Oil's Collapse Is a Geopolitical Reset In Disguise

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Oil's Collapse Is a Geopolitical Reset In Disguise

From Russia to Mexico, U.S. foreign policy makers face new risks and opportunities.

The world is on the cusp of a geopolitical reset. The global pandemic could well undermine international institutions, reinforce nationalism and spur de-globalization. But far-sighted leadership could also rekindle cooperation, glimmers of which appeared in the G-20’s offer of debt relief for some of the world’s poorest countries, a joint plea from more than 200 former national leaders for a more coordinated pandemic response and an unprecedented multinational pact to arrest the crash in oil markets.

The remarkable effort to address the turmoil in the oil markets will be critical to oil’s eventual balance — although the past two weeks have shown that its promised production cuts were too slow and insufficient in the face of oil demand’s plunge. The challenges and opportunities that the collapse in the oil market is pushing to the fore are perhaps just the first taste of Covid-19 induced geopolitical crises that world leaders and policy makers will need to grapple with in the coming months and years.

As history has shown, a big change in energy markets often precipitates a big change in geopolitics. For instance, the shift from coal to oil catapulted Middle Eastern countries to strategic significance. And the recent technology-driven boom in shale oil elevated the United States to net oil exporter status, changing its outlook on the importance of oil in global affairs. We now face a disruption of such proportions that it, too, will reorder some power relationships.

Right now, the focus in Washington is on how to save the U.S. oil industry, much of which is under enormous pressure given the drop in prices. While this is understandable and necessary, Washington needs to make room on its list of priorities for a number of strategic shifts that the crisis has created. For starters, policy makers should consider four challenges and opportunities that are already manifest.

Prepare for more fragile, or even failed, states and the risks that can accompany them.

For dozens of oil producers, the plunge in oil prices is devastating. No major oil producer can balance its budget at prices below $40; according to the International Monetary Fund, with the exception of Qatar, every country in the Middle East requires at least $60, with Algeria at $157 and Iran at a whopping $390. The average Brent price of oil over the past month has been a hair above $20.

Of course, fiscal break-even prices are only one factor when gauging which oil producers are the most vulnerable to deep economic dislocation and its accompanying social and political turmoil. Those with (comparatively) more diversified economies — such as the United Arab Emirates, Mexico and Russia — are obviously better off. Countries with fixed exchange rates — like Nigeria and Saudi Arabia — are at a particular disadvantage, as they need to use their precious foreign exchange reserves to prop up their currencies. Some countries have the capacity to cut expenditures, and others to borrow. And some have legitimate political institutions to manage the inevitable hardships as subsidies are slashed, jobs are lost and capital spending is curtailed.

But many do not. And, unlike the last price plunge in 2016, this shock does not come after a period of stable, high oil prices, which allowed some countries to bolster their finances. Instead, oil prices have been middling, as America’s surging shale oil production and OPEC+ production cuts kept them roughly in the $50-$70 range, below many oil exporters’ fiscal break-even levels.

Iraq, Oman, Algeria, Nigeria, Ecuador, Angola, Suriname — not to mention two countries already on the brink, Iran and Venezuela — are particularly vulnerable. They may not all fail in the sense of state collapse, but many could cease to meet their public sector payrolls, never mind expenditures related to health care, education and other services, including security.

The mere prospect of many countries unable to fund their security budgets should sound alarm bells in the United States and beyond. It adds urgency to a question that national security professionals, foreign policy makers and politicians have grappled with since 9/11: How to keep ungoverned territories from becoming safe havens for terrorist groups or drug cartels looking to target the West or undermine its security in other ways. Of particular concern to U.S. policy makers should be Iraq, Nigeria and Mexico. Each faces its own looming crisis, with potentially profound implications for U.S. interests.

In Iraq, a caretaker government confronts deep fiscal travails: Its oil revenues — which make up 90% of budgetary income — plunged by 46% for March, even before the full impact of the coronavirus on oil was apparent. This fiscal collapse has dire implications for the country’s struggle to stave off ISIS, for Iraq’s ability to stand up to interference by its neighbors and for its efforts to meet the demands of its young and restive population.

Nigeria’s economy is likewise beleaguered, having just begun to climb out of a recession before the imposition of strict pandemic containment measures. Signs of social discontent are on the rise, and President Muhammadu Buhari — a former military man — could resort to the army to maintain law and order. That would undermine the legitimacy and effectiveness of Nigeria’s battle against an Islamist insurgency in the northeast of the country, with ripple effects throughout an already vulnerable region.

With its diversified economy, a hedge on its oil for 2020 and relatively developed institutions, Mexico is much better positioned to manage the turmoil in energy markets. But President Andres Manuel Lopez Obrador’s apparent unwillingness to grasp the severity of the pandemic should be cause for concern. Even as other countries deliver eye-popping relief to the newly unemployed, Lopez Obrador has barely budged from earlier pledges of austerity or moved to revisit other elements of his economic plans. The federal government is struggling to wrest control of parts of the country from drug cartels, and to meet U.S. demands to contain Central American migrants heading north. Should Mexico be forced to cut back spending on security forces as seems highly likely, both those problems could metastasize.

How might the United States and its partners prepare for more turmoil in these countries, and in ungoverned territories, particularly in the Sahel or the Middle East where extremist groups already have toeholds? One answer is obviously the need to maintain and increase aid and humanitarian assistance to the many countries that will face existential crises, either from the oil plunge, the coronavirus, or both. Another answer, strangely enough, can be found in Syria. Far from being the “forever war” that President Donald Trump called it, the small, behind-the-scenes contingent of U.S. troops supporting a much larger group of indigenous forces against extremist fighters is the sort of arrangement that the United States — ideally with others — should replicate in countries that ask for help. Faced with the demands and fears of their own citizens, politicians in North America, Europe and elsewhere may struggle to justify security and other support for countries whose institutions wobble or collapse under the combined weight of low oil prices and the coronavirus. But being prepared to build more limited military partnerships — and, importantly, to explain to their citizens why such arrangements aren’t “forever wars” — will be part of managing the foreign policy fallout of this moment.

