This memo is solely the responsibility of its author and is not a Council on Foreign Relations publication.

Panel 1 – Context

Oil and the Threat of Trade Disruption

Rosemary Kelanic, George Washington University

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Memo: Petroleum Trade and Disruption Fears in Peacetime and in War

Rosemary A. Kelanic

Elliott School of International Affairs, George Washington University

Presented at the Council of Foreign Relations, Washington, DC, January 19, 2012

Oil’s importance for military power casts a long shadow over peacetime trade. Since the

emergence of mechanized warfare in the early twentieth century, oil has played a crucial role in the capacity of nations to wage war. No other fuel compares to petroleum on the battlefield. Because of its uniquely high energy density and naturally-liquid state, oil offers superior performance when it comes to military mobility and transportation. During World War II, for instance, Germany and Japan’s dearth of petroleum resources severely hampered the effectiveness of their militaries – especially when they engaged American and Soviet forces, which enjoyed plentiful supplies.1

Quite literally, oil fuels the engines of war. As a crucial material for national defense, countries must always worry about the security of their supplies should they get into a conflict or crisis. During peacetime, markets are very good at providing reliable access to petroleum, even in the face of accidental or intentional disruption.2 But because the international system is anarchic,3 there is an ever-lurking possibility that force could be used to sever oil imports, particularly as part of a strategy to undermine a nation’s military power in wartime. In other words, when power can be used to supersede markets, the ability of markets to adjust is beside the point.

With this threat in mind, countries dependent on foreign oil pursue a variety of trade policies designed to reduce the vulnerability of their supplies to physical interdiction.4 This memo provides a historical overview of the major trade strategies nations have used to minimize the threat of disruption. As I will argue, these security considerations shape both the “who” and the “how” of international trade, causing trade patterns to deviate from pure market-based outcomes in predictable ways. In particular, when it comes to the “whom,” nations design their trade policies to encourage petroleum imports from certain types of countries while discouraging reliance on others. As to the “how,” countries accomplish their oil security objectives through a variety of means, including the negotiation of comprehensive economic pacts and the imposition of lower tariffs for preferred suppliers. Throughout the memo, historical examples demonstrate that vulnerable nations exhibit similar behaviors across cases and times to cope with the 1 For a lengthy treatment of this topic, and the potential for countries to wield the “oil weapon” to get their way in world politics, see Rosemary A. Kelanic, Black Gold and Blackmail: The Politics of International Oil Coercion, PhD Dissertation, University of Chicago, March 2012; “No Oil for War: The Coercive Potential of Energy,” article manuscript, 2012. 2 Eugene Gholz and Daryl G. Press, "Protecting 'The Prize': Oil and the US National Interest," Security Studies, Vol. 19, No. 3 (July 2010). 3 John J. Mearsheimer, The Tragedy of Great Power Politics (New York: Norton, 2001); Kenneth N. Waltz, Theory of International Politics (New York: McGraw-Hill, 1979). 4 Trade policies represent just one subset of the anticipatory strategies that countries use to mitigate the threat of disruption. Other such strategies include oil stockpiling, military alliances, and in some cases, conquest. For an in-depth examination of anticipatory measures, see Kelanic, Black Gold and Blackmail.

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possibility of wartime cutoff. Indeed, striking parallels exist between the actions taken by great powers in the mid-twentieth century and the policies of today’s rising powers, such as China and India.

Preferred Partners: How Oil Security Considerations Influence Trade Relationships

The need to be prepared for the contingency of wartime cutoff drives oil-importing countries to seek out closer trade ties with certain oil-exporting nations, while avoiding direct dependence on others. Although wartime cutoffs rarely happen, the potential consequences are so grave that the shadow of cutoff looms large even in peacetime. Petroleum-poor countries, as well as nations that expect domestic production to dwindle in the future, exhibit three strong preferences in regards to choosing trading partners. First and foremost, countries prefer to get their oil from allies, or at the very least, from countries with common interests. The assumption is that friendly, like-minded nations are more likely to cooperate during war or crisis, and are less likely to end up as belligerents on the opposite side – which would almost surely result in a cessation of petroleum exports. Moreover, loyal partners may be willing to offer assistance in meeting the increased demand of oil-poor countries during a conflict. Governments encourage trade with friendly suppliers in two main ways: by instituting preferential trading arrangements with already-established allies, and by embarking on “charm offensives” to transform ambivalent exporters into allies.

During World War II, for instance, Britain benefitted handily from its close ties with the United States, the world’s largest oil producer. When British fuel stocks dipped to dangerous lows in April 1941 in the face of German submarine attacks on petroleum tankers, the United States stepped in by loaning American tankers to ferry oil from the Gulf of Mexico to the Atlantic and on to English shores. This made additional petroleum available to the war-strapped British – even at the cost of causing serious fuel shortages on the East Coast.5 Through lend-lease arrangements, the United States also provided aviation fuel to the beleaguered Stalin in the wake of Hitler’s invasion of the Soviet Union and airlifted large supplies of petroleum over the Himalayan “hump” to British and Chinese forces in the Asian theater.6 In all, the United States provided 85% of the oil used by the Allies to defeat the Axis – and did so despite the fact that it meant imposing a tight system of civilian petroleum rationing on the American homefront.7 It is difficult to imagine a country going to self-sacrificial lengths to supply a non-ally. Meanwhile, by running afoul of the United States through his European expansionism, Hitler effectively forfeited access to American petroleum imports that accounted for a large chunk of German consumption prior to the war.

