Oil Could Hit $400 a Barrel by 2018

That's the forecast from U.S. Navy Admiral William Owens, who sees rising tensions between the U.S. and China as they scramble for energy

US military analysts looking at trends that will affect the relationship between America and China believe they see clear signs of future trouble—and are developing ideas to foster cooperation to try to avoid conflict.

Admiral William Owens, former vice-chairman of the joint chiefs of staff—the second-highest ranking position in the US military—and former commander of the US Sixth Fleet in the Pacific, addressed the Asia Society in Hong Kong this week regarding some of the economic, social and military projections regarding US-China relations in 10 years' time.

Although now retired from the US military (he is currently CEO and chairman of private-equity group AEA Holdings and managing director of AEA Investors, a board member at Daimler Chrysler and Wipro, and former CEO of Nortel), Admiral Owens has been behind a recent, informal dialogue among senior retired military officers from the US and China.

Admiral Owens says one trend that can be safely extrapolated is the growth of the middle class in China and many other emerging markets. The demographics suggest these middle classes are entering a 15-year boom, which is great for many businesses but will incur environmental costs and change military relationships.

In 1945, there were around 50 million people in the world that could be counted as middle class. That figure rose to 250 million in 2005, and will reach 750 million in 2018—all wanting a car, a flat-screen TV, a refrigerator and so on.

"The big story is productivity in China," he asserts, noting it is an incredible 9%, or three times the level of productivity in the US during its 1990s peak. Admiral Owens attributes this to the country's high-quality infrastructure. It will allow the Chinese economy to soon become the second-largest in the world, with a GDP big enough to justify comparison with the US.

That in turn means demand for energy will see oil prices reach $400 a barrel by 2018, he argues. This is not only because of demand in China, India and elsewhere, but because of the nationalisation of oil fields in countries such as Russia, Venezuela and in the Caucasus. And energy efficiency in China is not very high.

A Sino-US initiative on clean coal could mitigate this, however, Admiral Owens suggests. China and America are the world's two main producers of coal, which is used to fire all those new power plants in China and elsewhere.

"We need a $100 billion Darpa-like fund for clean oil financed and developed between these two countries," he proposes, referring to the Defense Advanced Research Projects Agency, the Pentagon's research arm that has spawned, among other things, the precursors to the internet.

Such a project could help alleviate the pollution from industrialisation in China, but wouldn't affect his projection for oil prices. He notes today, US citizens are paying $4/gallon for petrol, and suggests they should expect to pay something around $10/galloon by next decade. The impact in China will be less dramatic, because of the continuing appreciation the renminbi (and indeed rising oil prices will contribute to the continued slide in the dollar's value).

Another projection of this: the internet will be a major mover in the Chinese economy. There are now 210 million mainland people online, up by 50% from 2006, and this will increasingly drive revenues for various industries. "China's moving to 3G and wireless media, and it will probably leapfrog the West," he predicts.

Put together these developments in China's growth, and it stands to reason that it will have a much bigger military budget. Today the US spends around $500 billion annually on its military—and that's before off-budget wars in Iraq and Afghanistan. Admiral Owens is critical of this large budget, noting the military annual budget during the Clinton presidency was around $250 billion.

"The first seven days of the Gulf War was fought with the Clinton military," he says. "I think it's enough, and that we should put that money into education, to help our society and grow our economy."

Even so, today the US spends around 4% of GNP on the military. Assuming China spends 2-3% of its GNP on its military—which is a reasonable figure for a big country—it would then have a military budget of $400 billion by 2018. It's only about $80 billion today, and can already challenge the US by shooting down satellites or build secret submarine bases on Hainan Island.

"How's it going to be when we're spending $600 billion and China's spending $400 billion?" Admiral Owens wonders, given the relative growth of both economies in 10 years' time. "The US will react," as it is likely that politicians in the US will find it impossible not to adopt a confrontational attitude.

The upshot: "2018 doesn't look good unless we take action," he says. This should involve collaboration in common areas, including a clean-coal technology initiative, but also in military areas, such as agreeing to ban weaponry in space or to negotiate reductions on nuclear arsenals.

Admiral Owens says cyber warfare will become an important area, and urges both governments to agree to a 'no-first-use' policy. "We can both shut down the other's society on the internet today," he warns. "Banks, insurance companies, everything is vulnerable." He adds that an attack by a nation is nothing like an attack by a hacker. Russia is suspected of launching a cyber attack on Estonia that had a serious effect on its economy.

On a positive note, he says that 'engagement' became the American byword for how to deal with China under the Clinton administration, one that has been pursued by George Bush. The national security advisor who came up with that buzzword, Anthony Lake, is now advising the Barack Obama campaign.