High oil prices and global power

With oil currently hovering at around the mid-US$60 per barrel, the price of oil may no longer make for headline-grabbing news as it did earlier this year, but energy costs remain high and constitute a major drag on the world economy.

The oil price today is still 300 percent higher than it was six years ago, and people in oil-consuming countries spend a much higher percentage of their income on energy than previously. High energy prices have become a fact of life and are unlikely to be reversed.

There are strong indications that the oil price is bound to rise again in the medium term. Despite an impending recession, worldwide demand for oil is still expected to increase next year, especially in emerging economies like China and India.

Last week, OPEC announced that it would cut output to maintain current price levels. In addition, oil remains a depleting resource and oil production is peaking or declining in many oil-producing states.

A high oil price has implications far beyond the global economy. Geopolitically, it helps increase the clout of some powers and weaken others.

Among the geopolitical winners will be those oil-exporting states that earn more income than they spend on domestic services. All oil-producing states on the Arabian Peninsula and in Russia are in this enviable position and today have large resources of cash.

The way these states choose to invest and spend these large cash reserves will impact global politics. These states may use the new wealth to increase their military capabilities, win over new allies or invest abroad via sovereign wealth funds (SWF), which are impacting the global economic system on an ever increasing basis.

SWF - investment accounts owned by national governments - have started to acquire stakes in strategic sectors of western economies, including in the US. For instance, the Abu Dhabi Investment Authority (ADIA) purchased a US$7.5 billion stake and the Kuwait Investment Authority (KIA) a US$12.5 billion share in America's largest bank holding company Citigroup. According to IMF estimates, SWFs may have a collective worth of about US$10 trillion within the next five years. These stakes may easily translate into political leverage in the years to come, with SWF holders increasingly being tempted to use their financial clout as a foreign policy tool.

Meanwhile, Russia, a clear beneficiary from lucrative energy exports, has enhanced its political clout over energy-dependent neighboring countries and Europe. With Russia's sword of Damocles - in the form of supply cuts - hovering over these vast regions, no energy-dependent state in Eurasia is willing to pose too strong of a political challenge to Russia. In the new energy-centric world of today, Russia's geopolitical power undoubtedly is on the rise.

Soaring oil prices will hurt oil importing countries with a large industrial economic base the most. Highly industrialized East Asian economic powers, including China, are expected to fare decidedly worse than post-industrial economies and states with large services sectors. 

High oil prices lead to rising production costs and thus higher export prices for manufactured goods, which will hurt international sales.

The Chinese fear that a drop in exports would lead to the closure of production plants and a widespread loss of jobs. This could easily translate into social turmoil and political opposition. The consequence could be disastrous for China's one-party government, which justifies its monopoly on political power on its ability to keep the economy growing and maintain social peace.

To prevent potential social and political unrest from spiraling out of control, Beijing is subsidizing oil prices. Moreover, many Chinese export companies, fearing a sharp drop in sales, are reluctant to pass on the full increase in oil prices on to the consumer, which leads to reduced or negative margins. These practices are not sustainable in the long term. If China is unable to make a profit from its exports, the country's money reserves will ultimately deplete. China's economic vulnerability and the specter of domestic unrest leave the country in a geopolitically weakened position as a result of high oil prices.

There is also the possibility of new alliances between energy-hungry economies and oil giants - a fear that has been heightened by Iran's application to join the Shanghai Cooperation Organization (SCO). China already receives a lot of its energy supplies from Iran, and common SCO membership would further cement China's relationship with this important energy power. For Iran, SCO membership may help the country break out of its international isolation and neutralize some of the pressures put on Iran regarding its nuclear enrichment program. This could put the US and Europe increasingly on the defensive.

Meanwhile, in the midst of the current credit crisis, energy-hungry Europe and the US not only need the oil from oil-producing states, but increasingly also their cash through SWFs to keep their economies afloat.

In conjunction with the credit crisis, the high oil price will continue to hurt oil-consuming states and will likely exacerbate the geopolitical shifts that are taking place between oil exporters and importers. Global recession or not, we continue to live in an energy-centric world.