Report

Running on Empty

Why unbridled oil consumption in the Middle East could pose a threat to the region and beyond.

From the American point of view, the biggest energy revolution in recent years has been the explosion in domestic supplies of oil and gas that has catapulted the United States into the top ranks of global energy producers.

But globally, one of the most important, if less visible, energy revolutions has been the ongoing explosion in demand for oil in the Middle East, still the epicenter of oil production and exports. The region's surge in demand over the past decade, and the likelihood of further increases in its consumption over the next 20 years, raise serious concerns about Middle Eastern countries' ability to keep exporting large volumes of oil. That could upend global oil-market balances, seriously erode the finances and domestic stability of important countries in the region, and spark even more regional instability.

That's one reason that U.S. and international policymakers have been increasingly reaching out to counterparts across the Middle East, urging leaders there to shift gears before it's too late, by, for example, reducing the generous energy subsidies that encourage the rampant use of oil and oil-generated electricity.

"The more they consume, the less they're going to be able to export, and that's the main source of revenue for most of the governments," Dennis Ross, a diplomat who's worked in several presidential administrations, told Foreign Policy. "Something's got to give."

The choice is stark and risky: If Middle Eastern countries don't rein in their popular energy subsidies, their future economic lifelines will be threatened. If they do, they risk roiling domestic populations already energized by the Arab Spring.

Over the past decade, oil consumption in the Middle East has skyrocketed because of the region's growing populations, relatively strong economic growth and increasing need to generate more power for its own use. While China's seemingly insatiable appetite for oil grabbed all the headlines in recent years, Middle Eastern oil consumption was just behind the Middle Kingdom's.

China, with the world's second-largest economy, consumed an extra 5 million barrels of oil a day between 2002 and 2012; the entire Middle East, whose non-petroleum economy is on par with Spain, increased oil consumption by 3 million barrels a day. Europe, in contrast, shrank its oil consumption by 1 million barrels a day over the same period.

That is eating away at the barrels that are available for export. According to statistics from BP, the Middle East exported more than 80 percent of the oil it produced in 2002. A decade later, it was exporting only 70 percent. That trend is also present in North Africa. Across both regions, most of the production gains over the past decade have gone to meet rising domestic consumption, according to a recent report by Securing America's Energy Future.

Publicly, regional leaders say they're aware of the problem and getting a handle on it. But the ugly truth is that most of the factors driving that consumption boom haven't gone anywhere and probably won't for years to come. Foreign Affairs recently noted that Saudi Arabia could by the late 2020s consume more oil than it exports. BP expects the region to add almost 5 million barrels of oil in demand over the next twenty years, even as it expects Middle Eastern exports to remain essentially "static."

Why, with relatively small populations and economies, are Middle Eastern countries guzzling so much oil? While there are plenty of examples of energy consumption run amok -- from Dubai's indoor ski slopes to Saudi Arabians' tendency to leave air conditioners running while on vacation -- the chief culprit is simple inefficiency. That shows up most clearly in power generation and use, and the profligate use of subsidized fuel for transportation.

Electricity generation is the most egregious demonstration of Middle Eastern oil consumption -- but also among the easiest to fix, on paper. Saudi Arabia, despite efforts to tap more natural gas for power generation and an increasing interest in renewable energy such as solar power, still gets about half its electricity by burning $100 barrels of oil.

"It's probably the most inefficient and expensive way to generate electricity right now," said Gary Clark, a commodities analyst with Roubini Global Economics in London. Regionally, he said, power generation accounts for about 25 percent of oil consumption.

That's why countries like Saudi Arabia and the United Arab Emirates are starting to consider across-the-board economic reforms to address the problem. The payoff could be huge: One study estimates that improvements in Saudi power generation, efficiency, and transport could save almost 2 million barrels a day of oil by 2025 -- allowing Riyadh to reap enormous amounts of new money.

They're also looking at alternative sources of energy, including nuclear power. When you're paying $200 to produce a megawatt-hour of electricity with oil, nuclear starts to look like a bargain. The UAE's landmark nuclear deal with the United States, the first nuclear cooperation agreement between the United States and an Arab nation, came about solely because of the small Gulf nation's rising domestic oil consumption. And it explains why even more ambitious nuclear plans, such as Saudi Arabia's hopes to spend $80 billion on 16 nuclear reactors, are getting Washington's blessings even as Iran's nuclear program has triggered a Western effort to use punishing sanctions to destroy the Iranian economy.

