Global Governance and World Energy Markets

NS4053 Week 5.2

Security implications of world energy market

• World energy markets periodically generate perception of insecurity for stakeholders. – What type of insecurity? For whom?

• Historically, reaction by key stakeholders to unpredictability has been to try to establish governance mechanisms.

• Which stakeholders and who gets to make the rules?

Evolution of Energy Markets Governance

• Ongoing struggle among stakeholders for the upper hand.

• Result is an international market that is (mis)shaped by efforts by stakeholders in both producing and consuming states to protect themselves.

• Patchwork quilt of international governance institutions try to address the cross-border effects.

Who sets prices?

ObsolescingBargains

Seven sisters set prices

OPEC sets

prices

MarketPrices?

Rise of theNOCs in2000s50/50

“Seven Sisters”

• Threat is that in a high fixed-cost/low variable cost industry, any drop below the cost of production is ruinous. – Perpetual issue with supply vastly exceeding

demand. – How to ensure prices remain above marginal costs

of production? Control costs and raise prices.• Market concentration ratio by 7 firms enables

tacit collusion.– In their self-interest to hold down production and

raise prices. The real issue is coordination.

“Seven Sisters” solution

• Control costs through vertical integration and advantageous deals with oil producing states.

• Coordinate to restrict supplies to drive up prices.– Control of major pipelines.– Interlocked boards with largest world financial institutions.– Shared pricing formulas.– Negotiated entry of new suppliers.– In the seven sisters self-interest to coordinate to restrict supply.

• System eventually slips under pressure from new entrants, rising demand, obsolescing bargains and collapses during oil shocks.

The OPEC alternative

• Example of difficulty of establishing supranational governance mechanisms.

• No central enforcement mechanism:– No Texas Railroad Commission

• Very easy to cheat• Difficult to coordinate (consensus voting)• Interests of members frequently at odds– Market position– Politics

Understanding lack of impact of OPEC

• Quotas have little significant impact on production• Depletion rate (reduced production) is significant but

problematic finding in a larger context.– Significant variables under Colgan model 2-4:

• Market position (oil rich vs. oil poor)• War• Corruption

– Not significant• OPEC membership• Sanctions• Regime type• Quotas

OPEC 1973 impact

• Raising posted prices to market prices.• Encouraging nationalization of oil industries.– Uncertainty for investors.– OPEC countries now control

production rates.• Claim to embargo certain

countries– Not empirically effective

• Psychological impact.

Persistence of beliefs about OPEC“They [OPEC] want to go in and raise the price of oil because we have nobody in Washington that sits back and says you’re not going to raise that f—-ing price, you understand me?”

— Donald Trump, April 2011

“You’ve got Donald Trump saying don’t pay OPEC $100 for the oil. Just tell them you’ll give them $50. Really? I go into Trump’s hotel, it’s $1,000 for a suite and I say I’m not going to give you that, I’ll give you $200. I’m on the street looking for another place to sleep. You can’t tell them I’ll give you $50 when the world market is $100. It just doesn’t work that way.”

– T. Boone Pickens , Feb. 2012

Why still focus on OPEC?

• Slow learning• Information asymmetries.– Complex market only understood by a few insiders

• Politically useful fiction for both OPEC and non-OPEC states.

Market pricing

• High prices in 1970s produce reactions by other stakeholders.

• Collapse of world energy demand breaks OPEC efforts to control prices.

• Market pricing predominates after 1986.• Increased privatization of energy industries through

1990s.• This mechanism still prevails, although higher prices

have revitalized national oil companies and created new fears about market politicization.

Governance issues going forward

• Securing a reliable international market for energy.– Preserve ability to enter into and enforce contracts across

borders.– Preserve security of energy production and distribution

channels.– Increase market information availability to reduce fear (and

fear mongering).– Reduce manipulation of markets by governments and other

stakehodlers in producing and consuming countries.– Deal with cross-border consequences of externalities.– Enable sharing of innovation (for efficiency and development)

while protecting intellectual property.

Problems

• Classic problems: free riders, public goods, commons, externalities.

• Globalization has added complexity.– Many more stakeholders demanding a say in

eventual solutions.• Mismatch between global nature of problem

and national locus of sovereignty.• Poorly organized institutional framework to

address issues.

Possible answers

• Inter-governmental institutions

• Summitry– Coordinate action by government leaders

• International financial institutions

• International public-private partnerships

Cases• International Energy Agency:

– facilitation, transparency, expertise, agenda setting, but not a lot of power.

• G8 Summits: – theoretically, meet the deciders. – In practice, decide to delay and dissemble.

• Regional development banks:– Money talks.– Good governance and technical assistance.– Have to make a return to continue to exist.

• REEEP hybrid– Voluntary– Invest in expertise. Focus on pilot programs that can diffuse.

Security implications

• Access and reliability– A major problem is disinformation, market psychology, rumors.

• Better information leads to better markets.

– Protect a reliable international contracting mechanism.• Tied back to issue of market politicization.

– Discourage market manipulation by governments.• Efficiency

– Technical expertise, information sharing, best practices.• Sustainability

– Future access through coordinated action? How? – Still have not answered the question of who pays.