Cuba, Oil, and National Security

A Special Report for the World Security Institute

By Dr. Jonathan Benjamin-Alvarado[1], University of Nebraska, Omaha[2]

August 2006

Introduction

Three years ago, Cuba announced the discovery of oil reserves off its northwest coast. Since then it has crafted an increasingly sophisticated energy development plan for exploiting these resources and struck deals with a growing list of international partners. As global demand for energy has expanded and prices skyrocketed, Cuba's oil discoveries have garnered increased interest from American policy analysts, oil companies, and a widening number of U.S. government officials. All this has also raised questions about how it might alter the 44-year U.S. trade embargo against the Castro regime.[3] Specifically, the questions have centered on the size and potential of the oil reserves and the possibility of American involvement in both the private and public domain.

This oil drilling rig in Matanzas province is used for subvertical or horizontal drilling to offshore fields. (All pictures in this article © 2006 World Security Institute)

This special report is an attempt to clarify the current conditions of Cuban oil and gas development schemes. It argues that cooperation in this area could serve long-term U.S. national security interests as they pertain to energy security and the diversification of strategic energy resources (especially refining capacity). It also demonstrates how cooperation in this arena now may prove beneficial after the eventual normalization of relations between the two countries.

Under the prevailing policies and regulations of the Bush Administration, there is little that can be done at this moment, and because little research and analysis has focused on this issue, this brief exposition is overdue. As the prospects for Cuban oil and gas grow, U.S. policies prohibiting American participation in the Cuban energy sector are increasingly at odds with the Administration's purported claims of promoting energy security.

Since the announcement of oil discoveries in Cuba, interest has grown significantly due primarily to three reasons: energy security interests; broader regional strategic interests; and purely economic interests. Cuban oil is seen as a possible if only partial remedy to U.S. energy supply concerns. Second, as Cuba expands its diplomatic and economic ties to countries such as Venezuela, China, Brazil, and members of the European Union (especially in the energy realm), these ties may provide Cuba with a buffer against U.S. opprobrium while solidifying it economic and diplomatic role in the region. This is important inasmuch as there is a de facto trend in the Americas that clearly disavows and attempts to minimize the influence of the United States in the region, and with the growing demands on the world economy by China, it stands to reason that Cuba may assume an increasing stature that almost entirely negates the presence of American influence in Cuban and hence regional affairs. Finally, as demonstrated by the presence of American oil interests in the February 2006 U.S. - Cuban Energy Summit in Mexico City, there is significant interest in cooperating in joint venture projects, and by extension assisting in the long-term development of Cuba's oil industry.

Aging thermoelectric plants such as the Maximo Gomez plant outside Havana have experienced increasingly frequent breakdowns due to the long-term use of heavy Cuban crude oil. The ensuing blackouts have forced Cuba to confront its decaying energy infrastructure and pursue new alternatives.

This report seeks to lay out some national security policy considerations, applying strategic thought to what I will term "Post-Oil" Cuba – a Cuba that has a small but vibrant and growing oil and gas production capacity with extensive relations with a number of partners, and an increasingly positive outlook toward addressing energy and economic development questions that have plagued the Castro regime since the Cuban Revolution.[4]

The primary consideration is to ascertain what options exist for American foreign policy decision makers as relations with Cuba evolve over the coming years.[5] The existing academic literature has clearly laid out the scope and objectives of Cuban energy development schemes since Cuba's favorable trade arrangements with the USSR ended with the Soviet collapse in 1991. Cuba's recent oil discoveries and its favorable energy arrangement with Hugo Chavez's Venezuela have renewed interest in Havana's energy policies. Most of that analysis has been focused on concrete possibilities where there can be cooperation in the energy field between the U.S. and Cuba.

Many of Cuba's old thermoelectric plants, such as the Antonio Guiteras plant in Matanzas, have shut down in recent years. Cuba has responded with an aggressive energy conservation program and international joint ventures to exploit new-found oil and gas reserves.