Second, oil-importing nations prefer to obtain supplies from neighboring countries. Geographic proximity makes defending supply lines easier, and interdiction by enemies harder. By fostering petroleum trade with neighbors, countries need not worry about interference by

5 John W. Frey and H. Chandler Ide, eds., A History of the Petroleum Administration for War, 1941-1945 (Washington: United States Government Printing Office, 1946), 23-24. 6 Ibid., 85. Petroleum products comprised over 60% of the net tonnage the United States delivered to its allies in the China-Burma-India region. Leo J. Daugherty, The Allied Resupply Effort in the China-Burma-India Theater during World War II (Jefferson, N.C.: McFarland, 2008), 170. 7 Frey and Ide, eds., A History of the Petroleum Administration for War, 1941-1945, 1.

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transit countries – i.e., nations through which oil commerce must travel on its way to market. A third and closely-related factor is whether trade routes are overland or across seas. Oceangoing petroleum is more vulnerable to cutoffs due to the prospect of naval blockade. Thus, when possible, governments encourage trade with countries that share a common land border, or are located nearby on the same land mass.

The United States followed this type of strategic logic in the Western hemisphere during the postwar years. Extraordinary wartime demand for American oil had placed a significant strain on domestic supplies, while at the same time, gloomy reports from the US Geological Survey suggested the United States reserves were not as plentiful as assumed. Rather, the scientific consensus circa 1943 was that the country only possessed enough oil to fuel 14 years’ worth of domestic consumption at prewar levels. American officials such as Harold Ickes, the Interior Secretary who oversaw the Petroleum Administration for War, warned that the United States would not have the oil to fight a World War III if the situation persisted.8

Given the alarm, American investment in petroleum development in the Western hemisphere mushroomed, with special attention paid to neighboring Canada and Mexico. From 1946-1959, US investment in the fledgling Canadian petroleum industry grew by 1400%, and by the 1960s, 90% of the increase in oil imports to the United States originated in the Western hemisphere – America’s “backyard.” Canada and Mexico were exempted from import quotas designed to protect the American oil industry from being undercut by cheaper oil from overseas. As a House committee report explained in 1968, due to their strategic proximity, "Canadian sources of crude should continue to be considered within the scope of our national security planning and therefore should receive special treatment" in international trade. The following year, 40% of all oil petroleum produced by Canada was sold to the United States.9

Trade Strategies Governments Use to Increase Supply Security Countries use a variety of means to increase their reliance on geographically proximate,

relatively-trusted sources and decrease dependence on distant, unreliable or adversarial sources. Among the most obvious, and widely-used, are preferential trade policies that can run the gamut from tariff and quota exemptions to comprehensive trade pacts. As discussed above, the United States pursued the former approach to shift imports away from cheaper Middle Eastern sources and encourage reliance on its Western hemisphere neighbors.

Nazi Germany, by contrast, took the latter tack. Expecting that American oil imports would be halted and a Western blockade imposed once his conquest of Europe began, Hitler in the pre-war years negotiated economic pacts with the only major oil producers on the Eurasian landmass: Romania and the Soviet Union. These countries were particularly desirable because they were not already aligned with the West, and because they were the closest major overland sources available. Establishing a steady trade relationship with the Soviets had been a high priority for several years prior to the conflict. From early 1936 until spring 1939, Hitler had tried to strike a bargain with Stalin on numerous occasions, but agreement could not be reached due to 8 Harold Ickes, "We're Running Out of Oil," American Magazine, January 1944, 26-27, 85; Gerald D. Nash, United States Oil Policy, 1890-1964: Business and Government in Twentieth Century America (Pittsburgh: University of Pittsburgh Press, 1968), 172. 9 Edward W. Chester, United States Oil Policy and Diplomacy: A Twentieth Century Overview (Westport: Greenwood Press, 1983), 35, 44-45, 105-106, 108.