A few countries, led by the UAE, are also diving into renewable energy, especially solar. Abu Dhabi even houses the International Renewable Energy Agency.

Meanwhile, Saudi Arabia has established a royal center for atomic and renewable energy, and even the Saudi oil minister talks up the prospects of solar power when he visits the United States. Other countries, from Qatar to Kuwait, are also looking into the prospects of renewable energy providing cheaper (and, incidentally, cleaner) power than their current mix.

Still, the transformation of the power sector appears to be lagging behind the explosion in electricity demand, according to the International Energy Agency's World Energy Outlook. That's especially true with the huge seasonal swings in electricity demand caused by the need for summertime air conditioning; Saudi Arabia alone uses up close to a million extra barrels a day for cooling in the summer. Coming to grips with institutional weaknesses -- such as ministries with dueling mandates -- as well overcoming a dearth of reliable data on energy use could help governments across the Gulf region finally start to implement smarter energy policies, Chatham House concluded recently.

The bigger, and much tougher, problem to tackle is the artificially cheap fuel prices that encourage residents to drive gas-guzzling cars as often as they want, and as far as they want.

"They provide cradle-to-grave energy subsidies as a kind of obligation of the regimes to the public, as a social contract," said Ross. Gasoline in Saudi Arabia, for example, costs about 45 cents a gallon, hardly an inducement to fuel-efficient vehicles.

The IEA estimates that subsidies for oil and oil products in the Middle East cost about $112 billion in 2012 -- or 13 percent of everything those countries made by exporting oil in the first place. Counting subsidies on electricity and natural gas, governments across the Middle East and North Africa are shelling out more than $240 billion a year, the International Monetary Fund estimates.

While U.S. and international policymakers for years have railed about fossil-fuel subsidies, and made calls for their rollback a staple of G-8 gatherings, that's easier said than done.

Many in the region consider fuel subsidies practically a birthright. Furthermore, countries that have rolled back subsidies have found it tough going; Iran's halting efforts to partially liberalize energy prices have been anything but smooth. Morocco just ended its own fuel subsidies -- but only under pressure from the IMF, while neighboring Tunisia had to scrap plans to raise energy prices due to popular protests. Saudi's economy minister publicly attacked energy subsidies' role in "distorting" the economy last spring -- but little has been done since. The UAE's efforts to rein in subsidies stalled after 2010, though the oil minister recently raised the need to cut energy subsidies, at least for expatriates.

The task for Saudi Arabia is even harder, because it has acquired a host of financial obligations outside its borders. Bruce Reidel of the Brookings Institution estimates that Riyadh's external commitments, including support for tottering allies such as Egypt, Pakistan, Bahrain and Yemen, now totals about $30 billion a year. "The cost of supporting the counter-revolution in the Arab and Islamic worlds adds greatly to the challenges facing the House of Saud in the years ahead," he wrote in a new Brookings study released Thursday.

But if the Middle East does not come to grips with its rising oil consumption, the implications could be dire. Saudi Arabia's crucial role in global oil markets comes both from the sheer volume of its exports, and the fact that it maintains "spare capacity" that it can essentially turn on and off as needed, making it a sort of central banker of oil markets. The greater the domestic consumption, the less potential spare capacity in OPEC's biggest producer. And that could lead to higher and more volatile oil prices, which would be bad news for the entire global economy.

Internal stability could also be threatened. Countries in the Middle East, as well as petro-states like Russia and Venezuela, have come to rely on exceedingly high oil prices in order to balance their budgets and meet domestic commitments. That has worked for the last few years because oil prices are, in real terms, about as high as they have been in a century.

But the rapid increase in oil production in the United States and Canada, coupled with the emergence of additional production in Brazil, Iraq, and possibly even Iran, has OPEC members worried about too much oil in the near future. That could send prices down to levels that would be great for the global economy -- but terrible for oil-dependent budgets. Only exporting greater volumes could make up for the lower price-per-barrel, but greater domestic consumption threatens those extra barrels.

