BERKELEY: Oil is still the world’s leading energy source, with growing demand, a fluctuating pricing system, and much of its production in volatile regions.
The oil market’s value is larger than the world’s valuable raw metal markets combined, with an annual production valued at US$1.7 trillion. A flourishing black market is no surprise, with about US$133 billion worth of fuels stolen or adulterated every year.
These practices fund dangerous non-state actors such as the Islamic State, Mexican drug cartels, the Italian mafia, Eastern European criminal groups, Libyan militias, Nigerian rebels and more – and are a major global security concern.
The top five countries accused of oil trafficking – Nigeria, Mexico, Iraq, Russia, and Indonesia – are also producers. It is estimated that Nigeria alone loses US$1.5 billion a month due to pipeline tapping, illegal production and other sophisticated schemes.
In Southeast Asia, about 3 per cent of the fuel consumed is sourced from the black market, estimated to be worth up to US$10 billion a year. In Mexico, drug cartels launder drug revenues through the oil trade.
Other countries are not immune. Turkey is not an oil producer, yet serves as a major transit route for hydrocarbons flowing to Europe from the Organisation of the Petroleum Exporting Countries (OPEC) like Iraq and Iran.
As an energy hub, Turkey is strategically situated for the illegal trade and lost an estimated US$5 billion in tax revenue in 2017. An uptick in smuggling oil and other refined products began 2014, when IS took control of major Syrian and Iraqi oil fields.
As with most commodities, the volume of oil smuggling is primarily linked to fluctuating prices. With climbing oil prices, illicit trade is expected to increase.
The European Union is a prime example on how price disparities of fuel within its own member state countries tend to incentivise illegal trade producing counter-intuitive routes.
Lower oil prices in Eastern Europe have created maritime smuggling routes to the United Kingdom and Ireland. Ireland estimates it loses up to US$200 million annually with fuel fraud, while up to 20 per cent of fuel sold in regular gas stations in Greece is illegal.
The legal complexities and ambiguities of the global oil and gas trade often create an opening for illegal activity.
In some cases, subnational actors openly export oil despite official prohibition by central governments. The Kurdistan Regional Government in Iraq maintains it is their region’s constitutional right to export oil independently, in defiance of the central government.
With Baghdad withholding the region’s 17 per cent of budget share, the regional government sought economic independence through hydrocarbons and found a degree of international sympathy, given its role in combating ISIS and hosting 1.9 million refugees and internally displaced people.
The unrefined product was sent via pipeline through Turkey’s Ceyhan port, loaded by various Greek shipping companies on tankers, then stored in Malta or Israel until buyers were found. Shifting routes of Kurdish oil tankers can be observed on sites like tankertrackers.com.
Authorities who benefit from the trade often stymie efforts to combat illegal trafficking, as seen in countries like Iraq or North Korea, with terrible consequences for citizens. Conflict and illicit trading near the Niger River Delta reduced overall foreign direct investment in recent decades.
SMUGGLING ON WATERS
With 90 per cent of the world’s goods, 30 per cent of which are total hydrocarbons, traded by sea, much of the illegal fuel trade is conducted on water.
Two-thirds of global daily oil exports are transported by sea, reports the UN Conference on Trade and Development, and a staggering 64 per cent of international waters are areas beyond any national jurisdiction.
Non-state actors offshore West Africa, Bangladesh or Indonesia take advantage of loopholes created by international law and the law of the sea.
Transfer of illegal fuel is often done ship to ship on neutral waters – with one ship commercially legal, recognised as carrying legitimate imports at the final port of destination. Thus, illegal crude from countries such as Libya or Syria finds its way to EU markets.
Recently Russian ships have been found involved in smuggling oil products to North Korea through ship-to-ship transfers.
Armed theft and piracy also occurs. Hijackings off the coast of Somalia resumed in 2017, the first since 2012, after the international community reduced enforcement.
Beyond jurisdictional issues, many governments are overwhelmed by other maritime security threats and cannot prioritise the illegal trade. In fact, fuel traders have reported that the problem is so pervasive that many companies calculate in advance for losses up to 0.4 per cent of any ordered cargo volumes.
COUNTRIES WILL SUFFER FROM ILLICIT TRADE
The industry runs on high risk tolerance. Transparency International estimates that over the next 20 years, around 90 per cent of oil and gas production will come from developing countries. The relatively low average salaries of state employees relative to the private sector in developing countries encourage the temptation to look for other income sources.
Consider Mozambique, where immense offshore natural gas reserves have been discovered. Emerging from decades of civil war, the country has a diverse wasta system – an Arabic term for bribing and asking for favours – along with strong political allegiances and state structures that struggle to withstand internal and external pressures.
Estimates suggest that 54 per cent of all cargo movements in the capital city, Maputo, involve bribes, and Mozambique risks following the path of Nigeria, a country in need of socioeconomic development despite vast oil and gas reserves under development since 1958.
The country is reported to have already lost around US$400 billion since its independence in 1960 due to theft or mismanagement in its oil sector.
The Organisation of Economic Co-operation and Development suggests that the impacts of the illegal oil trade go underestimated, and the affected countries suffer from the deteriorating rule of law, loss of biodiversity, pollution, degradation of critical farmland, increasing health problems and armed conflicts.
Other opportunity costs include increased financial risk premiums for investors with billions of dollars lost annually due to illegal bunkering, pipeline tapping, ship-to-ship transfers, armed theft, adulteration of fuel and bribery.
Illicit trade allows authoritarian states to maintain revenue flows for years despite international sanctions designed to weaken their rule. In the 11th year of UN oil sanctions, Iraq’s dictator Saddam Hussein had managed to become one of the world’s richest men, with an estimated US$3 billion in wealth.
Some governments condone the illicit trade. An intertwining of regime structures and corruption – often supported by governments and corporations – is a major stumbling block for the international community’s attempts to contain illegal trading.
So far, governmental and industry efforts to halt the practice have been ineffective – and it could be that the illegal oil trade offers enough benefits to consumers, producers and government officials to disincentivise investigation. Some officials suggest that condoning trade in illicit oil and petroleum products helps keep regional and local security intact.
The first global conference on fuel theft, held in Geneva in April, may be a watershed moment.
The conference aimed at encouraging discourse among stakeholders within the hydrocarbons industry on how to tackle the scale of this global crime.
Similar challenges confront the rapidly growing liquefied natural gas market. Strong international cooperation is required, or detrimental effects for global security, the environment and economic prosperity will continue.
Unless monitored and addressed by robust policy and regulation, the illegal oil activities will remain a key funding source for terrorism, organised crime, authoritarian states and violent non-state actors.
Peri-Khan Aqrawi-Whitcomb is a specialist in sustainable development policies and political affairs with a focus on the Middle East, particularly Iraq and the Kurdistan Region, and is a non-resident fellow at the Payne Institute for Earth Resources at the Colorado School of Mines.
Morgan D Bazilian is executive director of the Payne Institute and professor of public policy at Colorado School of Mines.
Cyril Widdershoven is a veteran global energy market expert and founder of Verocy. He holds several advisory positions at various international think tanks and is also non-resident fellow at Payne Institute for Earth Resources at the Colorado School of Mines.
This commentary first appeared in Yale Global Online.