Double-down on contingency planning and red-teaming for Iran and Venezuela.

Both Iran and Venezuela were careening before the coronavirus materialized. Under severe U.S. sanctions, oil exports — a lifeline for both countries — had been dramatically curtailed before the pandemic and the oil price collapse. The impact of cratering oil prices will therefore be far less than in the past, but each will still suffer as foreign exchange dwindles further, constraining imports even more.

Many in the Trump administration may hope that this confluence of historical factors leads to the downfall of the Bolivarian revolution in Venezuela and the Islamic revolution in Iran. Yet is the United States prepared if either scenario unfolds?

The fall of Venezuela’s Nicolas Maduro may lead not to the transitional government many have hoped for, but to complete state collapse and an epic humanitarian and security disaster. Alternatively, if the country is hit hard by Covid-19, pressures for political accommodation between Venezuela’s opposition and the government could extend Maduro’s tenure. Iran’s government is much more entrenched, and it is hard for outsiders to accurately assess what’s happening there right now. If the regime is under unprecedented pressure, the most likely outcome is not for a democratic alternative to emerge, but for the Islamic Revolutionary Guard Corps to assume more power, heightening U.S.-Iran tensions and the potential for hot conflict.

Now would be a good time for the U.S. not only to step up its contingency planning for such outcomes, but also to consider whether changes to American policy toward either country would better advance its interests and mitigate human suffering. In particular, the United States should reconsider its earlier decision not to establish some version of an Oil for Food program for Venezuela. Such a program could save Venezuelan lives, stem the tide of refugees that risks destabilizing the whole region and bolster the political opposition; in the face of a global pandemic, these benefits should now outweigh any concerns policy makers may have had about prolonging the life of the Maduro regime.

Defuse a looming U.S. crisis with Saudi Arabia.

Saudi Arabia and other OPEC+ members had multiple motives for agreeing on April 12 to curb oil production. In Saudi Arabia’s case, however, among those reasons was a sharp increase in hostility from members of the U.S. Congress who in the past appeared to appreciate the multifaceted relationship between Riyadh and Washington. Once willing to speak in favor of the U.S.-Saudi partnership, these members suddenly revealed that they were willing to upend economic, military, and diplomatic ties if Saudi Arabia did not curb its production to arrest the free fall of oil prices (and protect the American oil industry).

Such threats no doubt gave President Trump leverage when pressuring Saudi leaders to agree to a deep cut. But they also exposed the fragility in the bilateral relationship. If oil prices continue to fall, members of Congress may well try to punish Riyadh for a situation largely not of its own making. It would be a painful pressure point on the kingdom at a time when neither the United States nor the region can afford any greater destabilization. To avert that possibility, the administration should work closely with key members of Congress. It should not cede management of the bilateral relationship to the legislative branch.

Expand contacts over managing the oil market into more lasting areas of détente.

Recent efforts to pull the global oil market back from the brink exposed some new common interests and triggered intense contacts between leaders. Might this prompt greater cooperation in otherwise fraught relationships? As President Trump’s about-face on the value of OPEC demonstrates, now is a time for rethinking old orthodoxies and finding new ways to approach problems.

Despite Trump’s insistence that the United States needs and wants a better relationship with Russia, this dysfunctional dyad so far has been impervious to recalibration. Moscow and Washington are unlikely to come to any meaningful détente, given President Putin’s need to demonize the United States and the certainty that Russia is in for hard economic times. Putin has repeatedly tried to compensate for economic bad news by asserting Russia more aggressively on the world stage. He could well do the same again.

Yet a small opening exists to professionalize a segment of bilateral U.S.-Russia ties. Russia has long been interested in pulling the United States into coordinating the global oil market. Although the United States does not need to join OPEC+ and its pledges to mandate production cuts, having regular exchanges about global energy trends could create a niche for constructive discussions between Russian and U.S. officials. It is not crazy to think that a dialogue around common energy interests could evolve into a more meaningful conversation about how to deal with Venezuela’s collapse, for instance.

Similarly, although China was not a central player in trying to stem the oil market collapse, the United States and others should bring Chinese officials into regular consultations on the topic. As the world’s largest oil importer and its sixth largest producer, China’s interests are mixed. But as the world’s second largest economy, China may have its own tools to influence global supply and demand. Energy (and climate) are areas in which the United States and China have common interests, and where they have had productive exchanges, even during periods of tension. Again, it is not crazy to think that such dialogues, if intensified, could be a net positive in a critical but rapidly deteriorating bilateral relationship.

Finally, by giving Mexico, Saudi Arabia and Russia a face-saving way to paper over Mexico’s partial compliance with the April 12 production cut agreement, Trump should have secured some goodwill with Mexico’s president. That could come in handy as both countries, with their intertwined economies, cooperate to smooth the transition to normalcy, whenever that comes.

Foreign policy makers and leading thinkers do need to consider how the global order will change in response to the coronavirus. As John Ikenberry pointed out elsewhere, history suggests that initial moves toward isolation could be followed by global efforts to re-create needed institutions. But a U.S. failure to address the more immediate challenges stemming from the Covid-19 oil market collapse will not bode well for any larger effort to remake the world order.

Source: Bloomberg

Author: Meghan L. O'Sullivan