Fossil Fuels | Council on Foreign Relations

Iran

Oil Geopolitics and Iran’s Response

At first glance, last week’s Vienna Group meeting—that is the Organization of Petroleum Exporting Countries (OPEC) plus non-OPEC producers including Russia—seemed to have resolved some thorny issues. The producer group confidently announced it would increase oil production to stabilize the global oil market. Iran, which had previously threatened to boycott any agreement in protest, appeared to acquiesce to the joint OPEC production increase communique. That may have seemed like a win for the Trump administration, which had hoped to box Iran in to the negotiating table on a host of issues, including conflict resolution in Yemen and Syria, when it cancelled the nuclear deal and reimposed sanctions on Iranian oil exports. Iran had suggested OPEC take a more strident stance on the U.S. policy. Not unexpectedly, U.S. Gulf allies, under pressure from U.S. President Donald Trump’s tweets and back door diplomacy, offered a moderate approach, which will include significant production increases by Saudi Arabia, among others. For those who might construe Iran’s relatively mild public statements following the OPEC session as a sign that Iran had no real cards to play, a glance at regional conflicts might indicate otherwise. Immediately following the OPEC meeting, Syria’s army, which has a history of on the ground collaboration with Iran, broke a standing cease fire agreement with the United States and Russia and advanced on the southern province of Daraa. At the same time, Iranian-backed Houthi rebels from Yemen fired missiles into the Saudi capital city of Riyadh. Both could be taken as a sign that pressure on Iran to deescalate its participation in regional conflicts isn’t producing immediate results, increasing the probability that the Trump administration will actively press allies to buy less oil from Iran. These events raise important questions about what Tehran’s response will be in the coming days and months and what leverage the United States really has to alter facts on the ground. Granted, a twitter report suggested that Iran was unhappy with Russia’s collaboration with Saudi Arabia at OPEC and Russia’s stated posture on southern Syria. Ironically (or maybe not ironically at all) the whole complex situation could be an oil win-win for Moscow. Russia’s deal with Saudi Arabia to increase oil production achieves multiple benefits for the Kremlin. It demonstrates a willingness to consider U.S. interests but at a low cost to Russia. It helps preserve Russia’s long run influence on Saudi Arabia. And the chances that Russia will lose revenue as a result look slimmer, if Iran is dissatisfied with the situation. Russia is likely making a good bet that frustration in Tehran could lead to an escalation of Mideast conflicts, which in turn keeps oil prices lofty, giving Russia even more money since it is increasing its export volumes. A disappointed Iran could also be less apt to participate in conflict negotiations with the United States, leading to tighter sanctions enforcement, which ultimately reduces competition to Russian oil and gas companies from Tehran in long term natural gas markets for Europe. In recent weeks, French firm Total, which is likely pulling the plug on its South Pars natural gas project in Iran as a result of U.S. sanctions, ventured to Russia to sign a deal to participate in Novatek’s LNG-2 Arctic gas project. Europeans firms that are no longer active in Iran are also partners in the controversial Nord Stream 2 natural gas pipeline proposed to extend from Russia to Germany. That begs the question: What next moves make sense for Iran? The Iranian government remains under pressure from its own citizens, who took to the streets again in large numbers this week. But even with this intense internal pressure, it’s hard to see the logic behind the belief that the Iranian regime might simply just fold its cards on its regional ambitions. Even if Iran would consider reopening political negotiations with the United States and its neighbors to satisfy popular domestic sentiment—protesters have been chanting their government should spend more money at home than abroad—the ruling hardliners will likely want to gain negotiating leverage before doing so. That conflicts, for example, with the thesis that the battle for the Yemeni port of Al-Hodeida could set the stage for successful peace negotiations. Iran has many tactics at its disposal via its regional proxies and via asymmetric warfare that could be utilized to make its own interests appear more salient. Oil prices jumped back up again early this week despite reports that Saudi oil production is surging to 10.8 million barrels a day (b/d), partly on news of an oil production snafu in Canada. But realistically, that loss of Canadian barrels was small at 350,000 b/d and temporary through July. More likely, markets are jittery because it’s hard to construct a narrative on how Iran, Saudi Arabia, the United Arab Emirates, Israel, Russia, and the United States will navigate conflicts on the ground in the coming months.

Blog Post by Amy M. Jaffe June 27, 2018 Energy Realpolitik
Energy and Climate Policy

