09.08.2008
The Energy Exception
№3 2008 July/September

Energy is of fundamental importance to national and
international economies. Yet it is often neglected at the level of
international institutions, and international trading norms do not
apply to the energy sector. The international community, at least
economically, has suffered from a lack of cooperation between
energy consuming and energy producing countries. As such, the
establishment of international energy trading norms is of
fundamental importance. However, unlike other commodities, fossil
fuels and energy are unique. Geopolitical, environmental and
strategic factors all contribute to the difficulty of applying free
market trading norms to the energy sector. As energy crises from
the 1970s onwards demonstrate, however, dangers also lie in
persisting with approaches heavily dependent on state and
intergovernmental intervention. International energy trading norms
must therefore try to balance these two positions, and develop a
nuanced structure that is not rigidly embedded within a single
dogma.

FREE TRADE AND THE RE-EMERGENCE OF PROTECTIONISM

According to many specialists, international energy trading
norms should be centered on the construction of a competitive
global energy market. Government intervention should be confined to
limited forms of regulation to ensure transparency in the trading
system. This market would determine prices, direct investment to
the renewable energy sector, reduce expensive strategic reserves,
maintain commercial stocks at adequate levels and reduce
politically-motivated price volatility.

In principle, free-trade norms already apply to the energy
sector; for example, energy products are not exempt from WTO rules.
However, the WTO’s efforts are mainly focused on import barriers,
whereas trade restrictions in the energy sector are most often
export barriers. Energy has therefore always represented a de-facto
exception to the proliferation of free-trade multilateralism that
has increasingly characterized international trade, particularly
since the 1980s.

Worldwide, various countries and regions treat energy in a
similar, heavily-regulated manner. For example, in the European
Union, despite directives in favor of the liberalization of
electricity (in 1996) and gas (in 1998), no consensus has yet
emerged on yielding full responsibility for energy supply to market
dynamics. Publicly administered markets, dominated by large
national enterprises and regulated prices, prevail. New players are
often obstructed from joining these markets. The only exception,
perhaps, is Great Britain.

In North America, the U.S. has consistently pushed for a
“continental energy policy” that would include the free movement of
energy goods and services, and unrestricted access to resources.
Rhetoric aside, the U.S. consistently demands and pressures its
energy partners, enforcing restrictions such as import barriers on
alternative fossil fuels such as oil sands. If energy trade between
the U.S. and Canada is driven by market and private enterprise
strategies, there are also interconnected infrastructures that have
created an energy symbiosis, both in economic and physical terms
between these two countries. A former Canadian ambassador in Mexico
summarized recent difficulties with the Canadian energy sector as
follows: “to integrate free trade in the energy sector is a very
delicate question.”

Even in South America, which became a laboratory for free-market
fundamentalism in the 1990s, recent financial and economic trends
have shifted toward state intervention and economic nationalism,
including within the energy sector. This has taken multiple
dimensions, including price controls, revision of fiscal regimes
and contracts, and the possibility of canceling current
international dispute settlement mechanisms such as the
International Center for Settlement of Investment Disputes. New
terms, such as “resource nationalism” and “full oil sovereignty,”
are increasingly prevalent in discussions on energy. The increasing
usage of these terms reflects the new reality of heavy regulation
and state ownership of fossil fuel resources.

WHY IS ENERGY AN EXCEPTION?

A number of factors contribute to the unique nature of energy as
a commodity. Currently, fossil fuels provide an overwhelming
majority of the world’s energy. But it is widely understood that
they are a finite resource. Recent alarmist newspaper headlines
mention “peak oil” and “resource depletion.” Given the importance
of energy to modern economies, the fear engendered by increasing
resource scarcity leads important actors to take measures to ensure
access to energy supplies. These actions can often aggravate
international relations. Energy is already a cause of diplomatic
friction in places such as the East China Sea and the Arctic.
Further exacerbation of geopolitical conflict is likely, especially
since many experts posit a 50-percent rise in energy demand by
2035, with fossil fuels having to meet more than 80 percent of this
increase.

The continued importance of fossil fuels to satiate the rising
demand of consumer countries is mirrored by the significance of
these resources to energy exporting countries. These states
consider energy an important tool for development. Consequently,
they often take measures contrary to free market and WTO
principles. OPEC actions consist of quantitative export
restrictions and ensure income from natural resources by leading to
higher prices. This often results in the adoption of dual-pricing
practices through which rich countries pay the “real” price of oil
while poorer ones utilize subsidies.

The exceptional nature of energy is also increasing as a result
of rising environmental concerns. Governments, faced with
obligations to reduce emissions, are currently taking actions such
as subsidization and green energy taxation that are contrary to
international trading norms and the WTO process. Other measures to
reduce the harmful environmental impact of conventional sources of
energy have also emerged. These have led to the creation of new
global markets, such as the carbon trading (emissions trading and
trading in project-based credits) market.

For these reasons and more, free trade has never taken root in
the energy sector. Instead, energy has consistently been subject to
heavy regulation and persistent state intervention. However, these
norms are not a suitable framework around which international
energy trade should be conducted, as is demonstrated by the
politicized use of energy exports by certain countries.