"If the oil market becomes more flush, it's going to create problems for them, and they're going to have to make choices that, so far, high oil price have allowed them to avoid making," Ross said.

To date, U.S. policymakers have been trying to increase Washington's cooperation with Middle Eastern countries on issues such as energy conservation, energy efficiency, nuclear power, and renewable energy. The UAE inked a civilian nuclear cooperation deal with the U.S. in 2009. The State Department's roving energy ambassador, Carlos Pascual, spent last weekend in Abu Dhabi, talking up renewable energy. And Ernest Moniz, the U.S. energy secretary, just met with Saudi officials, including a tour of the King Abdullah atomic and renewable energy center, to chat up the prospects for greater U.S.-Saudi cooperation on clean energy and efficiency.

All of that underlines one simple truth: No matter how much oil flows out of Texas and North Dakota, the U.S. won't be disengaging from the Middle East anytime soon. The more things change, the more things stay the same.

Yasser al-Zayyat - AFP - Getty

Report

Green Means Stop

Europe is worried it can be a clean-energy paradise or a competitive economy -- but not both.

Europe's governments have poured in tens of billions into alternatives to fossil fuels. But now, the famously green Europeans are fretting that the continent can be clean, or it can be competitive, but are finding it increasingly hard to be both.

On Wednesday, with the release of its new energy blueprint, Europe will again try to square the circle between ambitious environmental goals and the nagging realization that cheap and abundant energy underpin economic growth.

The release Wednesday of the European Commission's energy strategy for the next decade and a half comes amidst an ever-louder chorus of concern that European energy policy threatens its economy.

The latest and loudest voice belongs to Sigmar Gabriel, Germany's "super minister" responsible for energy and the economy. He warned Tuesday at an energy conference that Germany simply cannot continue to bear the $32 billion-a-year cost of subsidies for renewable energy, the linchpin of Germany's ambitious planned transition towards cleaner energy sources. German electricity prices, both for individuals and for industry, are among the highest in Europe.

"We have to make sure that we connect the energy switch to economic success, or at least not endanger it," Gabriel said.

And he is not alone. British policymakers, led by Prime Minister David Cameron, railed against European plans to regulate hydraulic fracturing across the Continent. Polish leaders have also slammed what they call restrictive climate policies that could hobble the few countries that have managed to muddle through the economic crisis.

Corporate titans, too, have weighed in, albeit with self-serving arguments. Lakshmi Mittal, the chief executive of Luxembourg-based ArcelorMittal, the world's biggest steel maker, took to the pages of the Financial Times to warn that expensive energy and over-ambitious emissions-reductions schemes will de-industrialize the continent.

The new European energy blueprint is meant as a waypoint between the established energy and climate goals for 2020 and the long-term goals already in place for 2050, which include slashing greenhouse-gas emissions by about 90 percent compared to 1990 levels. But the eagerly-anticipated 2030 blueprint won't merely draw a straight line between those years. Instead, as Europe reels with the aftermath of the great recession, lingering unemployment, eroding economic competitiveness, and the siren call of the American energy-driven rebirth, the strategy is expected to scale back Europe's commitment to ever cleaner and greener policies, at least in the mid-term.

Indeed, ever since the eruption of the U.S. shale boom, which created a glut of natural gas in the United States, Europe has been struggling to keep its environmental and economic policies pointed in the same direction. Cheap U.S. coal, displaced at home by natural gas, for the last two years has pushed out pricey natural gas in Europe. That, in turn, has led to greenhouse-gas emissions increases in Europe, even as the United States got cleaner.

The challenge for European policymakers now is to figure out how to balance worries that its green focus will hamstring economic recovery, while still sending signals to the market that Europe backs clean energy and is committed to ambitious cuts in greenhouse-gas emissions.

Observers and blueprint drafts that have leaked into the press recently suggest that the 2030 blueprint will water down carbon-reduction goals, remove European-wide commitments on renewable energy, and take a pass on European-wide fracking rules for now.

European Union officials acknowledge that the current economic climate has greatly shaped the debate over the blueprint to 2030. "No one wants to kill the economy," one told Foreign Policy.

But at the same time, they say, concerns that European energy policy is strangling the economy are overblown. Few industries are actually energy-intensive in the way that big steel makers and cement manufacturers are. Rather, it's the contrast with America's sudden bounty of cheap energy that has Europeans wringing their hands.