Rebuttal: Oil Subsidies—More Material for Climate Change Than You Might Think

This post is authored by Peter Erickson, a staff scientist at the Stockholm Environment Institute and a co-author of a new paper in Nature Energy that studies how much of U.S. oil reserves are economical to extract as a result of government subsidies that benefit the oil industry. This post is a response to a previous post, by Varun Sivaram, arguing that federal tax breaks for the oil industry do not, in fact, cause a globally significant increase in greenhouse gas emissions, citing a recent CFR paper authored by Dr. Gilbert Metcalf at Tufts University. Dr. Sivaram’s short response to Mr. Erickson’s rebuttal is included at the bottom of the post. As Congress moves towards tax reform, there is one industry that hasn’t yet come up: oil. While subsidies for renewable energy are often in the cross-hairs of tax discussions, the billions in federal tax subsidies for the oil industry rarely are; indeed, some subsidies are nearing their 100th birthday. And yet, removing oil subsidies would be good not only for taxpayers, but for the climate as well. The lack of attention on petroleum subsidies is not for lack of analysis. Congress’ own Joint Committee on Taxation values the subsidies at more than $2 billion annually. (Other researchers have put the total much higher.) Just in the last year, two major studies have assessed in detail how these subsidies affect investment returns in the US oil industry. The two analyses—one published by the Council on Foreign Relations (CFR) and the other in Nature Energy (which I coauthored)—both show the majority of subsidy value goes directly to profits, not to new investment. That inefficiency—both studies argue—is reason enough for Congress to end the subsidies to the oil industry. But oil subsidies also have another strike against them: oil is a major contributor to climate change. The burning of gasoline, diesel, and other petroleum products is responsible for one-third of global CO2 emissions. That climate impact is one of the reasons the Obama Administration had committed, with other nations in the G7, to end these subsidies by 2025. Both the CFR and Nature Energy analyses arrive at a similar figure as to the net climate impact. As CFR fellow Varun Sivaram notes in a previous post on this blog comparing the two studies, the CFR study finds that subsidy removal would reduce global oil consumption by about half a percent. Our analysis for the Nature Energy study also finds a reduction in global oil consumption of about half a percent. (You won’t find this result in our paper, but it is what our oil market model, described in the online Supplementary Information, implies.) The most critical place where the studies—or rather, authors—differ is how they put this amount of oil in context. (Our study also addresses many more subsidies, and in much more detail, than the CFR study, but that is not the point I wish to address here.) Sivaram refers to the half-percent decrease in global oil consumption as “measly…washed out by the ordinary volatility of oil prices and resulting changes in consumption…the nearly-undetectable change in global oil consumption means that the climate effects of U.S. tax breaks are negligible.” I would argue that this assertion confuses the effect of subsidies on oil consumption with our ability to measure the change. But before I get into it further, let me first describe how much oil and CO2 we are talking about. By the CFR paper’s estimates, removal of US oil subsidies would lead to a drop in global oil consumption of 300,000 to 500,000 barrels per day (corresponding to 0.3% to 0.5% of the global oil market). The sequential effects in their model are shown in the chart below, which I made based on their results. It shows their lower-end case, in which global oil consumption drops by 300,000 barrels per day (bpd). (This case is described in their paper as using EIA’s reference case oil price forecast and an upward-sloping OPEC supply curve.) In their model, a drop of over 600,000 bpd in US supply from subsidy removal is partially replaced by other sources of U.S., OPEC, and other rest-of-world supply, yielding a net reduction in global consumption of roughly half as much (300,000 bpd, shown in the right column). (This ratio itself is also interesting and important. For each barrel of oil not developed because of subsidies, this case shows a drop in global oil consumption of 0.45 barrels. The CFR study’s other three cases show a drop of 0.51, 0.63, and 0.82 barrels of global consumption for each US barrel left undeveloped.) Each barrel of oil yields, conservatively, about 400 kg of CO2 once burned, per IPCC figures. So, the range of impacts on oil consumption in the CFR study (again, reductions of 300-500k bpd or 110 million to 200 million bbl annually) implies a drop in global CO2 emissions of about 40-70 million tons of CO annually. (The actual emissions decrease from subsidy removal could well be greater, because this estimate doesn’t count other gases released in the course of extracting a barrel of oil, such as methane or other CO2 from energy used on-site). From a policy perspective, 40 to 70 million tons of CO2 is not a trivial (measly) amount. Rather, it is comparable in scale to other U.S. government efforts to reduce greenhouse gas emissions. For example, President Obama’s Climate Action Plan contained a host of high-profile measures that, individually, would have reduced annual (domestic) greenhouse gas emissions by 5 million tons (limits on methane from oil and gas extraction on federal land), 60 million tons (efficiency standards for big trucks), and 200 million tons (efficiency standards for cars). The CFR authors don’t quantify their findings in CO2 terms, however, and Sivaram refers to oil market volatility as a way to discount CFR’s findings on reduced oil consumption, concluding that the effects are “undetectable” and “negligible.” The argument is essentially that because other changes in the oil market are bigger, and can mask the independent effect of subsidy removal, that subsidy removal has no effect on climate change. This line of argument conflates causality, scale and likelihood of impact (which in this case are either all known, or can be estimated) with ability to monitor, detect and attribute changes (which is rarely possible in any case, even for more traditional policies focused on oil consumption). By this logic, almost any climate policy could also be discounted as immaterial, because it is rare to be able to directly observe with confidence both the intended result of a policy and the counterfactual – what would have happened otherwise. Rather, I would argue that if we are to meet the challenge of global climate change, we’ll need these 40 to 70 million tons of avoided CO2, and many more, even if there is uncertainty about exactly how big the impact will be. Concluding an action represents a small fraction of the climate problem is less a statement about that action than it is about the massive scale of the climate challenge. Indeed, as the Obama White House Council on Environmental Quality stated, such a comparison is “not an appropriate method for characterizing the potential impacts associated with a proposed action… because…[it] does not reveal anything beyond the nature of the climate change challenge itself.” So, I argue that subsidy removal is indeed material for the climate, even by the CFR report’s own math. And as Sivaram also notes, the CO2 emission reductions would multiply as other countries also phase out their subsidies. Lastly, I need to disagree with Sivaram’s statement that our study is “written in a misleading way”. He asserts this because in the Nature Energy article we focus on the entire CO2 emissions from each barrel, rather than apply an oil market economic model as described above that counts only the net, or incremental, global CO2. But the incremental analysis method above is not the only way to describe CO2 emissions. Indeed, comparing the possible CO2 emissions from a particular source to the global remaining carbon budget is a simple and established way to gauge magnitudes, and nicely complements the incremental analysis enabled by oil market models. As another noted subsidy expert—Ron Steenblik of the OECD—commented separately in Nature Energy, our analytical approach provides an important advance because it enables “researchers to look at the combined effect of many individual subsidies flowing to specific projects and to use project-specific data to gauge eligibility and uptake.” Similar assessments of other countries, and other fossil fuels, would provide an important window on the distortionary impacts of these subsidies and their perverse impacts on global efforts to contain climate change. Sivaram Response to Erickson Rebuttal First of all, I am grateful to Peter Erickson for responding in this way to a blog post I wrote that was critical of his conclusions. His response was graceful and sophisticated—I think I largely agree with it, and he’s pointed out some holes in my post that I want to acknowledge. However, I do still stand by my headline, “No, Tax Breaks for U.S. Oil and Gas Companies Probably Don’t Materially Affect Climate Change.” In fact, I think the Erickson rebuttal above reinforces just that point. Tackling the overall thesis first: in his rebuttal, Erickson is willing to accept that a reasonable estimate for the carbon impact of U.S. tax breaks for oil and gas companies is 40–70 million tons of carbon dioxide emissions annually (there may be other greenhouse gas emissions, such as methane, that increase the climate impact). Erickson even compares the magnitude of this negative climate impact with the positive impact of President Obama’s efficiency standards for big trucks. I am absolutely willing to accept that removing U.S. tax breaks for oil companies would be about as big a deal, in terms of direct emissions reduction, as setting domestic efficiency standards for big trucks. Importantly, this direct impact is trivial on a global scale, which is the point that I made in my original post, reinforcing Dr. Metcalf’s conclusion in his CFR paper. I am, however, sympathetic to Erickson’s argument that the world needs a rollback of tax breaks, efficiency standards for big trucks, and a whole suite of other policies in the United States and other major economies to combat climate change. And there is certainly symbolic value to the United States rolling back its oil industry tax breaks, possibly making it easier to persuade other countries to follow suit. I also want to concede that Erickson very rightly called me out on unclearly discussing the relationship between oil price volatility and the effect on oil prices of removing tax breaks. We definitely know which direction removing subsidies would move prices (up) and global consumption (down). I should have been clearer that my comparison of the frequent swings in oil prices to the tiny price impact of removing subsidies was merely to provide a sense of magnitude, NOT to imply that measurement error washes out our ability to forecast the magnitude of tax reform’s price impact, ceteris paribus. Finally, Erickson took issue to my characterization of his paper as “misleading.” Indeed, I never meant to imply that he and his co-authors intended to mislead anybody. I still, however, stand by what I meant: that the paper might lead a casual reader to take away an erroneous conclusion by relegating the global oil market model to an appendix and only citing the increase in U.S. emissions in the main body. In my opinion, readers need to know that industry tax breaks have a very small effect on global greenhouse gas emissions, but there are other very important reasons to remove them. And yes, the United States absolutely should remove its tax breaks, as should other countries remove their fossil fuel subsidies. On that count, Erickson and I are in complete agreement.

