Russian-EU Energy Relations

With global energy needs growing at an unprecedented rate, the world has come to consider Russia as an increasingly important source of energy. Holding substantial oil and natural gas reserves, Russia stands as an attractive option for a world desperately in search of new sources of energy. Against this backdrop, Europe has become increasingly dependent on Russian energy imports, leading many analysts to view such a relationship as a dangerous predicament rather than a mutually beneficial exchange. As key allies to the United States, Europe’s energy dilemma stands as a mounting issue that may not only affect the region, but also the broader transatlantic alliance. Hence, this post seeks to analyze Russia’s reliability as a source of energy supply to Europe. In doing so, this post will first examine Russia’s current energy situation with regards to its oil and natural gas sectors, energy strategy, and infrastructure. This post will then analyze Russia’s political dynamics with Europe, examining if such a dependence on Russian energy is problematic for the region.

The current substantial rise in global crude oil prices reflects the insatiable energy demands of an expansive world economy being nourished by only moderate energy supplies. While global oil consumption rose by 1.1 million barrels per day (bbl/d) in 2006, the Organization of Petroleum Exporting Countries (OPEC) announced plans to cut production in the same year by 1.2 million bbl/d. Concurrently, non-OPEC production has been unable to keep pace with global oil demand, with production declines evident in Mexico, the United States, Norway, and the United Kingdom. Such a decline in production vis-à-vis high demand has led crude oil prices to rise substantially to an unprecedented US$ 96.32 in November of 2007.

Within such an unbalanced scenario, it is of little surprise that the outside world has increasingly turned its attention to alternative suppliers like Russia. As the Energy Department stated in its short-term outlook, “Russia and other countries of the former Soviet Union combined are projected to account for nearly half of the gain in non-OPEC supplies in 2008.” Such a renewal of interest in Russia’s energy resources has had direct effects on the country’s output. Russia’s total liquids production has increased substantially in comparison with its relatively low production in the mid 1990s, experiencing a turnaround in output in 1999.

Relative to OPEC producers, Russia’s output is also seen as a significant source of energy. While OPEC production growth was negative in 2006 and 2007, Russia and Caspian Sea production levels were concurrently positive, signaling the country’s role in compensating for OPEC’s lower production levels. Despite the Energy Department’s forecast of a substantial increase in OPEC production in 2008, current news reports indicate otherwise, as OPEC’s main producer, Saudi Arabia, has recently rejected lifting OPEC oil supply. Thus, the demand for Russia’s energy exports is likely to remain in the short term.

Given Russia’s role as an energy supplier, what is the country’s energy situation? What are the Russian oil and natural gas reserves that have acquired the world’s attention and demand? Furthermore, what are Russia’s production levels relative to increased world consumption? The largest country in the world, Russia is located over a landmass of considerable oil and natural gas endowments. Holding around 60 billion barrels of proven oil reserves, Russia’s oil reserves are the eighth largest in the world. Most of the country’s oil is located in Western Siberia, between the Ural Mountains and the Central Siberian Plateau, although Eastern Siberia has been reported to have some 35 million barrels of oil. With such oil endowments, Russia ranked second behind only Saudi Arabia as the world’s top oil producer in 2006, producing approximately 3.5 billion barrels that year. Despite Russia’s significant oil production, the country’s true energy potential lies in its abundant natural gas reserves. The largest gas endowments in the world, Russia’s 1,680 trillion cubic feet of natural gas reserves are twice as large as those of Iran, which has the world’s second largest reserves. In 2004, Russia was the world’s largest natural gas producer (22.4 trillion cubic feet (Tcf)), as well as the world’s largest exporter (7.1 Tcf). In 2006 Russia was the second largest producer, behind the United States but ahead of large producers in the Middle East.

Russia’s substantial production of oil and natural gas has had a positive impact on the country’s economy. Comprising 20 percent of Russia’s GDP in 2005, the oil and natural gas sectors generated 60 percent of Russia’s revenues and 30 percent of the country’s foreign direct investment that year. In 2007, the sectors’ share of GDP has risen to 64 percent of Russia’s revenues. A possible correlation between increased production levels and a rise in GDP is seen in Russia’s GDP values starting in 1999, when the country’s production levels began to rise. Although Russia had experienced a persistent decline in GDP from 1991 to 1999, the country began to experience a consistent rise in GDP since 1999, from US$ 195 billion to the current value of US$ 986 billion. Thus, it is possible that high oil prices may have substantially contributed to Russia’s recent economic expansion.

