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Global Energy Security – An Elusive Target


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By Manouchehr Takin

Politicians around the world have long used oil security as a critical national/international factor to initiate controversial public policies. In the last few years and particularly in recent months, energy supply security has made headlines.

The more recent include the reduction of gas deliveries from Russia to Ukraine and Europe, a 75% reduction target for US oil imports from the Middle East and the tension among some European countries and with the EU Commission on the extent of deregulation, market liberalization and takeover and mergers between utility companies.

In this article, it is argued that security of energy supply cannot be realized by one-sided public policies or political rhetoric without considering economic and business realities. More importantly, the policies should be based on global cooperation among suppliers, consumers, businesses and policy makers in an interdependent world. Furthermore, particularly for oil, it should also encompass the security of future demand. The latter, however, is not taken seriously, particularly under the tight oil market environment of the last two or three years.

Traditional View Of Oil Supply Security

This view is a legacy from the oil concessionaires in the early 20th century, their undue influence in the countries where they operated, acting almost as a state-within-a-state or an arm of the foreign ministry and intelligence services of their home governments, influencing and manipulating the domestic politics and even changing governments in the oil-rich countries. The goals of the concessionaire companies were to secure oil supplies for their home countries and enrich their shareholders.

The common view of the time is of a bipolar world with undue political influence exerted by the militarily and economically powerful industrialized oil consumers who supported the oil companies’ unfair exploitation of the oil resources in the weaker countries of the developing world. The companies controlled both production and price of oil. The oil world was a mix of the political power of the industrialized countries and the cartel power of the oil companies. The countries with oil resources had almost no control on their oil.

These views are beyond conjecture and conspiracy theory. They have been analyzed by researchers and analysts benefiting from the unclassified government documents that have since become available. The oil rich countries of the Middle East are classic examples of the traditional view.

Reactions To Oil Concessions

The conditions under concessions led to political movements for the nationalization of oil industry around the world. Similarly, the establishment of OPEC in 1960 had the political support of the governments of oil producing countries. These movements were for a more equitable share of the oil revenues for the producing countries and for some control on the production and pricing of oil.

It is important to note that the ultimate goals for both oil nationalization and establishing OPEC were business practice in a fair commercial environment, security of supply to consumers, oil market stability and a fair return to the investors in oil industry. Politics was not to play any significant role, nor to interfere in the commercial practice of oil business. Indeed, not long after nationalization, the governments and the national oil companies in many of those countries established commercial relationships with the former oil concessionaires.

The 1973 Arab Oil Embargo

A prominent example of oil, politics and security was the 1973 oil embargo by Arab producers during the Arab/Israeli war. It was a serious military engagement and in response the Arabs resorted to the use of oil. The Arab embargo, however, was limited to four countries and was gradually reduced and finally lifted a few months later. Nevertheless, for more than 30 years the oil producers in general and OPEC in particular have been wrongly criticized for using oil as weapon. In fact, the 1973 Arab oil embargo has been the landmark event used to justify numerous policies by the industrialized countries to increase their own supply security and to reduce their dependence on oil and particularly on the oil from OPEC and the Middle East.

What is not often realized is that they have been very successful in advancing the goals of those policies. For example, the OECD countries have since achieved a 50% reduction in the quantity of oil used for a unit of their GDP in real terms. This was reached by conservation, increasing energy efficiency, growth of alternative energies and diversification of energy supplies away from oil. The countries have also been successful in reducing their dependence on Middle East oil by encouraging the finding and production of more oil in other parts of the world.

A New and Different View Of Oil Security?

Half a century later, one could argue that the state of the world oil industry has changed from the traditional view. Since the middle of the 20th century, many new and independent oil companies, as well as new national companies from the oil consuming industrialized countries, have entered the scene. They introduced strong global competition, drastically changing the monopoly power of the former concessionaires, offering more competitive terms and adopting almost revolutionary policies. These developments and the establishment of OPEC brought about major changes and one could argue that the oil companies today are very different. They act as private enterprises with mostly business orientation and they try to be apolitical.