Blog Post by Guest blogger for Varun Sivaram November 2, 2017 Energy, Security, and Climate
Energy and Climate Policy

No, Tax Breaks for U.S. Oil and Gas Companies Probably Don’t Materially Affect Climate Change

Last week, the journal Nature Energy published an article from scholars at the Stockholm Environment Institute arguing that the tax breaks given to oil companies by the U.S. government could lead to carbon emissions that eat up 1 percent of the world’s remaining “carbon budget.” (The carbon budget is scientists’ best guess of how much more carbon dioxide the world can emit while still having a chance of limiting global warming to 2°C.) This is an enormous figure—few other national policies reach that level of climate impact. So, if true, this analysis provides a powerful argument in favor of ending preferential tax treatment for U.S. oil and gas firms (see Vox’s piece for an accessible discussion). But that conclusion flies in the face of the conclusion reached by a paper published here at the Council on Foreign Relations by energy economist Gilbert Metcalf. His paper concluded that tax breaks for oil companies modestly increase U.S. oil production, but, more importantly, global prices for and consumption of oil barely budge as a result, minimally affecting the climate. (The paper came to a similar conclusion about the climate impacts of tax breaks for U.S. natural gas production.) I was closely involved in the review and editing process for that paper, and I can attest that Professor Metcalf’s methodology was rigorously stress-tested. So who’s right? In a nutshell, I stand by the CFR paper’s conclusion that federal tax breaks for oil and gas companies aren’t a major contributor to climate change. The biggest reason is that both the Nature Energy and CFR papers are in agreement that the tax breaks barely alter global oil prices, which implies insignificant changes in global consumption of, and emissions from, oil. In fact, the Nature Energy authors do not dispute this, and they only explicitly say that tax breaks cause emissions from burning U.S. oil to increase. But their omission that those tax breaks likely cause emissions from burning other countries’ oil to decrease can easily mislead a casual reader to assume that they mean global emissions will increase as much as emissions from burning U.S. oil will. The two papers also have some other quantitative disagreements, and the Nature Energy paper might have more up-to-date industry data than the CFR paper. Nevertheless, I don’t think those other disagreements justify overturning the CFR paper’s overall conclusion about the limited climate effects of the tax breaks. Finally, the two papers do agree on one thing: the tax breaks should go. The Nature Energy paper contends that ending the tax breaks would bring “substantial climate benefits.” Although the CFR paper concludes that emissions “would not change substantially,” the two papers agree that tax reform has symbolic value that would strengthen U.S. climate leadership; U.S. taxpayers would also benefit from a few billion dollars annually of recouped government revenue from oil companies. Back to Basics The two papers are in agreement that there are three major tax breaks that oil companies get from the federal government that promote more U.S. oil production. The first allows firms to immediately expense “intangible drilling costs” (IDCs), which account for the majority of drilling costs, rather than deducting them from their taxable income over several years. The second tax break, percentage depletion, allows some oil companies to deduct a fixed percentage of their taxable income as costs rather than deducting the value of their reserves as they are depleted. And the third tax break allows oil companies to write off a percentage of their income through the domestic manufacturing deduction. Together, these three tax breaks amount to around $4 billion in foregone government revenue annually. (The Nature Energy paper considers several other tax breaks but concludes that these three are the important ones.) Both papers then set out to quantify how much more oil U.S. firms produce as a result of the tax breaks. In general, the two papers go about this in a similar way. The Nature Energy paper uses real industry data on U.S. shale oil fields to calculate which fields are profitable to produce oil from with the tax breaks but aren’t worth drilling without those breaks. And the CFR paper uses a new theoretical tool along with empirical statistics to find the percentage of wells that tax breaks make profitable to drill. But the two papers differ in their bottom-line conclusions. The Nature Energy paper rings the alarm bells by concluding that the total amount of oil in the fields that tax breaks turn from unprofitable to profitable is between 13 and 37 percent of the total amount of profitable oil (depending on where oil prices are between $75 and $50 per barrel; higher prices mean that less oil becomes economic to produce as a result of tax breaks—see figure 1). As a result, the authors conclude, if all of the oil in the fields turned profitable by tax breaks were produced by 2050 (and burned), the world would emit 6–7 gigatons of carbon dioxide, roughly 1 percent of the remaining carbon budget. Figure 1: Nature Energy paper summary figure: “The impact of subsidies is highly sensitive to oil price. These charts shows how much oil is economic at price levels between US$30 and US$100 per barrel according to whether it is already producing; discovered and economic without subsidies; discovered and economic only because of subsidies (‘subsidy-dependent’); or not yet discovered. a, Results at the base, 10% discount rate. b, Results at an alternative discount rate of 15%. The subsidy-dependence of the not-yet-discovered fields was not assessed, as these quantities are speculative, based on Rystad Energy’s assessment. Still, should they prove as subsidy-dependent as the fields we do assess, the impact of subsidies at higher prices would be larger than we currently estimate.” The CFR paper finds that 9 percent of the wells that oil companies drill each year are induced by tax breaks. But most of the additional oil that the U.S. produces will be offset by reduced production elsewhere in the world. After using a simple model of global oil supply and demand, the paper concludes that increased U.S. production translates only to at most a 1 percent decrease in global oil prices, and a measly half a percent increase in global consumption of oil (see table 2, which projects the oil market impacts of taking away tax breaks). Such a small uptick is washed out by the ordinary volatility of oil prices and resulting changes in consumption. So the CFR paper concludes that the nearly-undetectable change in global oil consumption means that the climate effects of U.S. tax breaks are negligible. Table 2: CFR paper summary table: “Table 2 presents the modeled equilibrium values of global oil price, supply, and demand in 2030. The first column lays out four ways that the global market could develop: two future oil price possibilities considered by the Energy Information Agency (EIA), and within each of those cases, the two scenarios for OPEC to be price-responsive or exhibit cartel behavior to maintain its market share. Within each of these four alternatives for how global markets might behave, the second column presents two options for domestic policy: the United States can maintain existing tax preferences (baseline), or it can repeal the three major preferences. The tax reform is assumed to shift the domestic oil supply curve by 5 percent. The remaining columns in table 2 report the equilibrium Brent oil price—the benchmark for most of the world’s oil—in 2012 dollars; supply, in million barrels of oil per day (mbd) from the United States, OPEC, and the rest of the world (ROW); and global demand. Table 2 shows that the long-run effects of U.S. tax reform are minimal under a wide range of input assumptions for how the future oil market behaves. The highlighted figures demonstrate that global prices and demand change by up to 1 percent, and U.S. production changes by less than 5 percent, regardless of the assumptions of future oil prices and how OPEC will respond. Although these changes are greater than those projected by previous studies, they are still small. An oil price increase of up to 1 percent would be over three hundred times smaller than price spikes in the 1970s and ten times smaller than the average annual increase in oil prices from 2009 to 2014. It would raise domestic gasoline prices by at most two pennies per gallon at the pump." I don’t think the Nature Energy paper makes any explicit errors, but I do think it’s written in a misleading way. The paper has a supplementary section in which it also runs a simple global oil supply and demand model, which produces a similarly small price change (a 2 percent increase) in response to U.S. tax breaks as the CFR paper reports. What the Nature Energy paper is really concluding is that tax breaks to U.S. oil companies increase the slice of the global emissions pie that is attributable to U.S. oil being burned, but they don’t commensurately increase the size of that pie. Remaining Quibbles Between the Papers Still, there is some legitimate disagreement between the papers even before running a global supply-and-demand model, suggesting that the CFR paper’s estimate of oil market impacts might have been understated. The Nature Energy paper finds that tax breaks convert 13–37 percent of reserves from uneconomic to economic to extract. It uses actual data on the size and extraction cost of reserves in different shale oil plays to make this conclusion, and the article implies that U.S. production could actually increase by 13–37 percent in the long run as a result of the tax breaks. By contrast, the CFR paper’s estimate of the long-run increase in U.S. supply is much smaller—less than 5 percent. As explained above, the CFR paper first finds that tax breaks account for 9 percent of domestic drilling. Then, the paper further diminishes its estimate of the impact of tax breaks. The difference between drilling rate and long-run supply arises because the CFR paper uses industry data to conclude that the fields that the tax breaks turn from uneconomic to economic to drill are smaller than the average field. Therefore, even though the tax breaks account for 9 percent of the new wells, those smaller wells produce less than 5 percent of U.S. oil supply. The CFR paper does use industry data—including a constant estimate of the elasticity of drilling with respect to price and a regression of well initial production against profitability—but my read is that the Nature Energy paper’s dataset might be more up-to-date. (There are a few other disagreements in assumptions, such as whether the hurdle rate for new investments is 10 or 15 percent and whether the future oil price will be closer to $50 or $75 per barrel. The Nature Energy paper, however, is careful to run a sensitivity analysis and copy the CFR paper’s assumptions to enable comparison.) As a result, the CFR paper’s estimate of the increase in U.S. supply as a result of tax breaks—less than 5 percent—might be a bit of a lowball. In some sense we are comparing apples and oranges by comparing the CFR paper’s estimate of annual U.S. production attributable to tax breaks to the Nature Energy paper’s estimate of total reserves converted from uneconomic to economic. But there is some reason to believe that the effect of tax breaks might be to induce greater than 5 percent of U.S. oil production. Even if that is true, however, it is unlikely that tax breaks materially affect global consumption of oil, mediated through price changes, because the United States accounts for less than 15 percent of global production. Therefore, the conclusion of the CFR paper—that tax breaks to the oil and gas industry are immaterial to climate change in terms of directly induced emissions—probably stands. That doesn’t mean the tax breaks are a good idea. In fact, both papers argue forcefully that the tax breaks should be abolished, at the very least because the United States in doing so can demonstrate leadership in the G20 and other forums where it urges other countries to eliminate fossil fuel subsidies. The effects of those subsidies, on a global scale rather than a national scale, are in fact material to climate change. The world would be better off if they were sharply curtailed.