But all the positive effects of energy production on Russia’s economy also demonstrate the country’s current dependence on oil and natural gas. Russia is highly vulnerable to fluctuations in world oil prices. It is reported that an annual US$1 per barrel increase in Urals blend oil prices raises federal budget revenues by 0.35 percent of GDP. Russia’s widening current account balance also reflects its economic dependence on high oil prices. As stated in a World Bank report, record oil prices pushed Russia’s current account to a record high of US$ 56.5 billion, a 32 percent increase from the first half of 2005. Russia has registered a substantial increase in its current account surplus since 1999, having increased concomitantly with Russia’s GDP and production levels.

While trading the currently high-priced hydrocarbon commodity can bring quick income to the government, economic dependence on the oil and natural gas sectors places the economy in the hands of volatile resource revenues. As stated in an in-depth study of the Russian energy sector by the Swedish Ministry of Defense:

Russia’s reliance on … hydrocarbons … demonstrate[s] that there is a risk of … a ‘resource curse’ … which bring[s] along risks of long term problems in terms of trade, revenue volatility, ‘Dutch disease,’ [and] crowding out effects.

In terms of resource volatility, the World Bank report on Russia’s economy concluded that a sharp fall in oil prices could lead to a steady evaporation of Russia’s current account surplus, and quickly push the country’s balance of payments into deficit. Therefore, while in the short-term Russia’s economic boom is feasible, its sustainability in the medium to long term might heavily rely on high oil prices.

Given the importance of energy to Russia’s economic expansion, it is of little surprise that the Russian government regards energy resources and economic security as closely linked. According to Russia’s latest energy strategy, published in 2003, the government’s key objectives is to strengthen the position of Russia in the global energy market, maximize the efficiency of Russia’s energy exports, and ensure that Russian companies have equal access to foreign markets, technology, and financing. Such an endeavor demands full attention of the Russian government in order to ensure Russia’s energy security – an important feature of Russia’s national security.

Hence, since the “Yukos affair” in 2003, Russia has been increasingly incorporating the energy sector under state control. The dismantlement of Russia’s largest private oil company, Yukos, unleashed a reorganization of Russia’s oil and energy sector that has led to the strengthening of the state’s position in energy. Non only did the state purchase most of Yukos’ assets, making the state-owned company Rosneft the largest in Russia, but the Kremlin also carefully placed members of President Putin’s inner circle in key positions in strategic companies. As stated by a study conducted by the Polish Centre for Eastern Studies, “these nominations were not just about granting lucrative posts to the president’s people; above all it was a sign that these same people were to coordinate the Kremlin’s new policy towards the oil sector.”

The Russian government’s presence in the energy sector is tangibly noticeable in Russia’s two major state-owned energy companies, Gazprom and Transneft. Responsible for 90 percent of Russia’s natural gas output and all of the country’s domestic and international gas pipeline networks, Gazprom stands tall as one of Russia’s most important energy players. The largest gas company in the world, Gazprom has no valid natural gas competitors both domestically and abroad, holding 17 percent of the world’s proven gas reserves, and producing 19.4 percent of global natural gas output. It is of little surprise, therefore, that a company of such stature in Russia is managed by a number of Russian officials close to President Putin. These officials include the First Deputy Prime Minister Dmitry Medvedev, the Minister for Economic Development and Trade, German O. Gref, the Minister for Industry and Energy, Viktor Khristenko, and the special representative of the President for International Energy Cooperation, Igor Yusufov.

In the oil sector, apart from owning Russia’s largest oil company, Rosneft, the government exercises control over the sector’s pipeline system. As noted by the Swedish Defense Ministry, “in short, the Kremlin controls the oil tap.” Controlling crude oil transport by pipeline, state-owned Transneft monopolizes a highly strategic segment of Russia’s oil sector. As the case with Gazprom, Transneft’s board of directors is comprised of key Kremlin officials, namely the head of the President’s Expert Department, Simon Vainshtock, the Deputy Minister for Industry and Energy, Andrev Dementiev, the Deputy Head of Russia’s Federal Property Management Agency, Yuri Mevedev, and the Minister of Industry and Energy, Viktor Khristenko.

Given Russia’s energy situation and strategy, who are Russia’s main consumers? Following Russia’s oil and natural gas pipelines will lead the analyst straight in the direction of its most important market, Europe. Although Russia’s oil and natural gas pipelines are spread out across Eurasia, these pipelines reach out to most of Eastern and Western Europe. With 80 percent of Russia’s oil exports and 60 percent of the country’s natural gas flowing to Europe, the region is evidently an important market for Russian energy exports. Last year, of the almost 4 million bbl/d of Russian crude oil exports, 33 percent flowed through the Druzhba pipeline alone, providing Belarus, Ukraine, Germany Poland and other destinations in Central and Eastern Europe, such as Hungary, Slovakia, and the Czech Republic with Russian crude oil. In terms of natural gas supplies, Gazprom has shifted much of its exports to serve the rising demand of the European Union. European countries comprise the majority of Gazprom’s consumers, as well as the largest amount of Russian natural gas exports.