"Yes, the competitive disadvantage is clearly there. But it seems to me that most of the reasons for that disadvantage are outside Europe, that is, cheap energy in the United States and cheap labor in Asia," Tim Boersma, an energy analyst at the Brookings Institution, told FP.

Rather than jettison its climate and clean-energy goals in the pursuit of a U.S.-style energy revolution that might be impossible to replicate anyway, he said, Europe should acknowledge that a big chunk of what determines economic competitiveness lies outside its control, and focus on finding a competitive edge for its industries where it can make a difference.

The contrast between the United States and Europe becomes crystal clear inside the electric meter, whether for regular consumers or for industries. Average nationwide retail electricity prices for residential users in the United States rose from 11.7 cents per kilowatt-hour in 2011 to 12.2 cents in 2013. The average residential rate in the 27 European Union countries, in contrast, rose from 24 U.S. cents a kilowatt-hour in 2011 to 27 cents last year.

The costs for businesses are equally stark. U.S. industries paid an average rate of 6.9 cents a kilowatt-hour last year, about the same as two years ago. European firms, on the other hand, pay 16 U.S. cents a kilowatt-hour, up almost 10 percent in the last two years.

Those averages mask some big variations from country to country, with further knock-on effects for economic recovery. Spaniards pay residential rates of about 30 U.S. cents per kilowatt-hour - and that's still not enough to actually cover the costs. Spanish power generators receive the difference from the government. As a result, the debt-ridden Spanish government is essentially on the hook for billions of dollars more, intensifying the difficulties for Spain to climb out of its fiscal hole.

But Germany, as the EU's largest economy and home to the world's most ambitious energy transformation, is the epicenter of the European debate.

Germany's "Energiewende" -- the transformation of its energy system from a soon-to-be-retired nuclear fleet to an array of solar panels and wind farms -- is a test case for whether "green" policies undergird, or undermine, economic growth. In Germany, the costs of the nascent transition already appear to be tipping the scales.

German residential power rates have risen from 34 U.S. cents a kWh to 39 cents in the last two years. Industrial rates rose from about 17 cents to over 19 cents a kWh in the same period. The tally for consumers and businesses from subsidizing renewable energy is $32 billion a year.

"I don't know any other economy that can bear this burden," Gabriel, the German energy minister, said. The German government plans to cap subsidies for green energy, even though that will do little or nothing to lower power bills in the meantime.

Big German industry groups have criticized the way the Energiewende has played out so far, calling for an end to open-ended subsidies for green power producers. But ironically, German industries have not had to pick up the tab for the costs of the transition to green power, most of which is borne by regular customers.

"I don't believe that the link that is often made between competitiveness and renewable-energy policies is really there," Brookings' Boersma said. "I think its very convenient for everyone who is not in favor of renewable to make that claim, but the industries that are at a competitive disadvantage are generally exempt and have all sorts of favorable conditions that would rule out making that link."

Indeed, a recent study by PriceWaterhouseCoopers found that European countries with aggressive climate policies, including Germany, can manage economic growth even while reducing energy use and greenhouse-gas emissions.

The danger, Boersma and others say, is that Europe may end up watering down its energy and climate policies to deal with economic fears that have little to do with subsidies for solar power or ambitious plans for wind farms. That, they say, could send muddled messages to investors, further clouding the investment climate in the energy sector precisely at a time when hundreds of billions of dollars are needed to make the clean-energy transition work.

Of course, if it's any consolation to European policymakers, Japanese and Chinese businesses are also grappling with rising energy costs. The post-Fukushima nuclear shutdown in Japan has led to a spike in costly, imported energy, which Japanese government officials say could drive business offshore. And China, which for years rode cheap energy and cheap labor to become the world's workshop, is steadily ramping up its own imports of pricey natural gas, even as rising labor costs on the coast push manufacturing into the Chinese interior and other countries in Southeast Asia.

But as Europe wrestles with just how to reconcile its environmental ambitions and its economic imperatives, the real irony is that the country that lacks any sort of energy policy at all -- the United States -- has managed to cut greenhouse-gas emissions, drive energy prices down, and jumpstart a manufacturing boom, all thanks to fracking.

Sean Gallup - Getty