Blog Post by Varun Sivaram October 10, 2017 Energy, Security, and Climate

Kurds

Unraveling the Oil Geopolitics Intertwined in the Kurdish Independence Referendum

For over a decade, U.S. efforts to promote stability across the Middle East have run afoul of many complexities. The recent independence referendum in the Kurdish Regional Government (KRG) territory of Iraq is no exception. Both the sudden actualization of the referendum and some of the related geopolitical maneuvering associated with it, could provide new challenges for the United States in the region and harken back to a repeating failure of even seasoned American diplomats to head off conflicts over the final dispensation and control of important disputed oil and gas assets. The idea that Iraq’s Kurdistan region meets the prerequisites for nationhood is compelling. An independent Kurdistan was, in fact, drawn into the Treaty of Sevres almost a century ago in 1920. But the devil will be in the details of how the long-term status of the KRG gets resolved. Many complicated variables have to be navigated in the post referendum equation. Seasoned experts will weigh in on the complicated politics that has led to the KRG action and how it should be handled by the United States. This blog is aimed to underline specifically how any effort to mediate conflicts arising from the referendum will need to consider carefully the oil geopolitical aspects to the crisis. At issue is not just the possible loss to the global oil market of 500,000 to 600,000 barrels a day of Iraqi oil exports from KRG controlled territory via Turkey. In today’s oil world, this volume would eventually, if not quickly, be replaced. Rather, it is the dangerous precedent of letting subnational political and military “events” and shifting regional geopolitical alliances dictate the final dispensation of the Kirkuk oil field, which sits in historically disputed territory, before an adequate effort at a negotiated (read, internationally legally binding) resolution can be attempted. The History of Kirkuk The area surrounding the Kirkuk oil field houses many different regional peoples, including Arab, Kurdish, and Turkoman communities, the latter of which historically represented roughly 8% of Iraq’s total population according to some estimates. During the reign of Saddam Hussein, “Arabization” of the region changed its complex mix amid efforts by the Baath regime to guarantee its better access to the oil region, which in the 1980s represented close to 1 million b/d of Iraq’s total oil output of 2.0 to 2.5 million b/d. Kirkuk field holds reserves of 9 billion barrels. ISIS began to encroach on the area of the field in 2014 and when the Iraqi army’s defense of the region collapsed in June of that year, Kurdish Peshmerga forces interceded and took control of most of the oil producing region. Production at the oil fields in and around Kirkuk have been producing about 400,000 b/d of which 160,000 b/d come from three fields, Baba Dome, Jambur, and Kabbaz, which were at one point administrated by the central Iraqi government controlled North Oil Co. With Kirkuk squarely under Kurdish control, it remains unclear what the long-term status of the oil producing assets will be. The KRG has for years made its claim to Kirkuk clear in words and actions. U.S. oil companies, including ExxonMobil, have given stature to such claims by signing oil exploration deals with the KRG for oil fields in disputed territories, including blocks in and around Kirkuk. Notably, one ExxonMobil block attained from the KRG, the Bashiqa block, was taken over by ISIS militants. The firm has since relinquished several of its exploration blocks in Northern Iraq given both political and geological difficulties. Baghdad maintains all Northern region fields should be under Iraqi central government control, and especially the Kirkuk fields, and Iraqi prime minister Haider al-Abadi is forced to stake his reputation on it, with negative consequences for the unity of Iraq if he cannot prove to the KRG, and by extension, other oil and gas regions, such as Anbar and Basrah, that they cannot go their own way. Iraq’s parliament is calling upon Al-Abadi to deploy national security forces in disputed areas. Iraq’s oil ministry recently ordered North Oil Company to take immediate steps to rehabilitate the Nineveh fields set ablaze by retreating ISIS troops in a possible effort to try to reassert claims to oil resources in the region. For the past several years, Turkey has supported, financially and through transit for exports, the KRG’s oil and gas industry. But the changing domestic political landscape inside Turkey has made such positions more difficult of late for Turkey’s President Tayyip Erdogan. Last March, the leader of Turkey’s Nationalist Movement Party (MHP) stated the territorial integrity of Iraq was indispensable to Turkey’s national security and called claim to Kirkuk, “Historically, Kirkuk was Turkish. It remains Turkish even now and will become one of the most glorious Turkish cities in the future.” Erdogan has been more circumspect on the referendum saying Kurdish authorities would pay the price for the independence referendum and threatening economic sanctions. Turkey has held joint military exercises with Iraqi national troops on the border. So far, Ankara has not made good on its threat to shut down Kurdish oil exports which also are critical to Turkey’s economy. Enter the Russians Finally, ever opportunistic, Russia has recently expanded its influence into the controversy about who should control Kirkuk in the long run, via moves by state oil firm Rosneft, run by U.S. sanctioned Putin crony, Igor Sechin. Rosneft in recent weeks accelerated its negotiations of a major energy collaboration with KRG. The mooted deal is said to include a possible stake in the Kirkuk oil field, investment in the expansion of the Kirkuk to Ceyhan oil export pipeline, and a possible investment in a natural gas pipeline from the KRG to Turkey and Europe. Last June, Rosneft took five exploration blocks in the KRG and signed a memorandum of understanding to create a 300,000 b/d oil offtake agreement. The KRG reportedly discussed the Avana, Baba, and Khurmala domes as part of the deal, which