Such a situation - whereby Europe has become increasingly dependent on Russian energy imports while Russia has increased control over its energy sector - is seen to have set the stage for Europe’s energy dilemma. Europe’s vulnerability to Russian energy imports was made most obvious and alarming during the Russia-Ukraine natural gas dispute in 2006. The Ukrainian gas pipeline system plays a strategic role as an intermediary connecting Russia to growing European markets, with 80 percent of Russia’s natural gas exports to Europe transiting through Ukraine alone.[1] When a longstanding dispute over price and payment mechanisms between Gazprom and Ukraine reached an impasse, the Russian company shut off gas supplies to Ukraine, affecting consumer countries in Europe. Currently only two natural gas pipelines reach Europe from Russia – one through Belarus, another through Ukraine – making Ukraine’s location strategically important for Russia’s natural gas exports.

While some analysts argue that Gazprom’s move was entirely business-driven - since Ukraine still paid a cheaper price for Russian natural gas than its real market value - others contend that state-controlled Gazprom served as a foreign policy tool for the Russian government. As Ukraine had recently undergone the pro-Western Orange Revolution, ousting a pro-Russian government, some viewed such cut-offs as a foreign policy lever to punish the newly pro-Western Ukraine for politically distancing itself from Russia’s sphere of influence.

What does the Russia-Ukraine natural gas dispute mean for Europe? Some analysts are increasingly concerned that if Russia’s main motivation in cutting-off natural gas supplies to Ukraine was politically driven, then energy-dependent Europe could find itself in a similar predicament. Most alarming is the fact that many large European countries are particularly dependent upon Russian gas. Gazprom’s largest consumer of Russian gas in Western Europe, for example, is Germany, the region’s leading economy, with 43 percent of its imports coming from Russia alone. As Ukraine and Belarus pipelines connect Russia to Germany, any stalemates in Russian relations with both Eastern European countries can significantly impact Germany’s - and Europe’s - economic stability. As other major countries in Europe, such as France, Austria, and Italy, also import significant amounts of natural gas from Russia, this destabilizing effect could also occur in these countries. Thus, it is evident that should geopolitical events in the future lead Russia to politically coerce Europe, Russia would have the necessary tools (namely Gazprom and Transneft) at its disposal to do so.

Several analysts judge that the former Soviet giant’s strategy is to make Europe increasingly dependent on Russian oil and natural gas. Russia expert Ariel Cohen at the Heritage Foundation claims that the country is consolidating its grip on Europe’s economic lifeblood by locking in demand and supply of oil and gas, and consolidating its control of alternative sources of gas supplies from Central Asia. On the demand side, Cohen points out that Russia has locked in European demand by signing long term bilateral contracts with most European countries, including France, Germany, Italy, and Austria. On the supply side, Cohen refers to Russia’s increased control of strategic pipelines throughout Europe and Eurasia, with Gazprom purchasing strategic infrastructure in Georgia, Hungary, Ukraine, Slovakia, while actively opposing Western-controlled pipeline projects linking Central Asia to Europe. For example, in a May 2007 deal with Turkmenistan and Kazakhstan Russia thwarted a US-EU plan for a trans-Caspian pipeline that would have enabled Central Asian oil exporters to bypass Russian-controlled routes by way of Caspian Sea-Turkey direction; the Prikaspiiski gas pipeline will carry gas from Turkmenistan to Russia via Kazakstan. In Europe, Russia is constructing the Nord Stream pipeline that will link Germany directly with Russian gas through the Baltic Sea, circumventing Ukraine, Belarus, and Poland.

Against this backdrop, it has been increasingly noticeable in the media that Russia’s foreign policy has become more assertive. As frequently noted in daily news reports, the list of confrontations with the West has been growing – leading some to refer to the post-Cold War period as a “Cold Peace.” Russia’s assertiveness in foreign affairs is evidenced in mounting recent developments, such as Russia’s
– Opposition to the U.S.-proposed missile shield
– Cyber attack on Estonia
– Spy scandal dispute with Britain
– Russian bomber violations of Norwegian airspace
– Refusal to sanction Iran on uranium enrichment
– Explosion of the largest-ever non-nuclear bomb in October
– Control of natural gas to Europe.
These developments indicate that Russia’s energy-driven economic boom has given the country a newly-found confidence that is driving Russia to project itself more assertively in international affairs.

