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Falling Oil Prices Could Rock Canada's Politics: Expert

A Tyee interview with Terry Lynn Karl, who wrote the book on petro states.

Andrew Nikiforuk 18 Dec

Andrew Nikiforuk is an award-winning journalist who has been writing about the energy industry for two decades and is a contributing editor to The Tyee. Find his previous stories here.

This coverage of Canadian national issues is made possible because of generous financial support from our Tyee Builders.

[Editor’s note: 'Oil Keeps Crashing': Just the latest headline marking a steady plunge that has the price of Brent Crude, the international benchmark, now scraping $52 a barrel. What are the political ramifications here in Canada and around the world? Andrew Nikiforuk’s interview with expert Terry Lynn Karl went viral when we published it on December 18 and remains one of the Tyee’s most read pieces today. In case you missed it…]

What do the plummeting oil prices tell us not only about our near term economic future in Canada, but the political fragility of the world's petro states?

If Canada fully joins the petro state club, as our prime minister and his party desire, is oil's volatility just the cost of doing business, or a threat to our nation's well-being?

The ideal person to ask is Terry Lynn Karl, one of North America's foremost experts on the politics of oil. The Tyee recently caught up with Karl, who teaches at Stanford University and lives in San Francisco.

Asked in a wide ranging interview what Canadians might expect if oil prices stay low for a few years, she predicted "a rapidly declining Canadian dollar, greater problems over pipelines, the reduction of future investments, and a very bumpy oil ride, especially for Alberta.

"Any adverse effect low oil prices will have on Canada's high cost oil industry will have a multiplier effect on the economy and polity. Government services will be cut back, house sales will decline, and banking will slow down. Canadians will not be so happy with their government."

'The Paradox of Plenty': a classic

How oil shapes the relationship between citizens and their governments has been the focus of Karl's work since 1976, when she journeyed to Venezuela as a young doctoral candidate. The researcher wanted to find and interview the founder of the Organization of Petroleum Exporting Countries (OPEC), Juan Pablo Perez Alfonzo.

But Perez Alfonzo, a testy fellow, wanted nothing to do with this academic inquiry.

Then he relented. Karl even stayed with his family for two days.

Her visit corresponded with the first huge increase in oil prices -- the days of "Venezuela Saudita" -- when petrodollars poured into the country, and Venezuelans partied as never before. But Don Juan Pablo (as she called him), one of Latin America's first conservationists, was not celebrating.

"You are such a smart girl," OPEC's founder remarked as he closed the interview. "Why study OPEC? It's so boring?"

"Don Juan Pablo, what would you suggest I study?" Karl wondered aloud. 

"Study what oil is doing to us," he said. "Eventually, oil will bring us ruin. We are drowning in the devil's excrement."

Since then, Karl has studied the impact of oil revenue on oil-exporting states. Her seminal book, The Paradox of Plenty, remains a classic on how the world's most capital-intensive industry corrodes the economy, politics, and culture of most oil exporting states in much the same way gold undid King Midas.

Karl even coined the term "petro state." She developed her thinking from the so-called staple theory of Canadian historian Harold Innis. "I was excited to read his work. Everyone at the time thought having oil meant certain and progressive development. But they had not read Innis, the Iranian Mahdavy or the great economist Albert Hirschman who wrote about how commodities shape development -- for good and bad."

Petro states aren't like other states for several reasons, says Karl.

For starters, their dependence on oil profits breaks the necessary link between taxation and representation. Instead of extracting state funds from citizens, wealth magically comes from the ground. This makes governments unaccountable; it means that people don't demand to see how money is spent.

And oil governments, in turn, tend to treat their citizens like subjects, either paying them off or, when necessary, repressing them. Wedded to boom and bust cycles, oil-dependent regimes are either overspending to keep themselves in power or accruing debt to mask problems with seemingly no ability for fiscal reform. 

Oil and highly centralized rule go together. Oil wealth permits governments to dismantle accountability mechanisms, weaken bureaucracies and undermine the rule of law.