Specifically, the work has looked at areas for the convergence of energy interests as they apply to the near- and long-term energy development scenarios facing both countries. Myers Jaffe and Soligo have addressed this possibility by looking at the potential to increase diversification and dispersion of energy resources. This is an important consideration when one takes into account that well over one-third of all oil refining capacity resides on or near the Houston shipping channel. The potential negative impact on America's refining capacity following Hurricane Rita[6] made a significant impression on oil industry analysts regarding the need to diversity the locations of these vital resources. Viewing Cuba as a potential entrepot for American oil storage and refining is plausible because of the island's proximity – a mere 90 miles from Florida. This also becomes more attractive in light of increasing climatic instability posing a threat to oil resources in the Gulf region, as clearly demonstrated by Hurricanes Katrina and Rita in 2005. While it is true that Venezuela has initiated an investment of $1 billion dollars to bring the defunct refinery in Cienfuegos, Cuba online, there are still many other possibilities open and available to American companies.[7]

Venezuela remains the fourth largest exporter of oil to the United States and one can surmise that the existing trade arrangements between the U.S. and Venezuela will remain intact, despite the evolution of the Bolivarian revolution under Chavez and the growing Chinese presence in the region. Additionally, pursuing such a path would allow U.S. policymakers to take advantage of Cuba's comparative advantage in the following areas: domestic technical capabilities; continuing human capital development; strategic positioning in the Caribbean; and an improved diplomatic stature. Cuba, by any tangible measure, possesses a largely untapped technical capacity owing to advanced training and education in the core mathematic and scientific competencies. This was clearly demonstrated by its attempt to develop a nuclear energy capability in the 1980s and 1990s, whereby thousands of Cubans pursued highly technical career trajectories, leaving Cuba with among the highest ratios of scientists and engineers to the general population in all of the Americas. Moreover, the foundation of Cuba's vaunted public education system remains intact, and increased investment under various scenarios suggests that Cuba will continue to produce a well-educated workforce that will be critical to its future economic vitality.

This raises an important consideration: the role Cuba will play in the region in the 21st century. Cuba remains a strategically important state by virtue of its geographical location alone, particularly in efforts against drug and human trafficking and related national security matters. The extent to which the Cuban government has cooperated with the U.S. in drug interdiction efforts in the past suggests that warmer diplomatic relations between neighbors would have a beneficial effect on national security concerns related to thwarting terrorism, illicit weapons transfers and the like. Ultimately, a successful rapprochement between the U.S. and Cuba in these areas may well enhance and stabilize regional relations that could possibly assuage (or at a minimum, balance) fears of a Chinese incursion into hemispheric affairs. To lessen those fears, it may be useful to review the present structure of joint-venture projects in the energy sector in Cuba to ascertain the feasibility and possible success of such an undertaking for American firms. Moreover, it is interesting to note that U.S. firms in the agricultural sector have successfully negotiated and consummated sales to Cuba totaling more than $1 billion dollars over the past four years under conditions that are less than optimal, but have well served the commercial interests of all parties involved.

Cuba's Joint Venture Success – Energas, Sherritt and the Environment

The Energas power plant is a Cuban joint venture with Sherritt International of Canada.

In 1997, Cuba launched an ambitious Energas joint venture project with the Canadian energy and mining firm Sherritt Ltd. to convert flared gas from its Matanzas-Varadero oil fields into fuel through a combined cycle process.[8] The project allows Cuba to make use of the associated gas for power generation facilities in Boca de Jaruco and Varadero, boosting capacity 15 to 30 MW (Megawatts), for a total capacity of 226 MW. The project was financed by an initial public offering (IPO) in Canada by Sherritt and construction was completed in 2004. The process entails the removal of the sulfur from the heavy crude of the region, utilizing the associated gas to fuel turbines. Environmentally, this process is much cleaner and allows the Cubans to capture emissions and particulates that were previously being discharged into the environment.

The yellow sulphur separated from the heavy crude at the Energas plant is reused in other industrial applications.

This is especially critical as the Matanzas-Varadero oil fields are contiguous to Cuba's major tourist destination, the beaches of Varadero, located some 90 miles east of Havana. There are no tell-tale signs of oil production in this region to the tourist crowds owing to two factors. First, most of the offshore fields are accessed by slant and horizontal drilling techniques, behind and out of sight of the Varadero peninsula, and the thermo-electric generation stations are relatively distant from the tourist zone.

Cuba's profitable tourist beaches in Varadero are close to sites of new oil and gas operations, making environmentally-sound practices a must.