include areas previously operated by the Iraqi state’s North Oil Company. Rosneft has also stepped in as a white knight to Kurdish finances, offering a capital injection of up to $3 billion in part to refinance debt coming from $1 billion in pre-financed oil sales deals with international traders. Firms Glencore, Vitol, Trafigura, and Petraco had loaned the KRG finance based on future oil sales. The trader oil has been going to Spain, Greece, Germany, Italy, and Croatia. The KRG’s annual oil revenues are projected at roughly $8 billion. With so many parties affected by any decision to stop oil exports from the KRG, Turkey’s Erdogan finds himself boxed in by domestic and international concerns. The involvement of Rosneft in KRG oil affairs adds additional tricky dimensions to any negotiation about the future of the KRG and purposely so. The Kurdish referendum gave the Kremlin a convenient possible out to peace negotiations in Syria by disincentivizing the Syrian Kurds from voicing cooperation. It also allowed Russia to counter checkmate Turkey, which saw energy cooperation with the KRG as a means to break the vice Moscow had on its own Turkish national energy supply. For the past several years, Ankara has been offering Turkish finance and technical support to promote KRG oil and gas export pathways to Turkey. Ankara had hoped to diversify itself from Russian energy and by extension, Europe, through its own link-up to the KRG energy supply. But the cost to Kurdish leader Masoud Barzani of high dependence on Turkey must have proved too restrictive. In effect, for the Kurds, the offer to sell oil assets to Russia would potentially solidify Russian assistance at the United Nations Security Council, should Baghdad or other regional powers seek to solicit U.N. sanctions against the KRG. What’s left is a geopolitical mess that will take skill and patience to disentangle. Possible outcomes that displease Iran could propel it to back local Shia militias to try to defy Kurdish Peshmerga control of Kirkuk. Iran has its own concerns, given its own restive Kurdish population which numbers 6.7 million or a little under 10% of Iran’s population. Iran was the first to move against the KRG after its referendum, closing its air flights and borders to the KRG. In other words, through Rosneft’s activities, Russia has gained leverage over Turkey and Iran’s interests in the Kurdish question and potentially reasserted oil and gas export leverage over not only Turkey but also major economies in southern Europe. The Oil Element and U.S. Interests The geostrategic element of Kirkuk as an oil producing province nearby to Turkey, Iran, and the Syrian conflict, makes the stakes higher than just the kind of economic conflict that has spurred localized military action by warring factions in South Sudan or Libya. The fate of Kirkuk will also be closely watched by other parties from contested oil regions who will look to U.S. and U.N. responses towards the KRG for some hints to their own aspirations. The United States has long kicked the can regarding the arduous task of navigating the finer details of oil revenue sharing shuttle diplomacy in failing states. The consequences of this failure has turned out badly in several locations, including Libya. Now, in the case of the aspirations of the KRG, is the time to redouble efforts to establish sustainable precedents. The principal of revenue sharing geographically by census/population count was rejected in the early days of reconstruction in Iraq, in my opinion, to the detriment of the entire experiment of trying to re-forge a national identity. To help the KRG and Baghdad create a viable path forward, the oil resource control and revenue sharing issue should be settled once and for all, peacefully and through binding negotiation that can include a payout or ongoing revenue sharing, depending on final deliberations. The consequences of a failure to diplomatically steer this “whose-oil-is-it” struggle to a successful outcome have been devastating for the people of the region. Militias throughout the Middle East have learned that they can undermine the authority of established political leaderships by overtaking oil producing areas. So far in the process of such conflicts, the oil and gas industries of Syria, Yemen, and to a certain extent Libya, have been destroyed. The United States should consider more active diplomacy on the resolution of the future of Kirkuk in hopes that persistence this time around might show better results than past efforts. Such an investment of diplomatic time, effort, and prestige could yield long-term benefits, not only for the people of Iraq and the KRG but also in other regions around the Middle East where oil revenue sharing and border fields remain in dispute. A win for a diplomatic settlement on the future dispensation for Kirkuk would offer a productive path for many other oil producing regions. This is not to say that the task is not a gargantuan one, but just that it is one well worth pursuing.

Blog Post by Amy M. Jaffe October 4, 2017 Energy Realpolitik
Fossil Fuels

Managing a Smaller U.S. Strategic Petroleum Reserve

Downsizing the U.S. Strategic Petroleum Reserve will have economic and foreign policy consequences that have not been fully considered. U.S. foreign policy should prioritize the management of these consequences.

Report by Jennifer M. Harris July 13, 2017 Greenberg Center for Geoeconomic Studies
Fossil Fuels

Using External Breakeven Prices to Track Vulnerabilities in Oil-Exporting Countries

The best single measure of the resilience of an oil- or gas-exporting economy in the face of swings in the global oil price is its external breakeven price: the oil price that covers its import bill.

Report by Brad W. Setser and Cole Frank July 11, 2017 Greenberg Center for Geoeconomic Studies

Asia

Don’t Let the Window of Opportunity for Increasing Asia’s Use of Natural Gas Close

Natural gas markets in the Asia-Pacific are on the cusp of an extraordinary transformation thanks, in part, to the rise of liquefied natural gas (LNG) exports to the Asia-Pacific from U.S. suppliers. If gas displaced coal, it would give a big boost to the world’s critically needed transition to a low carbon future.

