the diminished effects.
Long-term, bi-lateral supply contracts (where, for example, Angola commits to supply China with 200,000 barrels per day of crude oil at $60/barrel for the next 10 years) fundamentally alter this dynamic. First, by locking in future energy prices (at quantities far higher than can be achieved on the futures exchanges), everyone will not pay the same price for oil in the future. Second, by exiting the open market through such contracts, the precsion-targeting of future oil embargos increases dramatically.
Increasingly, significant portions of China and India’s energy supplies are being locked into such long-term, bi-lateral contracts, as are the majority of Russian gas shipments to Western Europe. As a result, much less of the world’s energy needs are being met through freely-traded market instruments. It is especially significant when we consider who remains primarily dependent on the free market for their energy supplies: the US, Western Europe, and Japan.
As traditional and swing producers (who’s production is expected to decline rapidly over the coming years) begin to export less oil to the open exchanges, the price impact on the “West” will be diproportionate. Similarly, the “West’s” vulnerability to oil embargos will increase dramatically.
Participants in bi-lateral agreements will not be exposed to the same risks to their supplies–they can always resort to the market exchanges to make up for shortfalls (though at higher prices), but the reverse is not true–the “West” cannot quickly resort to bi-lateral agreements to guarantee supplies in times of crisis.
Long-term, bi-lateral agreements also remove energy supplies from dollar-denominated exchanges far more effectively than does opening a non-dollar-denominated exchange. Russian supply contracts to Europe are already non-dollar denominated, even though Russia’s ruble-denominated exchange is not yet in full operation. China pays in yuan for oil from Africa–which doesn’t harm the petrodollar system for now, as long as that currency remains pegged to the dollar. But the tipping point when domestic Chinese consumption becomes the prime driver of their economy is fast approaching, and at that point the benefits of maintaining the dollar peg will have evaporated.
Peak oil, when it hits world markets with full force in an unknown number of years, will only exacerbate this trend. I’m not so sure about freedom, but energy mercantilism is definitely on the march.