Oil still plays an important role in the world. But one could argue that it is not the overriding factor in international affairs. Strategic considerations, seeking power and influence, access to markets for goods and services, economic priorities and even cultural and religious issues play a greater role than oil supply security. In these decades, business priorities have been paramount for the oil industry – super-majors, majors, other international companies and independents. Even the national oil companies aspire not to be unduly influenced by their governments. The oil industry wishes not to become involved in the vagaries of domestic and international politics.

The same could be said about various oil industry associations and institutions, as well as international organizations such as OPEC. The latter has tried to be apolitical and to remain concerned mostly with business considerations for the benefit of all its member countries. The Organization has been quite successful in this endeavor, in spite of the differences in the domestic and international political stances of the governments, and even military conflicts between members. Domestically, however, in some countries the running of the oil industry has been politicized.

Other oil and gas producing and exporting countries have also become more commercially oriented. Over the decades, the influence of politics has been decreasing in global oil and gas industry operations and trade. This trend has led to greater security of oil and gas supplies. A good example in this respect is the natural gas imports from the Former Soviet Union to Europe since the mid-1980s. At the time, the US under the late President Reagan exerted great efforts to stop the Europeans becoming dependent on the “evil communist empire”. The Europeans decided to go ahead with the deal for up to 30% of their gas imports. Twenty years later, the deal has been a great success in providing a reliable source of supply. The flow of gas to Europe was not disrupted, even during the turmoil of the collapse of the Soviet system.

Recent Increase In The Use Of Oil As Foreign Policy Tool

An interesting point is that although nowadays the companies try to remain apolitical, governments are politicizing the oil scene and we could say this about all governments.

1. Resource Holders

The governments of these countries use oil deal options as part of their diplomatic and international political maneuverings, eg giving preference to the companies from one country on political considerations. As another example, while the US companies entering Azerbaijan in the 1990s did not wish to be associated with the US government, the late President Heydar Aliyev of Azerbaijan insisted on signing those oil agreements in the White House, in the presence of President Clinton. In Russia, the state is gradually exerting greater control and limiting the share of foreign investors. Some interpret the break-up of Yukos oil company as an example of such policy under President Putin.

In the last few years, the rise in the price of oil has strengthened the negotiating position of oil producers vis-a-vis the international oil companies. Many producing countries are pressing for an increased share of revenue in their deals with foreign companies. These appear as higher royalties and taxes announced by the governments or direct pressure on companies for a renegotiation of the terms of their agreements. Though such developments could be viewed more as commercial matters (eg Angola and Kazakhstan), one has to acknowledge that they have become partly politicized (eg Venezuela and Bolivia). In many cases, these developments have appeared following the political changes after elections.

In the older oil producing countries (eg Middle East and Latin America) the emotional memories of concessions and oil nationalization persist. They influence the dealings and negotiations with oil companies; a purely business environment is not maintained.

2. Consumers

It is not often realized that the governments in oil consuming countries are also increasingly interfering in the international oil and gas business, banning companies from operating in some countries and imposing sanctions on others. The political element in public policy for oil and energy in the importing and consuming countries has gone beyond the issue of oil supply security. Oil has become a foreign policy tool. The oil companies worry more about the political risks, uncertainties and vagaries in their own home countries than the political risks in the oil and gas producing countries.

An obvious example is the US President and the Congress forbidding US companies from operating in some countries, imposing oil sanctions on others, or threatening to impose sanctions on non-US companies investing in oil and gas in third countries. The extra-territorial applicability of these restrictions were challenged, eg by the EU Commission. Nevertheless, they exist and could still be applied.

The sanctions, though politically motivated, have caused distortion in international business, and oil and gas production and transport. The development of the hydrocarbon resources of those countries was delayed and the output level or the rate of growth of oil and gas production has been reduced.