If Russia’s strategy to increase Europe’s dependence on Russian energy imports is the case, then it follows that such dependence could complicate the transatlantic alliance between Europe and the United States. Ariel Cohen believes that Europe’s dependence will significantly limit the region’s ability to cooperate with the United States with regards to issues that Russia disagrees on; Europe’s dependence might force the region to choose between an affordable and stable energy supply on the one hand, or siding with the US on key issues on the other.

Yet, what is the likelihood that Russia would use energy as a foreign policy tool of coercion against Europe? Russia’s 2003-2020 energy strategy recognized Europe as a vital source of economic safety for the country and focused on Russia’s reliability as an energy supplier to its most important market.

During the forthcoming 20 years, we have to realize the export abilities of Russian fuel energy complex and secure the economic safety of the country, remaining the stable and reliable partner for the European countries … The market of Central and Western Europe remains one of the greatest markets in the forthcoming 20 years.
Thus, given the importance of European markets for Russia’s economic sustainability, one can also say that Russia is just as dependent on Europe as Europe is dependent on Russia. A situation of mutual dependence arises whereby each party provides the lifeblood for the other’s economy – with European demand providing for Russian economic growth, and Russian energy sustaining European economies. Writing for the British Ministry of Defense, Michael Fredholm noted that

… even if Russia for political reasons felt obliged to take such a drastic step, disregarding the negative political fallout with the EU, the decision would drastically reduce revenues from export and thus be counter-productive to the Russian ability to go it alone.

Yet, Fredholm also notes that while in the short term this mutual dependence will constrain Russia from exercising political or economic pressure on Europe, mutual dependence will only go so far as long as both parties perceive a need for each other. “He who has nothing to lose will not hesitate to break a relationship of mutual dependence,” writes Fredholm. Thus, in the long term, geopolitical or economic situations may arise that call for Russia to change its political position towards Europe. Such situations could include Russia’s economic diversification and independence from energy commodities, or an eventual political crisis with the United States stemming from the aforementioned geopolitical developments that continue to tarnish Russia’s relations with the West.

Conclusion

The search for new energy supplies has interwoven Europe and Russia into a relationship of mutual dependence. While Russian oil and natural gas imports provide much of the lifeblood of European economies, Russian energy exports are largely sustaining the current Russian economic growth. Such dependence on Russian energy supplies, particularly natural gas, has led many analysts to worry about Europe’s potential vulnerability to Russia’s grip on energy. Yet, in the short term Russia is unlikely to wield energy as a foreign policy lever over Europe, as it currently streams revenues into Russian coffers while Russia pumps energy into European countries. In the long term, however, the tables may turn depending on how this former Soviet giant perceives the geopolitical realities around it, and if it is able to diversify its economy enough to become less dependent on exports of high-priced commodities.

Nevertheless, the ongoing political and economic ramifications of insufficient OPEC production on Eurasia persist without a pause; as oil prices tilt evermore toward US$ 100 a barrel, Russia expands its grip across Eurasia, while a thirsty Europe braces itself for an unpredictable future.

Smooth Sailing Through Turbulent Waters: Brazil’s Current Energy Situation

Record oil prices have cast an ominous shadow on the world, as insufficient production has been unable to keep up with the roaring advancement of global oil demand. Meanwhile, Brazil has recently declared self-sufficiency in oil, made the world’s biggest oil discovery in 7 years, and has greatly diversified its energy portfolio, especially with the substantial use of biofuels. While many net importing countries debate energy security measures, Brazil has made energy self-sufficiency a growing reality. As Brazil’s changing energy situation has propelled it into the international spotlight, with various countries looking south to emulate Brazil’s example, this post seeks to give an overview of the country’s current energy situation, looking specifically at Brazil’s oil, natural gas and biofuels sectors.

To understand the relevance of Brazil’s energy situation, one must first understand the country’s resource endowments and consumption levels in comparison to the rest of Latin America and the world. Brazil is the largest country in Latin America and the fifth-largest country in the world in terms of surface area. As such, it is endowed with vast energy and natural resources, which include Latin America’s second biggest oil reserves (11.7 billion barrels) after Venezuela, as well as the region’s fourth biggest natural gas reserves (306 billion cubic meters), after Venezuela, Bolivia, and Argentina. Its vast surface area also holds powerful water resources that are harnessed to produce hydroelectricity, as well as crop lands that produce sugarcane for one of the world’s largest ethanol production.