Blog Post by Guest blogger for Varun Sivaram May 22, 2017 Energy, Security, and Climate
Fossil Fuels

Increasing the Use of Natural Gas in the Asia-Pacific Region

Overview Increased use of natural gas in the Asia-Pacific region could bring substantial local and global benefits. Countries in the region could take advantage of newly abundant global gas supplies to diversify their energy mix; the United States, awash in gas supplies thanks to the fracking revolution, could expand its exports; and climate change could slow as a result of gas displacing coal in rapidly growing economies. However, many Asian countries have not fully embraced natural gas. In previous decades, the United States and Europe both capitalized on low gas prices by investing in infrastructure to transport and store gas and by creating vibrant gas trading systems. By contrast, Asian countries have not invested in infrastructure, nor have they liberalized gas markets. Strict regulations, price controls, and rigid contracts stifle gas trading. The window of opportunity for making the transition to gas is closing, as slowing Asian energy demand and copious global supplies are reducing prices and discouraging global investment in infrastructure for gas trading and distribution. If supply dries up, prices could increase markedly, making gas unattractive to Asian countries, especially when compared to coal. Still, this scenario is not inevitable. If global gas demand increased modestly over the next decade, raising prices enough for production to be profitable but not so much that consumption became unaffordable, Asian countries could invest in infrastructure and enact reforms to enable a large increase in gas consumption. However, because of sluggish global economic growth, the Asia-Pacific region itself is the only plausible source of an initial uptick in new gas demand that can support a sustained surge. A simulation of global gas markets finds that a 25 percent increase in gas demand in both China and India, compared with current market forecasts, could help stabilize prices. The 25 percent increase would represent just a 2.9 percent increase in global demand but would be enough to boost Asian gas prices by more than 20 percent over the next decade. Such an increase in demand is plausible in both China and India, because they are large and growing economies that use relatively little gas today as a share of their energy mix and are motivated to use more gas to displace the burning of coal, which causes air pollution. At the same time, because China is the world’s largest source of greenhouse gas (GHG) emissions and India is the third-largest and fastest-growing source, gas use that replaces coal would slow global GHG emissions. Such demand increases are not necessarily favorable for U.S. strategic interests. Still, the United States stands to gain more than it loses by promoting a transition to gas in the Asia-Pacific. Whether the initial increase in gas demand materializes will depend largely on domestic policy decisions—for example on infrastructure investment or on caps on local gas prices—in China and India. The United States can encourage Chinese and Indian governments to make these decisions by providing technical assistance to implement reforms and recommending that international institutions provide financial assistance. U.S. policymakers should also coordinate competing proposals from China, Japan, and Singapore to establish a thriving gas trading hub. Finally, to secure the environmental benefits of a transition to gas, the United States should develop best practices for measuring and minimizing methane leakage from natural gas infrastructure built in the region.

Report by Ian Cronshaw, Quentin Grafton and Llewelyn Hughes May 19, 2017 Energy Security and Climate Change Program
China

Can China Become the World’s Clean Energy Leader?

China seems poised to surpass the United States in leading clean energy innovation and climate change response, but Beijing faces internal challenges to energy reform.

Interview with Francesca Regalado and Jennifer L. Turner April 28, 2017
Americas

International Pressure on the Maduro Regime

The Venezuelan constitutional chamber’s decision last week to dissolve the National Assembly has made it abundantly clear that Maduro’s Venezuela is an authoritarian regime. The judiciary is at the beck and call of chavista forces, the military is corrupt and co-opted, and despite a last-minute reversal of the court’s decision, the continued dilution of the Assembly’s powers means that there are effectively no independent institutions left with the power to check the regime. Venezuela, meanwhile, is confronting a humanitarian catastrophe. The regime has run up against the limits of its economic policy: foreign currency is too scarce to cover both debt obligations and desperately needed imports. Three quarters of Venezuelans have lost weight under the “Maduro diet”; more than two-thirds of basic goods are scarce. The regime seems willing to play out the clock, at grotesque human cost, guided by one core strategy: waiting for global oil prices to recover. But the hole is now so deep that a modest increase in oil prices— of the sort predicted for 2017— may be insufficient: debt payments due in 2017 outstrip foreign currency reserves. Dictatorships sometimes crumble under the weight of their own contradictions, and this could yet be the case for Chavismo, given the depth of the crisis. Indeed, the uncertainty generated by the court’s action last week may be a sign of fissures within the regime. But as John Polga-Hecimovich and I noted last year, the Maduro regime has a clear strategy for repressing domestic opposition. Leaders who have mobilized against the regime are in jail. The military is fully in control of food supply and appears united against any regime change that might expose leading officers to prosecution for corruption or human rights abuses. The opposition has been fractured by the regime’s delay tactics, including the simulacrum of negotiations over the past year. Venezuelans are exhausted by the daily search for sustenance which, alongside regime repression, saps their ability to protest. Although Maduro walked back last week’s court decision, he retained the power to negotiate oil deals without congressional approval, a tool which may prove very important. China or Russia could yet help Venezuela out of its hole. But China does not seem eager to play a geopolitical role and it has little to gain from saving a crisis-ridden regime in the Western Hemisphere from seemingly inevitable collapse. Russia, on the other hand, seems to be doing what it can to help Maduro through his hard spell: it is reported to be negotiating loans and further investments by Rosneft that might help the regime through a heavy bout of April debt payments. The region has been slow to respond, but is at last finding its voice. Several countries withdrew their ambassadors over the weekend. Mercosur has been proactive: it suspended Venezuela from the trading bloc last year, and invoked its democratic clause over the weekend, which could culminate in Venezuela’s expulsion. The Organization of American States (OAS) has been proceeding more slowly, despite Secretary General Luis Almagro’s hectoring. Almagro’s hopes that Venezuela might be suspended under the Inter-American Democratic Charter continue to run up against simple math; although a few countries seemed to shift their stance last week, many Caribbean nations remain beholden to Maduro, meaning that Almagro may still be short of the votes he needs, even if a special session of the body meets today as originally planned (early reports suggests that the new Bolivian chair of the Permanent Council may suspend the session). The Trump administration so far appears to be following the policies adopted by its predecessor. The United States has imposed targeted sanctions against individual Venezuelans, including Vice President El-Aissami, but has wisely avoided the temptation to more directly and unilaterally confront the regime, allowing Latin America to lead. But patience is wearing thin in Washington. A flurry of congressional declarations last week could presage more muscular legislative action in the months ahead; Senator Marco Rubio suggested that he would lean on recalcitrant OAS members, including by withholding assistance to countries that failed to support OAS action. Policymakers hoping to encourage a peaceful resolution of the crisis must pinch their noses and maintain a channel for dialogue with the regime while giving regime hardliners guarantees of non-reprisal if— but only if— they facilitate a rapid transition. Dialogue has been unproductive in the past, but keeping talks open at least offers the possibility of a strategic exit for regime members. UNASUR has been playing a key role in encouraging dialogue; it may yet be an effective good cop to the OAS’s bad cop, provided it does not allow itself to be used as a convenient pretext for the Maduro regime to string out talks endlessly. Guarantees for regime members who cooperate in finding a way out of the crisis are needed to ensure that negotiations are not seen as a zero-sum game. But the regime has played games for far too long to be trusted to negotiate in good faith. Simultaneously, therefore, regional governments must tighten pressure on the regime. The symbolic weight of an OAS suspension would be great— as Almagro said, “peer condemnation is the strongest tool we have.” But in addition to declaring the Venezuelan regime a pariah, regional and global allies could also help to keep hardliners over a barrel. Prosecutions, asset seizures, visa restrictions, and other sanctions would be most effective if they were employed not only by the United States, but also by Latin American and European allies.