The Energas facilities are a small-scale showcase of the Cuban energy sector, exemplifying ecologically-friendly processes for the production of electricity to the national grid in partnership with a foreign firm that has been successful in creatively utilizing the existing oil reserves in a manner that promotes efficiency and, by all indications, has provided a sound return on investment for the joint venture.

But why has Sherritt succeeded when the perception on the part of many American observers has been that Cubans are difficult and mercurial partners? Sherritt Oil is a medium-sized firm with medium-sized aspirations that simultaneously seeks to produce a reasonable return on investment for its ventures in Cuba while operating a humanistic commercial enterprise in a country in dire need of reliable energy sources that operates under the strictures of a command economy.[9]

Inside the Energas control room.

This perhaps explains why Sherritt has been successful where others failed. The terms of "doing business" in Cuba are often too severe for conventional profit-seeking firms, but in this case, Sherritt appears to have altered its basis for success to coordinate its objectives with those available under the prevailing Cuban joint venture model. The Spanish oil firm, Repsol, spent $53 million in oil and gas exploration in 2004 and came up with nothing. Yet it has contracted to continue exploration of eight offshore tracks on the northwest coast of Cuba.[10]

It is also interesting to note that all of the firms currently operating in Cuba are using dated technology and must be able to service all of its own exploration operations. This owes in part to the fact that American engineering represents the leading edge of oil exploration technology and explicit in all of its foreign sales are export control stipulations that none of that technology can be sold or transferred to a short but well known list of countries: Iran; North Korea; until recently Libya; and of course, Cuba. This proscription adds up to 30 percent to the operating costs for what is still a profit making venture for Sherritt and other joint venture partners. Sherritt is also responsible for providing all engineering support services, as Cuba provides few of these services owing to the technology denial on the part of the U.S.

This heavy oil processing plant is another Cuban joint venture with Sherritt of Canada.

On this point, the U.S. embargo has been successful in relegating Cuba's energy development schemes to less-than-world-class status. Moreover, it appears to have had a residual effect: so as not to appear to be suffering from a technology gap, Cuba pursues upstream investment, such as the purchase of three drilling rigs from the Chinese for symbolic as well as practical reasons.[11] It is perhaps a questionable investment, given the limited resources on the island and interest from oil and gas exploration firms from Europe, Latin America and Canada, and especially because of Cuba's cozy relationship with oil-rich Venezuela. American oil industry experts suggest that for a small country like Cuba, it could derive a greater benefit from investment in oil infrastructure such as pipelines, terminals, batteries, etc. These are the types of services essential to oil production and serve as revenue generating sources long after the reverie of an oil find. In an inherently risky industry, it makes more sense for a small, relatively resource-constrained state to pursue this course of energy investment.

Another example of the Cuban effort to address "la problematica energetica" is the creation of remote diesel fueled generation sub-stations in Pinar del Rio province.[12]

New power substation in hurricane-prone western province of Pinar del Rio.

In the past 16 years, Cuba has suffered direct hits from hurricanes in the Caribbean. While there has been almost no loss of life from these natural disasters, the impact on the national electrical grid has been devastating. This owes to the fact that the grid extends the length of the island, traversing it east to west. Almost all of the hurricanes pass over the island in a south-north direction essentially slicing the island in half, destroying everything in their path, in this case the towers supporting the high-tension electrical wires of the national grid.

Part of new substation in Pinar del Rio province.

After the storms' passing these towers often resemble the set of a monster movie where the path of the beast has rendered a swath of flattened and twisted metal in its wake. This was most critically evident in 2004 after Hurricane Charley. Charley cut across Pinar del Rio province on August 12th with winds in excess of 145 mph, cutting the national grid in half and leaving the entire province of nearly a quarter of a million inhabitants without electricity for the next two weeks. The Cuban electrical utility, Union Electrica, and the Cuban Ministry of Basic Industry subsequently designed and implemented a project that would address disruptions to the grid from natural disasters and allow for additional electricity to be generated during peak demand periods.

Most importantly, this would enable the officials of Union Electrica to deal with an increase in the number and strength of hurricanes and tropical storms in the region.

