Dear Reader,
The world’s largest governments are drastically changing the way they buy and sell oil. And it could
affect every family, small business and multibillion-dollar corporation across the globe…
So far, this historic shift has been scarcely reported. But the transformation is undoubtedly underway,
and quietly altering the future of energy.
Rapid economic expansion in Russia, India and, most importantly, China, has led the governments in
these countries to review their traditional sources of oil, and to make substantial changes in the way they
get it.
And they’ve opted to circumvent the traditional distribution networks of the New York Mercantile
Exchange (NYMEX), and other bourses, entirely.
In fact, they’re undermining them, “locking up” supplies by purchasing crude from oil-producing
countries directly – behind closed doors:
✔ Angola committed to supply China with 200,000 barrels per day of crude at $60/barrel for the
next 10 years, in return for Chinese investment in infrastructure projects such as railroads, roads
and bridges.
✔ India already imports about 24 million tons of crude from Saudi Arabia every year, which is 26%
of its total crude imports. It has stated a desire to secure long-term contracts to assure delivery in
the future. Indian public sector firms have participating interests in oil and gas projects in
Vietnam, Sudan, Russia, Iraq, Iran, Myanmar, Libya, Syria, Australia, Ivory Coast, Qatar and
Egypt.
✔ Russia, India and China are involved in efforts to build and control petroleum pipelines throughout
the central-Asian and Middle Eastern regions. The Shanghai Cooperation Council, for
instance, was formed to ensure that oil from the giant Baku-Tbilisi-Ceyhan pipeline flows to the East, not West.
This strategy is coming to be known as “Energy Mercantilism.” Producers – and consumers – are
bypassing the marketplace altogether. And it’s taking massive quantities of oil off the open market.
Now, the free markets that have historically determined the pricing and allocation of oil are in sudden
danger of extinction. And with them, competitive prices for U.S. consumers…

State-Run Oil Will Dominate the World Energy Market
In the past, the world has relied on an open marketplace to set the price of energy. For decades, the
NYMEX has been the epicenter of energy trade.
But China and India, in cooperation with a key supplier, Russia, have turned the tables by making bilateral
agreements to lock in long-term supplies at set prices, or by forming consortiums to guarantee
supply.
China has become the world’s second-largest importer of oil. And the U.S. Energy Department
estimates that the country’s demand will more than double, to 14.2 million barrels a day, by 2025. More
than two-thirds of that will be imported.
Currently, China builds cities the size of New York twice a year.
Every time a new barrel of oil is discovered, the world uses four existing barrels. But China and India’s
demand for oil is still in its infancy – around 1.3 barrels per person per year, compared to 4.4 barrels per
person per year in the developed world.
When their economies begin using 2.4 barrels per annum per person, they’ll need 24 billion barrels of
oil a year – double the current amount consumed worldwide.
What’s important to emphasize is that in this new Energy Mercantilism, oil prices are locked-in, no
matter how the market fluctuates in the future. That means not everyone will pay the same price for oil,
fundamentally altering the dynamics of the energy marketplace. It directly counters market pricing, and
destabilizes the supply/distribution channels that currently determine who can afford oil.
And these “private” oil deals are beginning to roll in…
• In Russia, Vladimir Putin has been squeezing Europe by withholding supplies of natural gas while
negotiating for exclusive pipeline deals. In 2003, he dismantled the Yukos oil group who had expanded
dealings with the West. He has explicitly stated that Russia will demand bilateral long-term supply
contracts with consuming nations, so Russia could guarantee stable demand for its exports.
• China National Petroleum Corp. has entered joint development agreements with Sudan, which is
expected to produce as much as 300,000 barrels per day by the end of 2006. Another Chinese
firm, Sinopec Corp., is erecting a pipeline from that complex to Port Sudan on the Red Sea, where
the Chinese are building a tanker terminal for shipping raw crude to the Chinese mainland.
Altogether, Sudan, despite conducting what is widely regarded as genocidal warfare not far from
the oilfields, provides 10% of Chinese petroleum imports.
• In November 2005, Chinese President Hu Jintao toured Latin America and completed a number of
economic deals, including an oil deal with Argentina. Hugo Chavez, the President of Venezuela,
has said Chinese firms would be allowed to operate 15 mature oil fields in eastern Venezuela,
which could produce more than one billion barrels. Chavez has also invited Chinese firms to bid
for natural gas exploration contracts.
• Sinopec, China’s state-owned oil giant, signed a $70 billion deal with the Iranians in November
2004 to develop the Yadavaran oil field. Sinopec will also buy 250 million tons of liquefied natural
gas over 30 years. Iran is committed to export 150,000 barrels per day of crude oil to China
for 25 years.
• Recent testimony before the Congressional Committee on National Security, Emerging Threats and International Relations, outlined how China’s three state-owned oil companies “have managed to
establish control over about 3 mb/d [million barrels a day] of crude production, which could
reach up to 6 mb/d by 2008.”
The fact is, 90% of world reserves are controlled by national oil companies, as opposed to
market-driven public companies.
Exxon Mobil (NYSE: XOM), for example, is the largest publicly traded oil company. And it ranks only
14th in proven reserves, directly below 13 national oil companies, including those of Iran, Venezuela, and
other governments overtly unfriendly to the U.S.
The Bottom Line
A task force for the Council on Foreign Relations (CFR), a highly respected Washington think tank,
recently released a report that contains dire predictions for our economy and global oil markets.
Led by ex-CIA chiefs John Schlesinger and John Deutsch, the group reports that the United States will
be unable to achieve energy independence any time in the foreseeable future, even with massive injections
of ethanol, wind power and other alternative fuels.
Noting the potential ramifications of Energy Mercantilism, it recommends radical conservation
initiatives, possibly including higher gasoline taxes and gasoline rationing.
It also calls for the implementation of “an active public policy… to correct these market failures that
harm U.S. economic and national security.”
“Most oil and gas resources,” the report states, “are controlled by state-run companies, some of which
enter into supply contracts with consumer countries that are accompanied by political arrangements that
distort the proper functioning of the market.”
The fact is, more and more oil buyers and sellers are hooking up directly, outside of the marketplace.
And in many cases, they’re including other “payments” into the transactions – direct investment,
infrastructure development, political favors, trade agreements, etc.
And therein lies the uncertainty. How does one know if he’s paying the going rate for oil when a going
rate doesn’t exist?
Don Miller, Inevstment U Research
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