As another example, the pressures resulted in bypassing Iran as the logical and least-cost route for transporting oil and gas from the Caspian region to the international market. India and Pakistan are now under pressure not to initiate the project of importing gas from Iran, although this is a reasonable business proposal and will strengthen peace between the two countries.

Energy Security Concerns By Politicians – A Revival

Oil and energy supply security has again been attracting attention, particularly in recent years. Securing future oil and energy supplies has become a common term in the vocabulary of politicians. The politicians have also benefited from the recent headlines that world oil production has already reached or shall soon reach a peak and that an inevitable production decline will follow.

Achieving energy security is unfortunately becoming synonymous with energy self-sufficiency and is leading to protectionism and market distortion. This finds itself in conflict with ideals such as free trade, liberalization, globalization and free markets – the ideals long portrayed as the solution to most world problems. This conflict or inconsistency has appeared for individual countries as well as groups of countries. Examples include the US and the EU, as well as Russia and the Former Soviet Union (FSU). These are discussed below.

1. The US

Since 11 September 2001, the US has become more conscious of its dependence on imported oil from the Middle East. The early expectations for prolific oil exports from the Caspian basin, Russia and West Africa have proved to be over-optimistic. Oil production from these regions will be significant but it cannot replace the Middle East. Nevertheless, President Bush in his latest State of the Union Address called for a 75% reduction of US oil imports from the Middle East by 2025.

This statement is said to be contrary to liberalized trade and free market environments encouraged by the US, and has generated further debate on the relative merits of global interdependence, self-sufficiency, protectionism and energy security. A common response is that the oil produced in any part of the world will be traded in the international market by national, international or independent companies. Its final destination will be determined in the market, based on price and commercial criteria, least cost and maximum profit options, within a global network of many oil production and export terminals, import terminals and consumption centers connected via numerous tanker routes and pipelines.

In this system no one country could dictate the recipient of the oil, unless that state (eg the US government), rather than an oil company, has invested in oilfield development or concluded long-term oil purchase agreements with another country. This would involve committing enormous investments for exploration and development around the world or huge funds for oil purchase transactions in order to meet the future oil requirements of the country. It is not a practical financial proposition due to the large volumes involved and it cannot provide long-term oil supply security for any country. Such arrangements could be practical and are already in place on a smaller scale as the strategic petroleum reserves of the International Energy Agency. However, they would provide only few months of oil imports to the major consuming countries, in case of an unexpected supply disruption.

Nevertheless, it has to be recognized that the US dependence on Middle East oil could be gradually reduced, though not necessarily by 75%, using public policies that encourage energy conservation, increased efficiency of vehicles and other oil consuming equipment, and the development of other energies such as ethanol, as stated in the President’s address, the expansion of nuclear power within the US, and the encouragement of oil exploration and production in the US and in the world outside the Middle East. Such policies have been effective globally, and dependence on oil has been drastically reduced over the past 30 years. This trend could continue by the implementation of similar policies in the future.

2. The European Union

The recent developments in Europe pose similar contradictions, both within the EU and with energy suppliers outside Europe. Serious tensions have surfaced on the priorities for the individual states and for the Union. Although the main goal of the EU is reaching a liberal and free market, member governments are bluntly blocking mergers and takeover bids from across their borders, particularly in the energy sector. One also observes resentment when one European country has to import large quantities of electricity from another, although both are within the EU. “Economic nationalism” is now used by European leaders. The headline news in early 2006 provides recent examples:

The Spanish government trying to block the takeover bid by Eon, the German energy group, for Endesa the Spanish company.

The encouragement by the French government for a merger between Suez and Gaz de France to pre-empt a bid for Suez by Eni from Italy.

The merger of Eni and Enel, apparently with the encouragement by the Italian authorities.

