A 900-mile electricity blackout would seem to have little connection to attempts to crack down on fuel smuggling. But in Libya, actions can have unforeseen consequences. In January, the National Oil Company accused a militia providing security for the Zawiya oil refinery of stealing and smuggling fuel. Not long after, supplies to a power station in the same city were shut down by “protesters” widely rumoured to be linked to the militia. This left the power station unable to supply the electrical grid, causing the largest blackout in Libya’s recent memory.

The message was clear: The militias will fight back if their income is threatened, and the U.N.-backed government can do little about it.

When analysts try to unpack the causes of Libya’s seemingly interminable cycles of instability and conflict, they generally focus on the political process and security. But they too often overlook an important driver of the conflict: a war economy that has become a major obstacle to peace and a threat to the future of the state.

The chain of events leading to the blackout is just one example of the complex web of factions and interests that ties the country’s political economy together. It illustrates the weakness of the state, the challenges that its institutions face, and the ability of militias to assert themselves at the local level. Critically, state weakness in Libya has implications beyond Libya’s borders. It has contributed to major increases in migration to Europe and provides a fertile environment for extremist groups to operate and thrive. Effective international policy, it is broadly agreed, must invest more deeply in tackling Libya’s governance crisis. To do so, it must do something about its war economy.

State Disintegration and Compromised Institutions

The war economy is deepening due to the weakness of the state, but attempts to strengthen and rebuild the state are undermined by the incentive system created by the war economy. Competition between Libya’s rival factions has gravely eroded the state’s effectiveness and undermined its institutions.

Confusion reigns as two principal governments claim sovereignty but neither can demonstrate either a clear legal mandate or provide effective services. The Tripoli-based Government of National Accord (GNA), created following the conduct of the Libyan Political Agreement under the auspices of a U.N.-led process, has the support of most of the international community. But it has not been ratified by the House of Representatives, an elected body formed in 2014 and based in Tobruk, eastern Libya. As a result, Libyan courts have ruled that the GNA cannot be recognized, and have predominantly sided with the House of Representatives. Meanwhile, the House of Representatives’ mandate has expired (although it has voted to extend its own mandate) and has limited international support (principally from the United Arab Emirates and Egypt).

The tug-of-war between the rival governments has created severe challenges for the institutions that ensure the state’s survival: the National Oil Company, the Central Bank, and the Libyan Investment Authority. Both the National Oil Company and Central Bank have largely managed to navigate attempts to split them into rival branches in the west and east. But the struggle for influence over the two is a constant, and causes constant problems for officials trying to keep them up and running.

The National Oil Company is currently locked in a battle with the GNA over what it believes is an illegal encroachment on its mandate to dispense oil and gas contracts. Yet, despite its challenges, that this company continues to function is one of a vanishingly small number of reasons for optimism in Libya.

The Central Bank, meanwhile, is struggling to keep the economy afloat. It has largely been reduced to paying state sector salaries and providing energy subsidies. The Central Bank is locked in a dispute with the GNA over measures to counter inflation and the growing discrepancy between the official dollar-Libyan dinar exchange rate and the black market rate, on which many increasingly rely.

At the Libyan Investment Authority, rival heads Abdulmajid Breish and Ali Mahmoud Hassan, have been taking turns to oust each other from the organization’s headquarters in Tripoli. In February, Breish returned to the building armed with a court decision that Hassan’s appointment by a GNA-selected board was invalid. Hassan would return to the building on May 8, only for Tripoli’s Supreme Court to reject the GNA’s appeal on the February decision a few weeks later. In a sign of the times, it is the militia that controls the LIA offices that determines who has access to the building.

Libya’s War Economy

Nature abhors a vacuum, and the above examples of Libya’s governmental chaos have provided major opportunities for state plunder, either through capturing its natural resources or through cash grabs. Armed groups have occupied oil infrastructure and extorted rents from the state for their protection. Sometimes this is to hold the state to ransom: One militia leader, Ibrahim Jadhran, was reported to have been paid $42 million by the GNA in 2016 to end an oil boycott in Libya’s oil crescent. Such activities have taken a high toll on Libya’s oil-fuelled economy. In April, Central Bank Governor Sadiq el-Kebir said that the arbitrary closure of oil production facilities alone had led to losses in excess of $160 billion.