FORGING A NEW PATH

During the 1990s, explicit policies modified the “mix between
authority and market” (Susan Strange) by proposing a universal
adoption of the market as a mechanism of coordination with
precedence even over states. In today’s world economy, markets
prevail. This evolution implies a radical change for the role of
the state and international institutions. The U.S. position has
been to favor market action, and advocate removing most regulatory
prerogatives from states and international organizations.

But energy remains unique. With political, environmental and
geopolitical implications, the energy sector cannot merely be seen
as a field for economic transactions. For this reason, free market
norms have not characterized international energy trade. Although
some market liberalization would be beneficial, trade in energy
must be tempered by norms of regulation at various governance
levels.

Rather than adhering to either extreme, international energy
trading norms should be based on a middle way, avoiding the
impossibility of total free trade, but also steering clear of the
dangers of unilateral state or regional intervention. The Kyoto
carbon trading market offers a tentative example of just such a
middle way. The Kyoto approach administers public environmental
goods through market mechanisms and through the emergence of new
forms of property rights. Interestingly, this method first began in
the U.S., where governments, academics, environmentalists, UN
agencies and corporations worked together to develop a market
approach to climate change mitigation. A lesson from this
experience is that, where needed, the organization of a market
requires the intervention of states and multiple actors, combined
with complementary measures at various governance levels. The EU
Emissions Trading Scheme (2005) is a good example of this: it has
emerged, in part, as a result of broad support from
non-governmental organizations. The scheme represents a possible
transcendence of the ongoing debate between regulatory and control
measures as opposed to market-oriented instruments.

A global energy market would require exactly this sort of
complex mixture of intervention and regulation by various actors
and at various governance levels. The creation of new organizations
such as the International Energy Forum, which is in charge of
promoting a global dialogue on energy, is therefore particularly
promising.

One possible means through which such a system could be
developed consists of establishing an interface between OPEC and
the WTO. The former operates on grounds contrary to the principles
of free trade, and a free market in energy would necessarily entail
its dissolution. Despite the inherent contradictions between the
WTO and OPEC, however, both organizations are indispensable. OPEC
has a pivotal role in the regulation of petroleum supplies and
prices and the WTO is an organization that remains the center of
gravity of the multilateral trade regime.

The issue of whether energy can be integrated into the
multilateral trading system by building a connection between OPEC
and the WTO has never seriously been considered, but there is some
interesting literature and research that reflects on this pertinent
question. Areas of tension include OPEC’s concern with high
internal taxes on petroleum products, the development of renewable
sources of energy by consumer countries, market access of
downstream products, and the access to the energy service markets
of WTO members. Meanwhile, the WTO is concerned with OPEC’s
quantitative export restrictions, procurement in the energy sector,
and export taxes.

However, there exist a number of convergence points between the
two organizations, including agreement on the importance of
investments to build energy transportation networks and to expand
production capacities. In particular, OPEC approves “a fair
agreement” that recognizes owners’ rights to a just price for their
renewable resources and reassurance of their sovereign right to
control their natural resources and also consumer rights to a
guaranteed energy supply at reasonable prices. Likewise, leading
powers in the multilateral trading system, including the U.S. and
the EU, use similar terminology in calling for a strengthening of
trade alliances and the establishment of dialogue with major energy
exporters. The WTO has the potential to address both groups of
concerns.

Despite this potential, two important issues would first need to
be addressed. The first relates to the status of the WTO as a
member-driven organization. Its negotiation agenda and its scope
are controlled by member countries. As such, there is no guarantee
that there will be a consensus in favor of incorporating energy in
the multilateral norm. It would first be important to develop such
a consensus. Second, three important OPEC members, Iraq, Iran and
Libya, which are among the largest producers and exporters of
energy, are not WTO members. Indeed, the U.S. has blocked Iran and
Libya’s applications to the WTO. Political tensions would need to
be diminished before the WTO and OPEC could effectively negotiate
to form a new framework.

Due to the exceptional nature of energy, certain states and even
international organizations are likely to desire margins of
maneuver, for instance to define the rules on which market
activities should take place. At the international level, however,
some states are – whether in the relational or structural sense –
more powerful than others. Markets are not purely economic
constructs, they are predominantly social structures; they
therefore reflect the distribution of power in the international
system. Powerful states can therefore intervene or impose rules to
make those markets work for their own benefit. For these countries,
namely the U.S., energy is often perceived as essential for their
national security thereby hindering new energy-trading initiatives.
Recent claims that international economic power is shifting toward
resource-rich developing countries is also an exaggeration.
However, energy exporting countries must accept the fact that new
issues, like climate change, will influence energy trade and
actors’ strategies. The international energy scene is changing.
Rather than resist or be left aside in the process, resource-rich
energy exporting countries have to become active and constructive
partners. They need to join the debate on new challenges such as
climate change mitigation and try to influence the formulation and
implementation of policies worldwide.


This material was prepared for a discussion at the symposium
“Foresight: Russia in the 21st Century,” organized by the
international forum of Deutsche Bank, the Alfred Herrhausen
Society, in partnership with the Russian Council on Foreign and
Defense Policy, and Policy Network, a British think tank.