3. Russia And The Former States Of The USSR

The FSU is an obvious case of internal inconsistencies, now that it has been broken into a number of independent states. The energy sector in each country was only one component among many in the union. It was subject to command economy, central planning and the inter-relationships for the whole Soviet system and had operated for several decades. Naturally, contradictions and incongruent features have appeared after the break-up of the USSR. The interdependence within the former union was replaced by national priorities and aspirations of the individual countries. These were not necessarily in line with the former union and the tensions continue today. As examples one could mention:

The locations of Kazakhstan’s oilfields and its refineries, the incongruent prices and tariffs for oil and gas trade and transport within or between these countries, as well as foreign trade and import and export routes, etc.

The headline news on the reduction of natural gas supplies to Ukraine and Europe on the first day of 2006 is a more recent example. By the way, this has been wrongly identified as indicating a threat to energy supply security for Europe rather than a temporary commercial dispute between the Russian and Ukrainian companies on the price of gas and the ownership of pipelines.

Impact Of Financial Community On The Oil Market And Company Performance

The volume of oil trading in the spot and futures market has increased in the last two decades. Oil has become another commodity. Prices are decided in futures exchanges rather than deals between companies and refineries and/or traders. The prices in term-contracts are based also on reference crude prices in those exchanges. In addition, non-commercial participants have entered the market with huge funds taking speculative positions, entering and exiting the oil market, depending on market sentiment, news and rumors. Debate continues on the impact of these developments on the oil market and to what extent they have reduced market stability and increased price fluctuations or provided greater liquidity and improved transparency in the oil market.

Another important and adverse impact of the increased influence of the financial markets is the pressure from the investment community on oil company management. This has resulted in the managers giving greater priority to the short-term performance of company shares in the stock market. This is in contradiction to the nature of the oil and energy business that requires heavy front-end capital for projects with a lead-time of many years and long payback periods.

Market Liberalization, Mega-Projects And Public Versus Private Sector

In recent decades many state-owned enterprises and regulated monopolies in the gas and electricity sector have been deregulated and liberalized in many counties. The trend started in the US, is well advanced in the UK and is under way in Europe and elsewhere. The success of this policy is a subject of debate. The antagonists point to the power cuts in California after deregulation there and blame the private companies, while the other side blames the poor infrastructure and lack of investment under the regulatory regime in the previous decades.

Similarly the delay in European liberalization is blamed for the high price of UK gas in winter 2005-06. For example, the gas did not flow through the ‘interconnector’ pipeline from the continent into the UK. The state-controlled companies on the Continent preferred to keep the gas in their home markets, even though they could have sold it at higher prices in the UK market. In another view, the blame is put on the private companies in the UK. They should have been more prudent, made prior arrangements for larger gas storage or bid for a greater supply of gas in anticipation for a peak demand in an exceptionally cold winter. Their failure was due to profit motivation and preference for short-term financial performance.

A recent and important trend, seldom noted, is that most of the world’s small and medium-scale energy projects have already been developed – in oil, gas, electricity and others. Future energy supplies will rely increasingly on larger-scale and very capital-intensive undertakings. The question is whether such mega-projects could be better carried out by government institutions and state-owned enterprises or by private companies. The conventional wisdom is that the latter would be more efficient, completing projects within budget and on time. However, this view might not always be valid.

In the US in the 1970s and 80s, the construction by private companies of many nuclear power plants of different types and sizes suffered from many years of delays, huge cost overruns, safety issues and court cases involving billions of dollars. On the other hand, in France a national decision was taken earlier by the state for a ‘toutes électriques, toutes nucléaires’ energy policy. A particular type and size plant was chosen and many were built soon after the other and, as claimed by Electricité de France, at low cost.

National Oil/Energy Companies From Emerging Economies

The national oil companies from the oil importing countries in the developing world (eg China, India, Malaysia, Brazil and others) are gradually becoming powerful global enterprises. Some of these companies have been active internationally for few decades, while others had concentrated on their home countries. However, almost all of them have recently become globally very active. The main reason is increasing oil consumption, and the imports required for sustaining the countries’ expanding economies.