Karl further found that although petro states appear strong, and some governments last for long periods of time, these oil infused regimes are highly vulnerable. When they collapse, they fall apart very quickly. Neither autocracies nor democracies are immune.

Petro-fueled environmental damage, violence and civil war often dominate oil-producing regions. In this respect, Karl sees resonance in Perez Alfonzo's words: oil is indeed the devil's excrement.

In her conversation with The Tyee, Karl commented on falling oil prices, climate change, vulnerable petro states, aboriginal resistance to oil, the commodity's increasing volatility, and whether or not Canada is a petro state.

Tyee: How will falling oil prices affect global politics and the stability of some petro states?  

Karl: "The effects of falling oil prices will be quickly felt in Venezuela, which is extremely vulnerable. If oil keeps dropping, the country's employment, standard of living and GDP will be affected. This tends to make people not like their government.

"Venezuela, which is already extremely polarized, is in big trouble. In this respect, there is a big difference between how oil prices affect Canada and the U.S. and how they affect countries where the politics have become totally petrolized. Where there is simply no difference at all between wealth and power, where corruption and rent seeking have taken over the whole enterprise or where conflict is already very high, these are the most vulnerable countries.

"Venezuela has been an economic and political mess for a long time -- well prior to the rise of Chavez. Indeed, Chavez came to power during the 1998 price collapse because the former party system could not manage the oil economy, control massive corruption, or direct petrodollars to alleviate poverty.

"But the current government does not have the power or charisma of Chavez nor economic management capacity.

"Thus, even though prices are much higher than 1998, like the party system earlier, it too is facing a perfect storm. If prices stay low and the economy continues to contract, grave civil conflict could result. In this respect, those who want to see the complete collapse of chavismo should be careful what they wish for. Venezuelans would be better off negotiating their crisis."

What about Putin's Russia, a classic petro state where oil revenues make up more than 50 per cent of government revenue?

"Russia isn't quite as vulnerable as Venezuela, but because it is a global power its fate is more important. In the face of both sanctions and low prices, the ruble has plummeted, debt is rising, living standards are declining, and food prices are up sharply. With oil prices high, Putin took certain actions in the Ukraine and elsewhere because he felt untouchable; his popularity remains very high.

"But this could change very quickly if prices remain low.

"Most people don't understand that the decline of the former Soviet Union was closely linked to the 1986 collapse in oil prices. Putin later took advantage of high prices to build his own personal power. That could be at stake if prices stay low."

What about Saudi Arabia (a Sunni state) which has played a major role in orchestrating the price collapse by flooding the market with its low cost oil?

"Saudi Arabia is the most interesting petro state of all because of its continued influence on prices.

"The Saudis have obviously learned a lot from their orchestration of the 1986 price collapse, which they used to increase their market shares. This time the net effect of low prices is good for them in many ways. They have substantial financial reserves, and they can weather this low price better than any other major oil exporter.

"What is really interesting is how quiet and calm they are. The government is not saying much. But lower prices permit the Saudis to protect their market share in the face of the huge production threat from the U.S.; lower prices, if they last over time, will drive some high cost shale and bitumen producers out of the market.

"Saudi Arabia has always used oil prices for its regional political ends. When prices were high, they gave ten times more money than the US to the Egyptian generals. Now that prices have dropped, this plunge directly weakens their biggest rival, Iran (a Shia state), which is in a tacit alliance with the U.S. in the fight against ISIS. Saudi Arabia should weather this period well."

Why is this oil price collapse different than previous ones?

"The United States is a major oil producer this time around. Production is higher than it has been since 1972, and over half of this comes from relatively high cost fracking. Equally important, this has a secondary effect on international financial markets, especially because oil has become a hugely traded financial asset. Today, oil price volatility has become a tipping point in the financial system.

"Oil prices and stock markets used to go in different directions. When prices went up dramatically, market hysteria pushed stocks down, and recession would ensue. Because the price is now down, this should be a boon to consumers, help the economies of consuming nations, and represent a massive transfer of wealth from oil producers to oil consumers. But the stock market doesn't reflect this. In the last few years, the markets and oil prices are moving in tandem, and this is new.