Buscando Oro Negro: The Reality of a Cuban Oil Bonanza

In December 2004, the Castro regime announced that they had discovered a significant oil reserve off the northwest coast of the island. These oil finds have the potential to dramatically decrease the island's dependence on imported oil and serve as boon to the Cuban economy. There has been much conjecture of the size and scope of oil reserves in the 59 offshore tracts in the Cuban exclusive economic zone (EEZ). The working estimates are that there are a potential of 120,000 barrels of oil per day, perhaps more, but the sea floor is over a mile deep and the oil reserves perhaps an additional 3,000 feet beneath the sea floor. This lies within the capacity of the existing oil drilling technology, but as previously explained, the task of extracting the oil will have to be undertaken using second or third generation technology because of U.S. export control regulations against trading with Cuba. The challenge for Cuban oil development policy makers is to simultaneously pursue frontier exploration in the Gulf of Mexico, while continuing to produce from the existing mature oil reserves with higher levels of efficiency and environmental integrity. Add to this challenge the additional question of securing the appropriate technology for the task.

The shaded blocks in Figure 1 indicate the 16 blocks under contract with various oil companies. Six blocks are under contract to Repsol-YSP of Spain (yellow),[13] four blocks with Sherritt from Canada (green), six blocks are presently under negotiation (blue), and the remaining 43 are presently open. According to Cuban energy officials, the objectives for 2006 are to increase the drilling of wells by over 50 percent, to carry out a seismic campaign to collect more data for the available tracts, to increase the domestic production of oil and gas (presently 85,000 barrels/day), and to put more drilling rigs into operation. Discussion with American oil industry representatives strongly suggest that there is credibility to the claims being made.

Figure 1: Cuba's Exclusive Economic Zone for Oil Exploration



Source: CUPET, 2006

Conclusion

Why is it important to clarify the current status of Cuban energy in the face of continuing opposition by the United States to anything resembling what can be construed as "good news" for the Castro regime? Obviously, because up until this point it hasn't cost the United States much, if anything. The current policy continues to value a comprehensive embargo in the hopes that it helps to foment a change in regime and a transition to a democratic system of governance and a market-oriented economy. As concerns over energy security continue to grow in the U.S, we may begin to see the erosion of the hard position against the Cuban regime, regardless of its leadership.

The overview of Cuban energy developments clearly reveals that the Castro regime has every intention of continuing to promote, design and implement energy development policies that will benefit Cuba for generations to come. Cuba is sparing no effort by instituting bottom-up and top-down policy initiatives to meet this challenge. It has significantly increased its international cooperation in the energy sector and continues to enhance its efforts to ensure energy security in these most uncertain of times. But it stands to reason that no matter how successful these efforts are, they will come up short.

Two factors may alter this present situation. First, Cuba may indeed realize a bonanza from the offshore tracts that will allow it to address its many energy challenges, from increasing oil production and refining capacity, to improving the nation's energy infrastructure, ensuring a stable energy future. Second, and no less significant, is the possibility of normalization of trade relations with the United States. This is important not only because it would allow direct foreign investment, technology transfer and information sharing between these neighboring states; it would also enhance the energy security of both states, and hence, the region, realized through a division of labor and dispersion of resources that serve as a hedge against natural disaster and market disruptions. Moreover, all states could derive benefit from the public information campaigns to promote energy efficiency and conservation presently being promoted in Cuba.

Ultimately, and only after normalization, the task still falls to the Cuban government, but the cost will necessarily be spread through a number of sources that are predominately American because of strategic interests, proximity and affinity. It suffices to say that the requisite investment and assistance will have a distinctly American flavor, inasmuch as American corporations, U.S. government agencies, and international financial institutions, to which the U.S. is a major contributor, will play important roles in the funding of the effort to revitalize the Cuban energy sector. Cuban officials are not averse and perhaps would prefer that the U.S. be its major partner in this effort, owing to the fact that most if not all of the cutting-edge technology in energy, oil and gas comes from the United States. It is remarkable that the Cuban energy sector is as vibrant as it presently is, absent the type of infrastructural investment that is available to most developing states, in large part because of the U.S. embargo.

Finally, the cost is significant and it stands to reason that the longer one waits to address the challenge at hand, the higher the cost of modernizing the energy sector will be. For this reason alone, the American role in assisting Cuba in this effort will be significant, and every day that the task is put off, the price goes up. This should serve as an obvious point of entry into cooperation with the Cuban government and perhaps can serve as a catalyst for promoting confidence, trust and cooperation in these critical issues across the region.