Blog Post by Matthew M. Taylor April 3, 2017 Latin America’s Moment
Monetary Policy

Why Does the Fed Keep Lowering Its Unemployment Threshold?

Blog Post by Benn Steil and Emma Smith February 7, 2017 Geo-Graphics
Sub-Saharan Africa

Nigeria Claims $4.7 billion Lost Due to Oil Attacks

Maikanti Baru, the group managing director of the Nigerian National Petroleum Company stated on December 14 that the company’s subsidiary Nigerian Petroleum Development Company (NPDC) lost 1.5 trillion naira (about $4.9 billion) from militant and criminal attacks on its oil production facilities to date in 2016. Baru went on to say that NPDC recorded fifty-nine separate security incidents that resulted in crude production being shut down or deferred. Based on recent recent years budgets, $4.9 billion is about 10 percent of the total annual budget of the Nigerian government. It is difficult to gauge the accuracy of Baru’s claim. Nevertheless, his statement is an indication of the magnitude of the losses of revenue from oil production suffered by the Nigerian state because of insurgent and criminal activity. These losses are especially acute during the current period of low oil prices.

Blog Post by John Campbell December 16, 2016 Africa in Transition
Sub-Saharan Africa

Huge Oil Discovery in Nigeria

Last week, ExxonMobile announced the discovery of between 500 million to one billion barrels of oil in Nigeria. The discovery is located in the Owowo-2 and Owowo-3 oil fields. ExxonMobile owns a 27 percent interest in the field, it shares ownership with Chevron Nigeria Deepwater (27 percent), Total (18 percent), Nexen Petroleum Deepwater Nigeria Limited (18 percent), and the Nigeria Petroleum Development Company Limited (10 percent). The president of ExxonMobile Exploration Company, Stephen M. Greenlee, said that Exxon “…will work with our partners and the government on future development plans.” The countries oil production had dropped to 1.2 million barrels a day in May due to militant attacks in the Niger Delta, however, the Nigerian petroleum minister claimed on Tuesday that production had recovered to 2.1 million barrels a day. Though, groups like the Niger Delta Avengers (NDA) continue to attack oil infrastructure in the Delta and there is skepticism about the official production figures. The new oil discovery is off-shore. While such facilities are less threatened by insurgent attacks, they are by no means immune. The NDA has carried out attacks on offshore platforms in the past. Nevertheless, the recent ExxonMobile announcement highlights the immense size and potential of Nigeria’s oil reserves

Blog Post by John Campbell November 3, 2016 Africa in Transition
Energy and Climate Policy

Sustaining Fuel Subsidy Reform

Overview Fuel consumption subsidies threaten the fiscal and economic health of countries around the world. Economists widely agree that the subsidies, which reduce consumer prices for petroleum and natural gas below free-market prices, often strain government budgets, fail to target poverty efficiently, and distribute benefits unfairly. Yet, political barriers often obstruct practical policy changes; for example, the prospect of street protest discourages sensible subsidy reform. Still, over the last two years, governments around the world have taken advantage of the plunge in oil prices and reduced or eliminated subsidies. Recognizing that low oil prices can mitigate the increase in consumer bills caused by subsidy reform, ten countries have, since 2014, completely eliminated subsidies on at least one type of fuel, and a further twelve countries have reduced subsidies. This advances U.S. economic, geopolitical, and environmental goals because subsidy reform can reduce world oil prices, instability in strategically important countries, and wasteful use of fossil fuels, which contributes to climate change. In particular, recent reforms in India, Indonesia, Ukraine, Egypt, Saudi Arabia, and Nigeria all bring strategic benefits to the United States. Recent reforms may not be permanent, however. Past fuel subsidy reforms have often come undone when prices rose or when reform-minded leaders fell. Varun Sivaram and Jennifer M. Harris, reviewing the historical record, reveal three ways governments have reinforced reforms against backsliding: by depoliticizing fuel prices and transferring control over prices to independent regulators, who enforce the link between domestic and international prices; by preempting popular discontent and rapidly demonstrating tangible economic benefits from reform; and by locking in partial subsidy reforms with subsequent reforms as they pursued long-term strategies to eliminate all fuel subsidies and liberalize their energy sectors. The United States can help countries reinforce their reforms, and the authors make recommendations for how U.S. policymakers should do so. Where it has strong relationships, the United States should prioritize reform durability at the highest political levels. In addition, the United States, acting through institutions such as the World Bank, should provide financial support for a limited period of time that creates a path for countries to consolidate their reforms. Finally, the United States and international partners should create aid packages that reward long-term reform over decades; they should also drive private investment into the energy sectors of countries that have reformed fuel subsidies to support broader energy sector liberalization. Selected Figures From This Report

Report by Varun Sivaram and Jennifer M. Harris October 18, 2016 Energy Security and Climate Change Program
Brazil