To ensure future supplies, these companies are prepared to accept less favorable financial and regulatory terms in other countries. Their operating costs are also low because of lower wages, costs, charges and overheads. These companies generally benefit from a strong cash flow position and have already built up technical, institutional and managerial experience from their previous domestic and international operations. The strong earnings from the recent high price of oil allow them to undertake greater exploration and development projects and accept technical risks. They are also ready to take greater political risk in their operations around the world. Overall, they can successfully compete with ‘western’ oil companies. Their advantages override their shortcomings relative to oil majors. In any case, they could engage major contractors and top oil service companies from around the world for large field development projects and specialized ‘high-tech’ methods and equipment.

No Single Answer For Achieving Global Energy Security

The discussions so far suggest there is no single answer, no panacea and no clear black-and-white separation of good or bad policy options for energy supply security. For example, could or should private companies provide energy security, or should the state be responsible for it as a public service? The debate is similar to the choice between capitalism and socialism – private versus public ownership. Entrepreneurship and free competition could result in efficient operations and the optimum utilization of energy resources, while public ownership could lead to inefficient and high-cost bureaucracies. One could also argue that a private company’s goal is maximizing value for its shareholders and with short-term priorities. These are not compatible with securing energy supplies for the public, longer-term priorities of the state, resource conservation and concern for future generations. The Enron and WorldCom experience also shows that even shareholders might incur losses from misguided operations or misappropriation of funds.

Energy cannot be secured by an inflexible dogmatic policy. The issue is not ‘either, or’, but ‘both’, plus ‘a third, a fourth, a fifth….’, namely, a multidisciplinary and all-inclusive approach with flexibility and openness in an interactive world. The present relapse into protectionism, nationalism and politicization of energy security is regrettable. These are occurring on all sides – with resource holders and exporters, importers and consumers, the providers of capital, technology and management, and even those with transit routes and pipelines.

No single government can guarantee a quick success. In the US, examples from the 1970s and 80s show that tens of billions of dollars were wasted in a ‘policy push’ for too rapid expansion of nuclear energy, numerous “Energy Independence” projects, the “US Synfuels Corporation”, the half-built and abandoned small towns for oil shale developments, etc.

Governments and politicians in a country could set the framework through democratic decision-making processes to guide the enthusiasm of entrepreneurs, but not to cause undue distortion or discouragement. The same arguments apply to the global scene in the relationships between oil/gas producers, consumers and the industry.

Security of Oil Demand As Important As Security Of Oil Supply

Energy security analyses usually focus solely on the security of supply. Demand is not considered, though it is the complementary component of the equation for energy security. This is because, implicitly, the continuation and the stability of demand are taken for granted. Yet, as with the case of oil, the fluctuations of demand have been nearly as important as supply. The high price of oil (to more than $60/B) in the last two-to-three years has been mostly due to the strong growth in world oil demand. Conversely, the collapse of the price of oil to less than $10/B in 1998-99 was due to the decline in Asian oil demand. Similarly, the 1986 oil price collapse to less than $10/B was due to the rapid decline in the demand for OPEC oil (30mn to 15mn b/d from 1980 to 1985). Saudi Arabian production fell from 10mn b/d in 1979-80 to about 2.5mn in July 1985. The possibility of a recurrence of decline in world oil demand cannot be ignored, though these days this idea is not fashionable among oil price forecasters.

A major factor directly affecting the level of oil demand is the state of the global economy, and this is subject to fluctuations. We should not forget that economic and business cycles include slowdown and recession as well as growth and boom. In spite of the various national and international financial and monetary policies intended to reduce cyclic fluctuations, numerous other factors (political, environmental, psychological, etc) could induce a downturn, thus adversely affecting the demand for oil. A slowdown is likely in the world economy or in the economy of some major oil consumers.