As the world’s tenth biggest economy in GDP terms,as well as the world’s fifth most populous country, Brazil is a big energy consumer. With a population of 188.6 million, Brazil is Latin America’s largest consumer of energy, accounting for over 40 percent of the region’s primary consumption in 2004. Beyond Latin America, the magnitude of Brazil’s energy consumption makes the country the world’s 10th largest energy consumer, as well as the third largest in the Western Hemisphere, behind the United States and Canada only. Hence, Brazilian energy consumption levels are as substantial as its vast natural resources and surface area.

Given Brazil’s energy resources and consumption levels relative to the region and the world, what is the composition of Brazil’s current energy matrix? A review of the country’s energy mix in the past 20 years reveals three significant patterns. The first pattern is the substantial share of biomass in the country’s energy matrix. From 1980 to 2004 biomass has accounted for an average of 31 percent of Brazil’s energy matrix, varying from 34 percent in 1980 to 27 percent in 2004. According the International Energy Agency (IEA), biomass will continue to maintain its significant share of Brazil’s energy matrix in the next twenty years.

The second noteworthy pattern in the Brazilian energy mix is the increased use of natural gas over the years. While natural gas consumption accounted for 1 percent of the Brazilian energy matrix in 1980, it comprised a significant 8 percent of Brazil’s total energy use by 2004. The IEA predicts that natural gas consumption will continue to rise in the next 20 years, accounting for 12 percent of the Brazilian energy mix by 2030.

As biomass and natural gas have gained ground, oil consumption has concurrently declined over the years. While oil accounted for 50 percent of Brazil’s energy use in 1980, by 2004 oil use had declined by 8 percentage points to 42 percent. This third pattern is of significance as it demonstrates how energy diversification policies in Brazil have allowed the country to progressively become less dependent on oil. Even though oil is expected to still maintain its considerable share of Brazilian total energy use, other sources of energy are continuing to offset traditional oil consumption patterns.

What have been the government policies behind the evolution of Brazil’s energy consumption patterns? As noted above, biomass has made a significant contribution to the country’s energy matrix, accounting for approximately a third of Brazil’s energy use over time. As the world’s second largest producer and leading exporter of ethanol, Brazil’s ethanol production has significantly contributed to the expansion of biomass in the Brazilian energy matrix. How has biomass come to occupy such a significant share of the country’s energy use?

While countries today are analyzing the feasibility of biofuel production programs, Brazil launched its first ethanol program over 30 years ago in 1975. The National Alcohol Program, ProAlcool, began as a response to soaring oil prices and a crisis in the international sugar market. While international sugar prices were at an all time low, the first oil crisis caused oil prices to rise by 328 percent in less than two years, from US$ 2.91 in September 1973 to US$ 12.45 in March 1975. This combination of events incentivized the government to search for new fuel sources as well as for a renewed stimulus for its large sugar production. From 1975 to 1979, the Brazilian government provided funds to help construct distilleries near existing sugarcane mills, and embarked on a massive campaign to promote synergies between sugarcane growers and ethanol producers.

Although ProAlcool began in the mid 1970s, it would only gain momentum after the second oil crisis, in 1979, when Brazil’s continued vulnerability to oil shocks became exposed. With a strong political will to enhance the national program, the government designed several incentives to lure sugarcane producers, car manufactures, distillers and others to adjust their operations to produce ethanol. With such incentives, Brazil was able to develop a substantial ethanol industry by the 1980s. It is reported that in 1987 ethanol production in Brazil had increased by 290 percent from the late 1970s, producing 15 billion liters in 1987. Thanks to high subsidies and other government incentives, 92 percent of new car sales between 1983 and 1988 were alcohol-fueled.

Yet, the ethanol boom in Brazil experienced an external shock when the main factors that originally incentivized the government to invest in ethanol production changed. While declining oil prices in the mid-1980s made ethanol production less economically viable, rising sugar prices in 1989 led sugarcane growers to divert crops to sugar exports. As declining ethanol production was unable to satisfy ongoing demand generated by the spread of alcohol-fueled vehicles, consumers lost confidence in the reliance of ethanol, which greatly discredited ProAlcool. By the end of the 1990s, ethanol-fueled vehicles accounted for less than 1 percent of Brazil’s total car sales.