[1] [Prof. Benjamin-Alvarado is one of the United States' leading specialists on the Cuban energy situation. Since 1992, he has visited Cuba 19 times for field research on energy development. He has published extensively, including the book Power to the People: Energy and the Cuban Nuclear Program (2000) and the forthcoming volume, Cuba's Energy Strategy: Economic Structures, Technological Choices, and Sustainability.]
[2] The author wishes to thank Glenn Baker and Bruce Blair of the World Security Institute for the invitation to accompany their delegation to investigate Cuban energy in March 2006. The author also wishes to express his gratitude to the following individuals who were instrumental in providing him with the information and materials that made this work possible: Kirby Jones, Dagoberto Rodriguez, Raul Perez de Prado, Vicente de la O, and Guillermo Rodriguez del Pozo.
[3] See Jay Newton-Small, "Oil Firms and Cuban-Americans Fall Out Over Off-Shore Drilling." The New York Sun, June 22, 2006.
[4] The scenario makes no judgment regarding the ideological or political composition of the Cuban government in the "Post-Oil" setting, nor in any post-Castro regime, but under the prevailing economic and political practices in Cuba there has been significant opening of the economy for joint venture projects in critical areas such as tourism, mining and energy development.
[5] Benjamin-Alvarado, Myers Jaffe and Soligo, Piñon and others have clearly laid out the possibilities presently available to American policy makers. See Jonathan Benjamin-Alvarado, "The Problems and Prospects of a Sustainable Energy Future in Cuba"; Amy Myers Jaffe and Ron Soligo, "Energy in Cuba" in Cuba in Transition: Volume 15. (2006) Papers and Proceedings of the Fifteenth Annual Meeting of the Association for the Study of the Cuban Economy (ASCE); Jorge R. Piñon Cervera, "Cuba's Energy Challenge: Fueling the Engine of Future Economic Growth," forthcoming in Cuba in Transition: Volume 15. (2006) Papers and Proceedings of the Fifteenth Annual Meeting of the Association for the Study of the Cuban Economy (ASCE).
[6] Oil industry insiders were greatly relieved that the Houston area avoided the devastation of a direct hit from Hurricane Rita. Such an event might critically injure America's capacity to meet market demands, raising the costs of oil and perhaps triggering an economic crisis.
[7] "Venezuela and Cuba agree to oil link," BBC News, April 11, 2006.
[8] For a detailed illustration of the Energas joint venture project see Jonathan Benjamin-Alvarado, Power to the People: Energy and the Cuban Nuclear Program (New York: Routledge, 2000) 97-98.
[9] Interview with Barry Hatt, Senior Vice President, Sherritt Oil Ltd., Havana, Cuba, July 20, 2005.
[10] One could argue that like many oil exploration firms, Repsol subjected itself to "gambler's ruin" by placing all of its chips on a single bet -making the enormous oil find in Cuba. From all estimates, there is oil in Cuba but not readily present and of the scope necessary for firms like Respol, Petrobras, Total SA or ExxonMobil for that matter to justify in the already risky business of oil and gas exploration. For an excellent review of the joint venture project, see Eloise Linger, "Joint Ventures: New Developments in Cuban Mining and Oil Exploration," paper presented at the National Summit on Cuba, June 10, 2005, Mobile, Alabama.
[11] Cuba Petroleo (CUPET) signed a $40 million dollar contract for drilling rigs with China's SINOPEC Group, a state-run oil firm, to conduct drilling operations in Santa Cruz de Norte, some 33 miles east of Havana. See EFE, Prensa Latina, 1/31/05 and Reuters, 6/4/05).
[12] Interviews with Cuban Vice Minister of Basic Industry Raul Perez de Prado, and Vicente de la O, Director General of Union Electrica, February 4, and March 3-4, 2006
[13] Spanish oil-prospecting company Repsol YPF resumed subsurface sounding in Cuban waters, following a failed attempt in 2004. With a new joint-venture deal that entitles it to 40% of all revenues and puts it at the helm of the drilling rig, the company is planning to pick up where it left off. Other shareholders in the joint-venture will be Chinese state-owned CNOOC, with a 30% stake, and Norwegian Norsk Hydro, with the remaining 30%. (Notimex, 3/6/05)