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Stalin’s demanding terms. German efforts became urgent in July 1939, as the Fuhrer sought to ensure Soviet cooperation in supplying oil in time for the invasion of Poland planned for the end of August. Yet, in a pattern that was to characterize Soviet-German relations for the next two years, Stalin dragged his feet on the deal, increasing the Germans’ desperation and strengthening his own bargaining position.10

A slew of reports over the next several months highlighting the Nazis’ precarious position in fuel continued to up the ante for the Reich. The German Office for War Economy Planning estimated in late August that if the USSR was hostile to Germany and Italy in the coming war, the two countries would be 9.9 million tons short of the oil they needed to mobilize their forces.11 Finally, a diplomatic breakthrough on February 11, 1940 secured the terms for the first major Nazi-Soviet economic pact. In short, the deal was “gas and grain for coal and cruisers.” The Soviets agreed to export 1 million tons of grain, 900,000 tons of oil, and 500,000 tons of metal ore to Germany, among other items. In exchange, the Germans would provide “massive military support” to the Soviet Union, furnishing coal, machine tools, synthetic material factories, gun turrets, mines, ships, combat aircraft including Dornier-115s, Messerschmidt-110s, and Junker-88s, and various other military equipment.12 In essence, Hitler was so desperate for Soviet petroleum that he was willing to arm a country he knew he would invade the following year. Meanwhile, the Nazis worked out a similar arrangement with Romania, whereby Germany offered military materiel in exchange for petroleum. Romania became the Reich’s largest supplier, providing 2 million tons of oil annually.13

Countries also intervene diplomatically to promote the interests of oil companies owned or operated by their nationals abroad. While it is still necessary to defend supply lines to bring overseas petroleum home safely, rightly or wrongly, countries seem to have historically believed they would have easier access to foreign oil in a crisis if it was controlled by their nationals. As the importance of oil for war slowly dawned on the British in the years leading up to World War I, for instance, one of the most important steps taken by the British government was the government’s involvement in creating and maintaining an exclusively British oil concession in Persia. Covert British agents played a key role in convincing William Knox D’Arcy, an Australian who had negotiated a sixty-year petroleum concession with the Shah of Iran, to sell his exploitation rights to a British-owned company, the Anglo-Persian Oil Company (APOC).14 Over the next several years, the British government then extended diplomatic support to Anglo-Persian in its efforts to obtain a concession in Ottoman Mesopotamia, while the Admiralty pressured APOC to retain strictly British ownership over Persian oil.15 When tough competition from Royal Dutch-Shell, an oil conglomerate with majority non-British ownership, threatened the company (Anglo-Persian) beginning in 1912, the British Government bought a 51%

10 Edward E. Ericson, Feeding the German Eagle: Soviet Economic Aid to Nazi Germany, 1933-1941 (Westport, Conn: Praeger, 1999), 6, 23-26, 43, 53-54. 11 Ibid., 53-54, 77. 12 Ibid., 3, 105, 109, 114; James E. McSherry, Stalin, Hitler, and Europe (Cleveland: World Pub. Co., 1968), 76. 13 Maurice Pearton, Oil and the Romanian State (Oxford, UK: Clarendon Press, 1971), 229, 243. 14 William Engdahl, A Century of War: Anglo-American Oil Politics and the New World Order (London: Pluto Press, 2004), 28. 15 Marian Jack, "The Purchase of the British Government's Shares in the British Petroleum Company 1912-1914," Past & Present, Vol. 39 (1968): 141.

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controlling share in Anglo-Persian in May 1914. It was an unprecedented move; never before had such an arrangement been negotiated with any major company.16

The British emerged from World War I with a mandate over several former Ottoman territories believed to possess massive oil deposits. The government continued its policy of favoring British oil commerce in these lands – while excluding activities by others. “During the months after the armistice, the British had refused to allow geologists of the Standard Oil Company of New York to investigate its claims obtained in Palestine prior to the war,” according to John DeNovo. “Soon they excluded from Mesopotamia American geologists eager to investigate oil possibilities there.”17 This discriminatory policy was codified in the 1920 San Remo agreement, whereby Britain and France divvyed-up the most promising oil territories and pledged to bar petroleum development by foreign nationals.18 At the time, American leaders worried that the British were trying to “lock-up” Middle Eastern oil reserves at the expense of the United States – concerns that are echoed today in reference to China’s equity oil agreements.

While many contemporary observers date energy security concerns to the 1970s oil shocks, in fact, countries have long worried about the security of their supplies. The cases described in this memo represent common trade approaches countries have adopted to make their supplies more secure from forcible interdiction. Policies currently used by emerging powers like China to bolster their oil security – such as building a “New Silk Road” of oil pipelines and trade routes across Central Asia to circumvent a potential American naval blockade, negotiating closer trade relationships with the Saudis and the Gulf States, and fostering a strategic relationship with Pakistan, which sits just astride the Persian Gulf – should be viewed in this context. Far from being unusual, moves like these represent continuity over time; they are contemporary versions of actions taken by vulnerable countries going back over a hundred years.

16 Ibid.: 139, 141-142, 146, 150, 167. 17 John A. DeNovo, "The Movement for an Aggressive American Oil Policy Abroad, 1918-1920," The American Historical Review, Vol. 61, No. 4 (1956): 861. 18 Ibid.: 860; Stephen J. Randall, United States Foreign Oil Policy since World War I: For Profits and Security (Montreal: McGill-Queen's University Press, 2005), 16-17. Nash, United States Oil Policy, 1890-1964: Business and Government in Twentieth Century America, 52.