More importantly, the general concern about the environment and its related public policies has already resulted in a reduction of oil consumption in the world. It suffices to remember the fuel switching and modifications to transport vehicles, power plants and industrial installations and the encouragement of alternative energies and other measures in the last few decades. More stringent policies will continue in the future and their impact should not be ignored. Environmental policies around the world are directed at reducing the use of oil and other fossil fuels. We will experience increasing influences from Kyoto and post-Kyoto agreements and more ambitious targets for reducing CO2 emissions. Further reduction in the demand for oil and other fossil fuels will follow. The goal of public policies in many countries is to reach those targets. In spite of many practical difficulties, these policies have already reduced the growth of the demand for oil and will continue to do so.

In addition to environmental aspirations and CO2-reduction targets, governments in many oil-consuming countries are explicitly targeting a drastic reduction in the consumption of oil, particularly from the Middle East. President Bush’s latest State of the Union Address is a recent example of such policy goals. The outlook for oil demand is subject to great uncertainty, risk and insecurity.

Oil Supply Growth: Will There Be Sufficient Investment In Time?

A common concern often raised by politicians and analysts is that even where sufficient quantities of oil reserves are present, these are not developed in time to meet future demand. Such criticism is often directed at Middle East countries – that they do not allow the entry of international oil companies and their own national companies are not investing sufficiently for expanding their oil production capacities.

What the critics do not state is that these and other OPEC countries were left with a total of about 15mn b/d of unwanted oil production capacity after the mid-1980s. That excess capacity acted as de facto spare capacity and a cushion against an unexpected surge in demand or a sudden disruption of supply anywhere in the world. It provided a comforting backup for world oil consumers over the last 20 years. Gradually, however, with rising world oil demand, that spare production capacity has been utilized. The present estimate of the remaining spare capacity is about 2mn b/d; but the oil world wishes it were higher.

In general, international oil companies and all private and national oil companies outside OPEC have not had excess capacity. They always try to develop oilfields and bring them on-stream soonest and produce them at the maximum allowable rate for the shortest payback period for their investments. They will continue to do so in the future. It is left to the Middle East and other OPEC countries to produce spare capacity, though this time it would be by design and not by default. But would they or should they do so?

About three-quarters of world oil reserves are located in the Middle East and other OPEC countries. Under ‘conventional wisdom’ these high reserves are expected to meet future world oil requirements; but they have to be developed and brought on-stream. Moreover, with ageing oilfields and maturing oil provinces, maintaining and expanding capacity involve heavier front-end investment and a longer lead-time than in the past. Expansion projects need to commence many years before the anticipated demand for their output.

On the other hand, these countries (particularly Saudi Arabia) remember the costly experience of being left with unwanted capacity. Huge funds had been invested in developing the fields and installing surface facilities, yet the investment did not generate any revenue for many years. That bitter experience is not forgotten. The authorities in those countries will not readily expand their production unless they can convince themselves that the costly experience will not be repeated. The uncertainty in oil demand outlook makes producers wary of committing huge investments to maintain and expand oil production capacity.

The dilemma is how to match the uncertainty of future oil demand with the need for expanded output capacity. International trust and cooperation will be critical for solving this dilemma. A detailed coordination of global field development projects and fine-tuning with evolving world demand is not a realistic expectation. However, broad consensus and cooperation in an atmosphere of détente could be a reasonable hope for the future.

 

Manouchehr Takin, PhD in geophysics from Cambridge University is Senior Petroleum Upstream Analyst of the Centre for Global Energy Studies in London (takin@cges.co.uk). Petroleumworld not necessarily share these views.

Editor's Note: The preciding article by Dr Takin, is a version of one presented to “The International Conference on Energy & Security: Asian Vision” organized by the Institute for Political and International Studies and the Institute for International Energy Studies in Tehran on 12 March 2006. The views expressed are the author’s and not those of CGES.

This article was first publish by Middle East Economic Survey- MEES and published on MEES, vol. XLIX, No. 19, 8-May -2006 ( part 1) and vol. XLIX, No. 20, 15-May-2006 ( part 2).Petroleumworld reprint this article in the interest of our readers.

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Petroleumworld News 06/11/06

Copyright©2006 Manouchehr Takin. All rights reserved

 

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