Ethanol became once again an attractive option for both producers and consumers in 2003, when car manufacturers introduced the “flex-fuel” vehicle. This new technology allowed consumers to switch from ethanol to gasoline, or vice-versa, in accordance with fuel prices and preferences. This flexibility allowed consumers to regain confidence in ethanol, which became an even more attractive fuel with record oil prices. Hence, ethanol production in Brazil regained impetus in 2003, and has now reached approximately 18 million liters in 2006-2007. Flex-fuel vehicles have become such an attractive option for consumers in Brazil, that it now comprises 86 percent of the Brazilian auto market, and 91 percent of all passenger vehicles in the country.

While Brazil has experienced a growth in ethanol production and consumption, the country has also experienced a rise in natural gas demand. As natural gas is mainly used in Brazil’s industrial sector, high oil prices have led industries to demand more natural gas as a substitute for oil. However, unlike ethanol, much of the demand for natural gas is supplied by imports; natural gas production has grown slowly in recent years due to an underdeveloped domestic transportation infrastructure that connects regions to the coast but not to one another, as well as low domestic prices that do not appeal to producers. Low domestic prices, however, are part of an explicit government policy to diversify energy sources. Hence, as low domestic natural gas prices preclude domestic producers from producing natural gas to their full potential, Brazil has increasingly relied on imports from Bolivia and Argentina.

Of the two countries from which Brazil imports natural gas, Bolivian imports represent one of Brazil’s current problems in terms of energy self-sufficiency. Bolivian natural gas comprises a considerable share of Brazilian imports, accounting for 42 percent as of 2006. Yet, on May 1, 2006, Bolivia declared its hydrocarbon nationalization decree, which established the transfer of ownership and possession of 100 percent of oil and gas production in the country to the state-owned company Yacimientos Petroliferos Fiscales de Bolivia (YPFB). This decree affected Brazilian investments in the country, as following the nationalization, Bolivian troops proceeded to seize gas fields and installations, including two Brazilian-owned refineries and their associated downstream operations. Ongoing talks between the two countries have revolved around prices of natural gas imports, which Bolivia seeks to increase by 80 percent, and compensation for Brazilian investments in the country.

This decree has created a conundrum for Brazil’s policy of importing natural gas, as much of Bolivian gas supplies Brazil’s burgeoning industries in the southeast of Brazil. To reduce the country’s vulnerability, Brazil plans to accelerate the development of its domestic natural gas resources to supply its growing southeast market. At the same time, however, Brazil declared recently that it will invest between US$ 750 million and US$ 1 billion in Bolivian natural gas, stating that it is “willing to invest in Bolivia especially because of demand for natural gas in Brazil,” and thus accepts “a risk for investment in the countries like Bolivia” (sic). Hence, despite Brazilian policy to diminish its vulnerability to Bolivian gas, the necessity of supplying the country’s voracious industry has led Brazil to not only maintain its import policy, but to also invest in it. Yet, as Brazil imports 72 percent of Bolivia’s total gas production, the latter is inexorably dependent on Brazil for much of its revenue, making both countries interdependent at least in the short-run.

The increase of natural gas and biofuels in the Brazilian energy matrix may have contributed to the diminished use of oil in Brazil over the years, although such correlation cannot be demonstrated without a statistical regression analysis. As seen previously in figure 3, oil consumption has declined over the years, from comprising 50 percent of the Brazilian energy matrix in 1980 to accounting for 42 percent in 2004. As government policies allowed for greater accessibility of alternative fuels, ethanol was reported to have substituted approximately 230 billion liters of gasoline, while high oil prices have led industries in Brazil to increasingly use natural gas.

In line with Brazil’s policy of becoming more energy self-sufficient, the government has reorganized the oil sector in an effort to become less dependent on foreign sources of oil. Brazil’s oil sector has undergone profound regulatory and structural changes in the last decade. Created in 1953, Brazil’s national oil (and natural gas) company, Petrobras, had enjoyed exclusive rights to explore and produce oil and natural gas in Brazil. This situation changed in 1995 when Brazil adopted the Ninth Amendment to the Brazilian Constitution, allowing other companies to become involved in oil exploration and production. Two years later, further significant changes were adopted with the Oil Law of 1997, whereby a legal and regulatory framework for the oil industry was established, creating Brazil’s national regulator for the industry, the Agencia Nacional do Petroleo (ANP). ANP is now responsible for issuing exploration and production licenses, as well as ensuring compliance with Brazilian regulations.

Although Brazil’s national oil company competes with 50 other companies that have received exploration and production rights in Brazil, Petrobras remains the country’s dominant player in the oil sector. Although the company is no longer state-owned, it is nevertheless state-controlled, with the government retaining 55.7 percent of Petrobras’ voting shares, as shown in figure 6. Petrobras has also inherited most of the country’s exploration and production projects, controlling 95 percent of Brazil’s crude oil production and holding majority positions in up-, mid-, and downstream activities.

