East Asia has been most affected by the combination of sustained high oil prices and disruptions in the food supply. Japan, which imports all of its oil and remains heavily industrialized (along with South Korea), is obviously affected. But the most immediately affected is China, where shortages of diesel fuel have been reported. China’s miracle — rapid industrialization — has now met its Achilles’ heel: high energy prices.

China is facing higher energy prices at a time when the U.S. economy is weak and the ability to raise prices is limited. As oil prices increase costs, the Chinese continue to export and, with some exceptions, are holding prices. The reason is simple. The Chinese are aware that slowing exports could cause some businesses to fail. That would lead to unemployment, which in turn will lead to instability. The Chinese have their hands full between natural disasters, Tibet, terrorism and the Olympics. They do not need a wave of business failures.

Therefore, they are continuing to cap the domestic price of gasoline. This has caused tension between the government and Chinese oil companies, which have refused to distribute at capped prices. Behind this power struggle is this reality: The Chinese government can afford to subsidize oil prices to maintain social stability, but given the need to export, they are effectively squeezing profits out of exports. Between subsidies and no-profit exports, China’s reserves could shrink with remarkable speed, leaving their financial system — already overloaded with nonperforming loans — vulnerable. If they take the cap off, they face potential domestic unrest.

The Chinese dilemma is present throughout Asia. But just as Asia is the big loser because of long-term high oil prices coupled with food disruptions, Russia is the big winner. Russia is an exporter of natural gas and oil. It also could be a massive exporter of grains if prices were attractive enough and if it had the infrastructure (crop failures in Russia are a thing of the past). Russia has been very careful, under Vladimir Putin, not to assume that energy prices will remain high and has taken advantage of high prices to accumulate substantial foreign currency reserves. That puts them in a doubly-strong position. Economically, they are becoming major players in global acquisitions. Politically, countries that have become dependent on Russian energy exports — and this includes a good part of Europe — are vulnerable, precisely because the Russians are in a surplus-cash position. They could tweak energy availability, hurting the Europeans badly, if they chose. They will not need to. The Europeans, aware of what could happen, will tread lightly in order to ensure that it doesn’t happen.

As we have already said, the biggest winners are the countries of the Arabian Peninsula. Although somewhat strained, these countries never really suffered during the period of low oil prices. They have now more than rebalanced their financial system and are making the most of it. This is a time when they absolutely do not want anything disrupting the flow of oil from their region. Closing the Strait of Hormuz, for example, would be disastrous to them. We therefore see the Saudis, in particular, taking steps to stabilize the region. This includes supporting Israeli-Syrian peace talks, using influence with Sunnis in Iraq to confront al Qaeda, making certain that Shiites in Saudi Arabia profit from the boom. (Other Gulf countries are doing the same with their Shiites. This is designed to remove one of Iran’s levers in the region: a rising of Shiites in the Arabian Peninsula.) In addition, the Saudis are using their economic power to re-establish the relationship they had with the United States before 9/11. With the financial institutions in the United States in disarray, the Arabian Peninsula can be very helpful.

China is in an increasingly insular and defensive position. The tension is palpable, particularly in Central Asia, which Russia has traditionally dominated and where China is becoming increasingly active in making energy investments. The Russians are becoming more assertive, using their economic position to improve their geopolitical position in the region. The Saudis are using their money to try to stabilize the region. With oil above $120 a barrel, the last thing they need is a war disrupting their ability to sell. They do not want to see the Iranians mining the Strait of Hormuz or the Americans trying to blockade Iran.

The Iranians themselves are facing problems. Despite being the world’s fifth-largest oil exporter, Iran also is the world’s second-largest gasoline importer, taking in roughly 40 percent of its annual demand. Because of the type of oil they have, and because they have neglected their oil industry over the last 30 years, their ability to participate in the bonanza is severely limited. It is obvious that there is now internal political tension between the president and the religious leadership over the status of the economy. Put differently, Iranians are asking how they got into this situation.

Suddenly, the regional dynamics have changed. The Saudi royal family is secure against any threats. They can buy peace on the Peninsula. The high price of oil makes even Iraqis think that it might be time to pump more oil rather than fight. Certainly the Iranians, Saudis and Kuwaitis are thinking of ways of getting into the action, and all have the means and geography to benefit from an Iraqi oil renaissance. The war in Iraq did not begin over oil — a point we have made many times — but it might well be brought under control because of oil.

For the United States, the situation is largely a push. The United States is an oil importer, but its relative vulnerability to high energy prices is nothing like it was in 1973, during the Arab oil embargo. De-industrialization has clearly had its upside. At the same time, the United States is a food exporter, along with Canada, Australia, Argentina and others. Higher grain prices help the United States. The shifts will not change the status of the United States, but they might create a new dynamic in the Gulf region that could change the framework of the Iraqi war.

This is far from an exhaustive examination of the global shifts caused by rising oil and grain prices. Our point is this: High oil prices can increase as well as decrease stability. In Iraq — but not in Afghanistan — the war has already been regionally overshadowed by high oil prices. Oil-exporting countries are in a moneymaking mode, and even the Iranians are trying to figure out how to get into the action; it’s hard to see how they can without the participation of the Western oil majors — and this requires burying the hatchet with the United States. Groups such as al Qaeda and Hezbollah are decidedly secondary to these considerations.

We are very early in this process, and these are just our opening thoughts. But in our view, a wire has been tripped, and the world is refocusing on high commodity prices. As always in geopolitics, issues from the last generation linger, but they are no longer the focus. Last week there was talk of Strategic Arms Reduction Treaty (START) talks between the United States and Russia — a fossil from the Cold War. These things never go away. But history moves on. It seems to us that history is moving.

Source: The Geopolitics of Oil

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