For others, such as the militia in Zawiya, the dysfunction is a chance to skim from the oil industry’s proceeds. In a January report, the Libyan Attorney General’s office estimated that fuel smuggling had cost the country over $3.5 billion, although it was unclear over what period the losses had occurred. In Libya, smuggling state subsidized fuel to neighbouring countries has long been a cottage industry, but in recent years elaborate schemes that allow the fuel to enter the European market directly from Libya’s refineries also seem to be thriving. Without a functioning security sector, the National Oil Company is powerless to stop it.

The revenues generated from oil and gas have also been subject to graft, corruption, and extortion. A huge discrepancy between the official exchange rate for the Libyan dinar (1.4LD = 1USD) and the black-market exchange rate (currently 8.2LD = 1USD) has created significant opportunities for those who can access foreign currency at the official rate and sell at the black market rate. But this, in turn, is accelerating the dinar’s decline.

Fraudulent “letters of credit” have been used to profiteer from the arbitrage opportunity between the two rates. Letters of credit are issued by the Central Bank to underwrite payments for goods in U.S. dollars, but all too often fewer goods than promised are actually procured and the excess dollars received at the official rate end up being filtered either into the black market or out of the country. One incident saw militia leader Haithem al-Tajouri extort the Central Bank employees to receive letters of credit worth $20 million.

Indeed, extortion of those working in the financial sector has become commonplace. Banks have been a key target for militias and criminals, who have regularly kidnapped their managers and major depositors, or alternatively plundered vaults directly. This undermines what remains of the private sector while exacerbating a liquidity crisis. According to private discussions with experts, inflation has now reached an estimated 30 to 40 percent. In a country that imports almost everything, and whose citizens have traditionally relied on the state, many Libyans are struggling in a way to which they are not accustomed.

The collapse of state authority has also led to a boom in smuggling all kinds of commodities, an increasingly important revenue stream. Most high profile of these trades is the proliferation of human trafficking. A recent report by the Global Initiative concluded that Libya’s chaos has seen trafficking develop into a significant industry. The emergence of well-organized criminal networks, along with the territorial access provided by militia control, has seen traffickers’ capacity expanded, and more migrants smuggled to Europe.

The business is a lucrative one, worth an estimated $275 to $350 million to Libya’s coastal cities. According to the same Global Initiative report, militias typically charge traffickers per-migrant fee at checkpoints ranging between $2 and $25. Considering that there were over 181,000 recorded illegal crossings from Libya into Europe in 2016 — and likely many more that weren’t recorded — this is a significant revenue stream. There are also many reports that armed groups take the opportunity to extort the migrants en route, with international monitors even asserting that migrants have been bought and sold in modern day “slave markets.”

The growth of the smuggling industry has benefitted some groups, such as the Tebu who dominate smuggling routes on Libya’s southern border. The Tebu have long been politically and economically excluded by the state and denied citizenship rights. For such communities, there are few opportunities for licit income.

An Impediment to Peace

Despite the havoc Libya’s war economy is wreaking on the state and most of its citizens, it allows armed groups to sustain themselves. This creates a set of perverse incentives to prioritize short-term gains at the group level over national stability and security.

A return to functioning central governance is inimical to the major beneficiaries of the war economy, making them powerful spoilers if their interests aren’t addressed. The profitability of the war economy also makes a mutually hurting stalemate — often theorized as a critical precursor to successful mediation — a distant prospect.

The potential for an accord between leading actors — the Libyan National Army chief Gen. Khalifa Haftar and the U.N.-backed Prime Minister Fayez al-Serraj — is a necessary step towards a sustainable settlement to Libya’s governance crisis and has been much discussed. No deal would function without agreement at this level. Yet, such is the fragmentation in Libya that any lasting political settlement will have to satisfy the interests of a dizzying array of local actors with a significant stake in Libya’s war economy.

The extent to which such actors are accommodated in any peace deal is likely to prove a thorny issue. Mahmoud Jibril, the former leader of Libya’s National Transitional Council, recently said at a conference that it may be necessary to provide amnesty to militia leaders, potentially grant tax exemptions, and even offer land in return for the militias keeping their financial assets within the country. No militia leader has read the Libyan Political Agreement, he said, adding, “they just wanted to know who was the next [prime minister] was so they could blackmail him.”

Including disruptive militia leaders in a peace deal would no doubt raise significant opposition from those who argue that those fuelling Libya’s disintegration shouldn’t be rewarded for their actions. Yet, ignoring the increasingly powerful war economy elites’ interests will raise problems of its own for any prospective deal.

Tim Eaton is a Research Fellow for the Middle East and North Africa Programme at Chatham House. You can follow him on Twitter: el_khawaga