Despite Petrobras’ de facto monopoly of the Brazilian oil sector and the government’s significant control of the company, Petrobras has demonstrated large efficiency gains since the liberalization of the Brazilian oil sector. The company has received international recognition for its technical efficiency and expertise in deepwater offshore drilling technology and production. Petrobras’ deep-water and ultra-deep-water exploration have yielded substantial discoveries that have significantly contributed to Brazil’s growing oil reserves. Oil reserves are reported to have increased nearly eightfold from 1980 to 2005.

Recently, Petrobras’ technical expertise has allowed the company to make the world’s biggest oil field discovery in 7 years, discovering 5 to 8 billion barrels of oil in the Tupi oil field, in Brazil’s Santos basin. The magnitude of such a discovery can be better appreciated when compared to other countries’ current proven oil reserves, as the Tupi field holds the equivalent amount (or more, if greater than 5 billion barrels) of Ecuador’s proven oil reserves. The recent discovery has, therefore, substantially added to Brazil’s 11.7 billion barrels of proven oil reserves. Further substantial discoveries are expected, as Petrobras has recently announced the possible existence of an even bigger field neighboring the Tupi oil field, expected to be five times larger than the Tupi.

Concurrent with these new discoveries, Petrobras’ production has also contributed to Brazil’s oil self-sufficiency. Oil output in Brazil is reported to have nearly doubled since the 1990s, reaching 1.7 million barrels per day in 2006 and 2.1 million barrels per day in 2007. Such an increase in production is largely attributed to Petrobras, which controls over 95 percent of crude oil production in Brazil. As shown in figure 8, Brazil’s oil production and consumption levels had been narrowing over the years, and finally on April 21st, 2006 - the anniversary day of Tiradentes, the country’s independence hero – Brazilian President Luis Inacio Lula da Silva proclaimed the country’s self-sufficiency in oil, an achievement sought by the Brazilian government since the country’ reorganization of the oil sector.


Conclusion
This post has sought to explain the internal mechanisms driving Brazil’s recent accomplishments in energy self-sufficiency. Such accomplishments have been achieved due to a combination of resource endowments and government policies. However, despite Brazil’s vast resources, the country has only begun to achieve self-sufficiency after the government established policies to diversify its energy matrix. Exogenous factors such as high oil prices have certainly provided the initial impetus to launch such policies. Yet, the technological outcomes of such government policies have sustained much of the momentum. With new technology in the form of flex-fuel vehicles for Brazilian transportation, and Petrobras’ growing expertise in deepwater offshore drilling technology and production, Brazil’s dependence on foreign sources of energy has progressively diminished.
Although Brazil’s “Achilles heal” lies in its imports of natural gas from Bolivia, the country nevertheless remains in a comfortable position as Bolivia’s most important customer. This position, therefore, allows Brazil to set the tone of future negotiations while it reconsiders the Bolivian dilemma as well as its domestic natural gas potential. With new oil field discoveries led by Petrobras, the natural gas conundrum may be resolved if substantial natural gas reserves are concurrently located. New discoveries together with complications in the Bolivia-Brazil natural gas relationship may provide further political will for Brazil to invest in its domestic distribution network for natural gas, an outstanding issue in Brazil’s energy matrix.

Yet, despite the natural gas dilemma, Brazil’s energy policies have paid dividends for the country’s energy situation. As the volatility of fossil fuels have led many net importing countries to debate the best policies to achieve greater energy security, Brazil stands as the vanguard country in devising policies to achieve such goals. Hence, the Brazilian experience serves as a model not only for energy diversification efforts, but also for efficient government policies.

Moving Past Corn-Based Ethanol

In his State of the Union Address, President Bush called for a reduction of 20 percent in the use of gasoline in ten years, hoping to increase the supply of alternative fuels in 2017 to 35 billion gallons. Though the initial goal was to reduce oil dependence from unstable regions of the world, the use of corn-based ethanol invariably created a detrimental economic side effect, as it increased food prices at home. The same happened in China and Mexico, leading many to believe that corn-based ethanol is not the answer to a nation's energy needs.

In the U.S., here’s how it happened. In order to meet such goals, the government offered a 51-cent-per-gallon excise tax credit to refiners, thus stimulating domestic production of ethanol. This increased production, in turn, lead to higher demand for corn, the main feedstock for ethanol in the United States. Increased corn demand incentivized U.S. farmers to divert their crops to the production of ethanol, rather than for human and cattle consumption. A higher demand for corn thereby lead to higher corn prices, as farmers looked into cashing in on this increased demand. As corn prices increased so did food prices in general, with corn being used not only to feed cattle, but also as an ingredient in several food products.