"I suspect there are several reasons for this. First, advanced industrialized economies, and most especially the United States, have reached historic highs in inequality. This means that there is no wage growth, there is little consumer spending and the main concern is deflation, not inflation. While low prices help consumers, they simply will not have the same effect given acute poverty levels and the squeezing of the middle class.

"Second, the global economy may be de-accelerating, meaning this is not just a supply glut but also a reflection of lower demand from China, Europe and elsewhere.

"Finally, the stock market is reflecting the dangerous intertwining between oil futures and junk bonds, which was not the case decades ago."

Both oil companies and global economies are now carrying great debt loads as hydrocarbons become more extreme and difficult to extract. The world's largest 127 oil and gas firms generated $568 billion in cash from their operations during 2013-2014, while their expenses totalled $677 billion? How is debt affecting this whole picture?

"Debt is the Achilles heel of this picture. If prices remain low for several years, a lot of U.S. shale producers have high debt loads, especially in junk bonds. Today, energy debt currently accounts for a substantial 16 per cent of the U.S. junk bond market. If these producers start going bust, investors in junk bonds will be in for a shock.

"But this is only part of the picture.

"Dropping oil prices affect international debt as well, creating a high risk of default by countries like Venezuela. Around the world two sets of debt are coming in -- from the high cost bitumen and shale oil producers who borrowed to help create the current supply glut and oil exporting producers who have borrowed heavily. Both affect the entire financial system.

"The biggest danger of prolonged low prices is a debt-related collapse linked to the rising cost of hydrocarbon extraction. Because low oil prices take a while to work their way through the system, this is not an immediate threat. But we should not forget that falling oil prices and junk bonds all played a role in the crash of 2008."

Will oil prices stay low for a while?

"Uncertainty is the name of the game now. The price of oil is more volatile than ever before. Oil is linked to finance more than ever before. And the economies of producing and consuming countries are more intertwined than ever before.

"Predicting prices is a fool's errand. Oil prices could stay down in 2015. There is a lot of supply and little demand right now. But what happens if unrest increases inside some oil-exporters because their regimes are forced to cut back on their extensive food and oil subsidies? What happens if conflict disrupts supply in Libya, Venezuela, Nigeria, Iraq or Iran? The price of oil could soar overnight.

"I don't know how things will play out. But there is the tightest of links not only between the global economy and finance but also energy producers, environmental damage and the speed up in climate change. We are in a situation where oil supply limits can cause recessions and oil supply gluts can cause stock market failures.

"We urgently must wean ourselves from fossil fuels. All we are doing now is moving costs and benefits around in a highly volatile system. Few win, and most people lose. But I am not optimistic that this will happen before the consequences are catastrophic. There is just too much money in oil. As long as these extraordinarily high profits exist, oil will be extracted and politics will be petrolized to prohibit better alternatives."

What have some aboriginal people foreseen about oil that industrialized societies haven't?

"In Asia, Africa and Latin America, companies are searching for oil in pristine areas where ethnic minorities and indigenous peoples live. There are conflicts between Aboriginal people and oil companies everywhere. In northwestern Columbia, for example, some 5,000 U'wa have been battling Occidental Petroleum for years. The U'wa believe that oil is the blood of earth. When you take out too much blood from the body of Mother Earth, this will bring fluctuations in weather, fires, huge storms and changes to the climate.

"One U'wa chief came to my office at Stanford and stood in line during my office hours. Dressed in traditional garb, he did not look like any of my students. He did not speak Spanish, and I quickly learned that the U'wa do not have a written language. But through an interpreter, he explained that as head of 200 religious leaders; it was their duty to protect the earth. These U'wa religious leaders had made a pact to commit collective suicide if they failed to protect their territory from Occidental Petroleum.

"After years of struggle, including court cases in Colombia, Occidental was stopped -- at least temporarily. Pretty sobering..."

Does the term petro state fit for places like Alaska, Texas, Louisiana, Alberta and Saskatchewan?