Political Fault Lines in Post-Rousseff Brazil

After nearly nine months, Brazil’s impeachment drama is over. The process ended on a curiously subdued note: the Senate’s questioning of Dilma Rousseff on Monday was a staid affair, and Tuesday’s speeches were calculatedly calm and measured. By the time the Senate began to vote today, Rousseff’s removal was a foregone conclusion. But the civilized, even boring, proceedings obscured an important objective of this week’s debates: shaping the historical narrative that will guide each side’s supporters over Michel Temer administration’s next twenty-eight months in office. On the Senate floor, Rousseff and her defenders stuck tenaciously and defiantly to script: the fiscal pretext for impeachment was weak and no previous president had been held responsible for the same errors; the economic crisis was not her doing but the result of international circumstances she could not control; and she herself never personally benefitted from the corruption that took place during her presidency. Rousseff was impressive, showing all of the qualities that led President Lula to choose her as his successor: attention to detail, intense message discipline, and an unwillingness to cede any ground. Most important to the Workers’ Party (PT) narrative, she returned over and over to the theme that when they lost at the polls in 2014, “sectors of the economic and political elite” began conspiring against her. By her account, the impeachment battle had its origins in Rousseff’s principled refusal to bargain with the former Chamber of Deputies President Eduardo Cunha, who is deeply enmeshed in his own bribery scandal but has yet to be removed by Congress. Rousseff was supported from the wings by twenty former ministers, her predecessor and mentor Lula, a number of PT bigwigs, and the starpower of crooner Chico Buarque. The opposition, meanwhile, hammered home the depth of the economic, political, and moral crises Brazil faces. They honed in on the narrow text of the impeachment petition—premised on arcane minutia about unauthorized spending and improper loans to the government by state banks—but also sought to show that the transgressions for which she could have been impeached were much broader. They repeatedly reminded Rousseff of the bait-and-switch between the lofty promises made during her 2014 campaign and the austere policies that were actually implemented during her second term, made grand statements about the usurpation of legislative functions by her administration, and noted that almost all of the costs of her fiscal maneuvers were borne by taxpayers. They repeated the now well-trod line that if Rousseff was not complacent with corruption she must be incompetent, and noted that while Rousseff was not personally enriched by corruption, her presidential campaign was financed by ill-gotten means. Most important to their long-time narrative about the legitimacy of impeachment, they noted that all three branches of government were represented at the Senate trial, and that by her very presence, Rousseff was acknowledging the legitimacy of the impeachment process. What sort of golpe is this, they asked, in which the defendant has the right to self-defense? They were supported from the wings by a handful of youthful leaders from the street protest movement. Whatever the arguments, what best explains the impeachment vote is exhaustion. It has been a turbulent three years since the first street protests erupted in July 2013, and many Brazilians simply want the political crisis to go away. In a poll published by Istoé magazine over the weekend, nearly two-thirds of Brazilians said that if they were senators, they would vote to see Rousseff go. That doesn’t mean that Temer is beloved: when asked who should govern Brazil, more than a third (35 percent) of those polled spontaneously responded that they would choose neither Temer nor Dilma. There is also a solid core of opposition, with 30 percent opining against Dilma’s impeachment. But by and large, Dilma had lost much of the public support she had when elected two years ago, and the Petrobras scandal appears to have greatly diminished her mentor Lula, whose ratings continue to decline as police and prosecutors close in on his family’s questionable dealings. What comes next for Brazil? This blog has repeatedly noted the importance of legitimacy to Brazil’s impeachment process. The PT narrative of golpismo by neoliberal forces on the right was artfully deployed by Rousseff and is likely to be a core message of the PT in coming years. This drumbeat will keep Temer and his coalition on the defensive, while turning attention away from the Rousseff administration’s own failures and the PT’s involvement in the corruption scandal. Temer has been playing a complicated game since he became interim president in May. On the one hand, he has been trying to keep the rowdy impeachment coalition in check, promising whatever he could offer to wavering supporters. On the other, he and Finance Minister Henrique Meirelles have been trying to convince investors that the economic team has a coherent plan for recovery that will come together when the political stars align. These dueling priorities were especially evident in the renegotiation of state debts, where investors’ cautious support for an emergency renegotiation lapsed into disappointment as Temer made repeated concessions to state governors in exchange for political support. Temer’s Janus-faced approach may also have reached a natural limit: the PSDB and the DEM parties in late August threatened to withhold support if Temer moved forward on planned wage increases for the judicial branch, which might have earned him short-term political support from some sectors, but would have cascading effects throughout the civil service and a brutal impact on the rapidly deteriorating fiscal results. Now that he is confirmed in the presidency, Temer will be under pressure to commit to the fiscal reforms that were impossible while he was a temporary stand-in. The challenge is significant, in at least three regards. First, the left’s criticism of the new government’s “neoliberalism” will limit what Temer can realistically achieve on the fiscal front. Temer seems to be aiming for a constitutional cap on spending that will promise hard choices about spending in the future while providing his administration some credibility gains in the present. But even this middle of the road solution will be politically difficult, requiring changes to constitutionally guaranteed health and education budgets. The second major reform would be to social security, reducing special privileges for some professions and raising the minimum retirement age, in an effort to cut one of the largest areas of government expenditure and expand on reforms undertaken by Presidents Fernando Henrique Cardoso and Lula. So far, the details of these reform proposals are nebulous, but they are likely to become more concrete by November, and the opposition will pillory Temer for even the slightest proposed change in social spending. The second major challenge is that the timetable for reform is remarkably short. All political oxygen between now and the end of October will be sucked up by the 2016 municipal elections, and then again during much of 2018 by the presidential election. These two contests will be the most wide-open elections of the post-1985 democratic era, in light of new restrictions on corporate contributions, the effects of the corruption scandal, the weakening of the two most important parties in the Brazilian party system (the PT and the PSDB), and the widespread “throw the bums out” sentiment expressed by voters. The field for the presidential race will begin to form by late 2017. As a consequence, the reform calendar is essentially restricted to fourteen months between November 2016 and late 2017. Considering that many less controversial constitutional reforms have taken much longer, and that so many different political actors will be angling for advantage as they look ahead to 2018, Temer will have a tough slog. The third major constraint is the ongoing Lava Jato investigation, and political scandals that keep popping up around it. It is hard to avoid the conclusion that Temer’s coalition is held together at its core by a pragmatic and ideologically malleable center—“Centrão”—that is unsympathetic to the Lava Jato investigation and the increasing power of prosecutors and judges. I wrote recently about recent moves to dilute accountability reforms in Brazil, with support from actors across the political spectrum. These pressures seem likely to build, if only because so many different political forces are under threat. Temer has already been forced by public pressure to dismiss three ministers caught up in various scandals, he himself has been mentioned by witnesses in the Lava Jato investigations, and he is still the subject of an electoral court case investigating the financing of the 2014 Rousseff-Temer ticket. Meanwhile, disgraced former Chamber President Eduardo Cunha has not gone away, and the mid-September vote on his removal will be a bellwether of how well legislators have understood the lessons of voter anger. Concurrently, the progress of a plea bargain by Marcelo Odebrecht, scion of the construction fortune, has already led to allegations of illegal donations to candidates across the political spectrum, from the PT through Temer’s PMDB to the PSDB. It is symptomatic that despite the low-legitimacy moment, Temer has not dared to suggest a political reform that might change some of the perverse incentives that have led to the campaign finance abuses that fueled the Petrobras scandal. There is little prospect that Lava Jato or any of the many other parallel investigations will go away any time soon. The upshot is that the prospects for constitutional reform under Temer are limited. As is so often the case in Brazil, much change will therefore have to be incremental and will take place within the government bureaucracy, rather than through Congress. The shifts underway at Petrobras and the Brazilian Development Bank (BNDES) are good illustrations of where things may be headed, with reprioritization of strategic objectives, asset sales, and general belt-tightening taking place far from the legislative melee. Meanwhile, Temer will be engaged in a mission to build his statesman credentials, including a trip to the G20 meeting in China today, followed by a big speech on Brazil’s independence day, September 7, and then the UN General Assembly. All along the way, expect him to be trailed by challenges to his legitimacy, in the form of celebrity protests, catcalls, and street demonstrations. A new political battle has just begun, to define Brazil’s trajectory after thirteen years of PT rule.

Blog Post by Matthew M. Taylor August 31, 2016 Latin America’s Moment