A more viable option to corn-based ethanol is sugar-based ethanol from Brazil and the Caribbean. As sugar-based ethanol is not produced from a staple feedstock, it does not cause the invariable effect of raising food prices. Moreover, sugar-based ethanol is more energy and cost- efficient than corn-based ethanol. U.S. ethanol from corn costs $1.05 per gallon to produce, while Brazilian ethanol from sugar cane costs 81 cents per gallon to produce. U.S. ethanol production from corn, per acre, yields about 400 gallons, while Brazilian ethanol production from sugarcane, per acre, yields approximately 590 gallons.

Even though Brazilian sugar-based ethanol is more energy and cost-efficient than U.S. corn ethanol, the U.S. government continues to impose a 54-cent tariff on Brazilian ethanol imports, thus providing protection to the inefficient domestic production of corn-based ethanol. Brazil, however, is able to circumvent the tariff by exporting ethanol through the Caribbean, which is able to export products (including ethanol) duty free to the United States under the Caribbean Basin Initiative (CBI). Yet, only up to 7 percent of the U.S. market (or 60 million gallons a year, whichever is greater) may be supplied with duty-free ethanol imports. Ethanol imports from the Caribbean Basin Initiative have so far been below the 7 percent cap, despite the 900 percent increase in Brazilian ethanol exports to the United States in 2006.

If the United States is to achieve the goals set forth by president Bush, it must at least diversify its sources of ethanol. Protecting an inefficient corn-based ethanol production will not lead this nation to greater fossil fuel independence, as such policies inevitably serve to protect the interests of corn farmers rather than national security. Investing in the Caribbean’s capacity to produce ethanol will generate greater benefits, as it will increase jobs in the region, as well as imports of cost- and energy-efficient ethanol.

Fossil fuel independence will only be reached through the use of sustainable sources of energy. Currently, corn-based ethanol does not provide the answer to our fuel needs. Tax payer dollars should be diverted to further research of alternative sources of ethanol, such as cellulosic ethanol, which is more energy efficient, but still requires greater investment in technology to become viable. Meanwhile, the tariffs and limits on ethanol from imported ethanol should be lifted, allowing for greater imports of high-efficient sugar-based ethanol. Energy security requires this choice – it’s not politics, it's common sense.

Cultivating the Seed of Conflict

Last week, the President of Bosnia, Dr. Haris Silajdžić, came to speak at a local event here in Washington, DC. Apparently disappointed with the lack of world attention to the International Criminal Court's recent ruling on the Bosnian genocide, he eloquently pleaded with the crowded conference room that all attending academics, politicians, and businessmen be attentive to the internal affairs of this small Balkan nation. Bosnia & Herzegovina, he said, remains a perilously divided nation, a result of the Dayton agreement, which split the warring factions into two entities - a joint Federation of Bosnia and Herzegovina (a mostly Bosniak and Croat entity), and the mostly Serbian Republica Srpska. The result of this constitutional situation was a divided nation in every aspect - a divided government, a divided economy, a divided educational system, a divided society. Such current divisions not only severely restrain any necessary reforms in the country, but, when combined with an apparent international disinterest toward Bosnia and Herzegovina, are ripe ingredients for a future conflict between Bosnians, Serbs and Croats, as divisions emphasize differences rather than commonalities.

Within these internal differences lie the seed of a conflict with international aspirations. As the ICC found Serbia guilty of not preventing genocide in the ethnic cleansing of Bosnian Muslims - rather than finding Serbia guilty of genocide - President Silajdžić argued that the ruling had served to disparage the suffering of Bosnian Muslims a decade ago. Understanding that Iraq is inevitably occupying the current spotlight of international affairs, President Silajdžić nevertheless rhetorically asked "Should there be more important nations than others? Should there be more important people than others?" Failing to acknowledge the genocide of Bosnian Muslims, who already live in a divided society, may fuel frustration and resentment, leading to a fertile soil for Islamic extremism in the Balkan nation, retorted Silajdžić

Thus, while the world looks east to the explosive insurgency in Iraq, conflict may be quietly brewing closer to home. Should a conflict erupt in the Balkans, or a terrorist attack emanating from frustrated Bosnian Muslims astonish us all, President Silajdžić forewarning may well come to be seen in the future as ephemeral words that quickly dissipated in a world overly preoccupied with Iraq.