"Yes and no. When I developed the idea, I referred to the central government, not states in a federalist system. The petro state applied only to capital deficient oil exporting countries with big populations that were late developers.

"Since the U.S. was a producer but not an exporter, the same effects were not present.

"I showed that petro-states had the effect of replacing tax mechanisms with excessive oil profits, and this, in turn, then petrolized the whole political and economic environment. Oil influence and oil issues dominated the government.

"Petro states do not have to bargain or negotiate with their citizens. Their power depends on how they pass around oil revenues, how this wealth is distributed. Regimes that do that well, like the Saudi royal family or the former Venezuelan two party system, stay in power for a long time. Those that keep the revenue too closely inside their own support base, whether this is an autocratic family or a small religious or ethnic group, often don't last as long.

"In most petro states, government spending is never an issue for public debate. Norway, the exception that proves the rule, has constant debates about oil distribution, even between its citizens today and future generations.

"A centralized power, to the contrary, just hands out petrodollars, quieting the loudest voices and its own power base. Thus statecraft is stifled. Because petro states invite little debate, nourish no coherent bureaucracy and engage in volatile spending, the state's institutions get weaker and weaker. Stability-wise, this is not good.

"Alaska and Texas and Alberta are all part of a federal system, but they certainly take on some of the same characteristics of petro states. If you look at Texas or Alaska, and how they distribute oil wealth, they have boom and bust cycles just like an oil state, and they have repeated serious trouble balancing their budgets. But this volatility is mediated by central government.

"As easy oil becomes scarcer, and the commodity becomes even more valuable, oil politics inside these states have a contagion effect and tend to increasingly influence the central government. I suspect this same phenomenon can be seen in Alberta and the Canadian government."

There are many such indicators in Alberta and Canada. Pipelines dominate all political discussion. Environmental legislation has been gutted while environmentalists and aboriginals protecting their land have been branded as foreign-funded radicals.  The Harper government has centralized power enormously. Climate change is regarded with skepticism. Little money has been saved from oil. Alberta is a fiscal basket case. Foreign policy consists of bashing other petro states because Canada has so-called ethical oil. And scientific dissent has been muzzled.

"This does not surprise me. Democracies today are especially vulnerable to oil interests. But if oil prices stay low, this political arrangement won't last over time.

"Instead, if prices continue declining and if they stay low for a few years (two big 'ifs') -- they have already dropped 40 per cent but no one knows whether this price will endure -- expect the following: a rapidly declining Canadian dollar, greater problems over pipelines, the reduction of future investments, and a very bumpy oil ride, especially for Alberta.

"Any adverse effect low oil prices will have on Canada's high cost oil industry will have a multiplier effect on the economy and polity. Government services will be cut back, house sales will decline, and banking will slow down. Canadians will not be so happy with their government.

"How long will the prices stay down, and how long will it take for those effects to work their way through the economy? That is the question. If other vulnerable petro-states collapse, like Venezuela or Libya, or if conflict removes oil from the market, prices quickly could soar again."

Has oil ruined us, as Perez Alfonso feared?

"For those of us living in advanced industrialized countries, inexpensive oil through 1970 has largely made our current standard of living. But Perez Alfonzo understood that oil is a non-renewable resource. It has huge costs associated with it, not only benefits.

"Let me be clear: the commodity itself is neither good nor bad.

"But the excessive profit involved from what Adam Smith called 'reaping what has not been sown' has led to a concentration of power and influence that makes it exceptionally difficult to fight the negative consequences of hydrocarbon dependence. This is true not only in Venezuela, Nigeria, Russia and the Middle East but also in the U.S. and Canada.

"Today, more than ever before as the 'easy' oil is being used up, the exploitation of petroleum in pristine environments hurts our water and the air we breathe. It threatens our climate. It props up authoritarian regimes and increases the propensity for war. In this respect, Juan Pablo Perez Alfonso was a visionary. He saw something about 'the devil's excrement' before anyone else, and then he was kind enough to show it to me."  [Tyee]

Read more: Energy, Politics

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